The IRS’s Rejects Judicial Interpretations of the Six Year Statute of Limitations Rule

Dec 21, 2010   

On December 17, 2010, the Internal Revenue Service (IRS) “eliminated a perceived ambiguity in the temporary regulations that was brought to light by the Tax Court in Intermountain Insurance Service of Vail v. Commissioner, 134 T.C. No. 11 (9th Cir. 2010)” by publishing a final rule in the Federal Registrar. Definition of Omission From Gross Income, 75 Fed. Reg. 242, 78,897 (December 17, 2010) (to be codified at Treas. Reg. §301.6501(e)-1).  Specifically, the final regulation defines an omission from gross income for purposes of the six-year period for assessing tax.

In Intermountain, the United States Court of Appeals for the Ninth Circuit found that overstatements of basis in cases outside of the trade or business context were not omissions from gross income as discussed in IRC §6501(e)(1) and Treas. Reg. §301.6501-1T. Additionally, the court in Intermountain indicated the “applicable period for assessing tax” for these overstatements in basis was the general three year limitation. In reaching its decision, the Ninth Circuit relied on the Supreme Court interpretation of the predecessor of IRC §6501(e) in Colony v. Commissioner, 378 U.S. 28 (1958).

The IRS rejected this position, relying on National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005), inwhich the Supreme Court held that “the Treasury Department and the Internal Revenue Service are permitted to promulgate a reasonable construction of an ambiguous statute that contradicts any court’s interpretation.” The IRS indicated in its final regulation that “the interpretation adopted by the Supreme Court in Colony represented that court’s interpretation of the phrase “omits from gross income,” but this was not the only permissible interpretation of it.”  Definition of Omission From Gross Income, 75 Fed. Reg. 242, 78,897 (December 17, 2010) (to be codified at Treas. Reg. §301.6501(e)-1). 

Note, however, that the IRS’s position depends entirely on whether IRC §6501(e) is in fact ambiguous.  In its final regulation, the IRS indicates that the Supreme Court stated in Colony that the statutory phrase “omits from gross income” is ambiguous. Id.

The Ninth Circuit in Intermountain suggests that the Supreme Court in Colony came to a contrary conclusion: 

Although the Supreme Court initially found the statutory provision ambiguous, that was only a preliminary conclusion before considering the statute’s legislative history. After thoroughly reviewing the legislative history, the Supreme Court concluded that Congress’ intent was clear and that the statutory provision was unambiguous.

Intermountain, 134 T.C. No. 11 at 7.

Additionally, the IRS does not respond to Ninth Circuit’s application of the test from Chevron U.S.A. Inc. v. Natural Res. Def. Council, 467 U.S. 837, (1984),to determine whether the statutory provision at issue was ambiguous.

The first step in Chevron’s two-step analysis is to ask “whether Congress has directly spoken to the precise question at issue” If the intent of Congress is clear, that is the end of the matter, for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.

Intermountain, 134 T.C. No. 11 at 8.

Notably, when answering the first step of the Chevron analysis, the Ninth Circuit relied upon the 1958 Supreme Court’s examination of the legislative history of IRC §6501(e)’s predecessor in Colony, IRC §275(c) to determine whether Congress had spoken to the question at issue.

The Supreme Court found the legislative history to be persuasive evidence that Congress was addressing itself to the specific situation where a taxpayer actually omitted some income receipt or accrual in his computation of gross income, and not more generally to errors in that computation arising from other causes. It further indicated that this history shows to our satisfaction that the Congress intended an exception to the usual three-year statute of limitations only in the restricted type of situation already described [an omission of an item of gross income] The statute’s legislative history clarified its otherwise ambiguous text and, as a result, explicated Congress’ intent and the meaning of the statutory provision.

Id.

The predecessor statute, IRC §275(c), contains the exact same statutory language as IRC §6501(e).  “Thus, the Supreme Court’s opinion in Colony, Inc. v. Commissioner, supra, “unambiguously forecloses the agency’s interpretation” of sections 6229(c)(2) and 6501(e)(1)(A) and displaces respondent’s temporary regulations.” Id. 

The Ninth Circuit emphasized the clarity of the Congressional Intent when enacting the predecessor of the statute at issue.  Despite the holding in Colony finding the statutory language to be “unambiguous”, however, the phrase “omits from gross income” as used in IRC §6501(e) is pending before several United States Courts of Appeals.  Definition of Omission From Gross Income, 75 Fed. Reg. 242, 78,897 (December 17, 2010) (to be codified at Treas. Reg. §301.6501(e)-1).

The IRS, relying on the Supreme Court’s language in Colony finding the language to be ambiguous, promulgated its own interpretation of IRC §6501(e). The IRS’s construction of IRC §6501(e) as it pertains to overstatements in basis is provided in the recently published final rule:

The term gross income, as it related to any income other that the sale of goods or service in a trade or business has the same meaning as provided under IRC §61(a), and includes the total of the amounts received or accrued, to the extent required to be shown on the return.  In the case of amounts received or accrued that relate to the disposition of property, and except as provided in paragraph (a)(1)(ii) of this section, gross income means the excess of the amounts realized from the disposition of the property over the unrecovered cost or other basis of the propertyConsequently, except as provided in paragraph (a)(1)(ii) of this section, an understated amount of gross income resulting from an overstatement of recovered cost or other basis constitutes an omission from gross income for purposes of IRC §6501(e)(1)(A)(i). 

Id. at 78,899.

In the recently finalized regulation, the IRS clearly includes the overstatement of basis in the sale of property within the phrase “omission from gross income” regardless of whether the property was sold in course of trade or business.

The IRS indicated that the regulation applies to taxable years with respect to which the six-year period for assessing tax under IRC §6501(e) was open on or after September 24, 2009. Id. at 78,900. Thus, this includes (but is not limited to) all taxable years for which six years have not elapsed from the later of the date that a tax return was due or actually filed, all taxable years that are the subject of any case pending before any court of competent jurisdiction in which a decision has not become final, and all taxable years with respect to which the liability at issue has not become fixed pursuant to a closing agreement. 

If you have any questions regarding overstatements of basis in previous or current tax returns, omissions of income in previous or current tax returns, the applicability of Treas. Reg. §301-6501(e)-1, or questions pertaining to any other tax provision, please contact Fuerst Ittleman, PL at contact@fidjlaw.com