CIR v. MITA ( 2011 )

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
February 9, 2011
No. 09-11061 Lyle W. Cayce
Clerk
DANIEL S. BURKS, Tax Matters Partner of Key Harbor Investment
Partners,
Plaintiff - Appellant
v.
UNITED STATES OF AMERICA,
Defendant - Appellee
---------------------------------------------------------------------------------------------
DANIEL S. BURKS, Tax Matters Partner of DJB Investment Partners,
Plaintiff - Appellant
v.
UNITED STATES OF AMERICA,
Defendant - Appellee
Appeal from the United States District Court
for the Northern District of Texas
Cons w/ No. 09-60827
No. 09-11061
COMMISSIONER OF INTERNAL REVENUE,
Petitioner
v.
MITA, Partner; JOHN F. LYNCH, A Partner Other Than the Tax Matters
Partner
Respondents
Appeal from the United States Tax Court
Before DEMOSS, BENAVIDES, and ELROD, Circuit Judges.
HAROLD R. DEMOSS, JR., Circuit Judge:
This consolidated appeal requires us to determine whether an
overstatement of basis constitutes an omission from gross income for purposes
of the Tax Code, 26 U.S.C. § 6501(e)(1)(A), which extends the tax assessment
period from three to six years. Because we conclude that an overstatement of
basis is not an omission from gross income for purpose of the relevant statute,
the Commissioner was limited to three years to pursue unpaid tax claims
against the taxpayers. We further find that the recently promulgated Treasury
Regulations do not apply to the taxpayers. We thus affirm the tax court’s
judgment in favor of the taxpayer, and reverse the district court’s judgment in
favor of the government.
I.
Appellee United States of America and Petitioner Commissioner of the
Internal Revenue Service (IRS) (collectively “the government”) assert that
Appellants Daniel Burks, M.I.T.A., and John E. Lynch (collectively “taxpayers”
2
No. 09-11061
or “the taxpayers”) utilized the “Son of BOSS”1 tax shelter to create artificial tax
losses in order to offset capital gains. In a Son of BOSS scheme, partners engage
in various long and short sale transactions and transfer the resulting obligations
to the partnership thereby improperly inflating the basis in the partnership
assets. See e.g., Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1343 (Fed.
Cir. 2006) (outlining steps of transactions used to inflate basis in assets). The
partners do not reduce the basis by the liabilities assumed by the partnership.
See id; I.R.S. Notice 2000-44, 2000-2 C.B. 255 (describing prohibited transactions
used to create an artificial basis). When basis is overstated, “gross income is
affected to the same degree as when a gross-receipt item of the same amount is
completely omitted from a tax return.” Colony, Inc. v. Comm’r, 357 U.S. 28, 32
(1958).
The Tax Equity and Fiscal Responsibility Act of 1982 “established ‘a single
unified procedure for determining the tax treatment of all partnership items at
the partnership level, rather than separately at the partner level.’” Kornman &
Assocs., Inc. v. United States, 527 F.3d 443, 446 n.1 (5th Cir. 2008) (quoting
Callaway v. Comm’r, 231 F.3d 106, 108 (2d Cir. 2000)). Generally, taxes must be
assessed and collected within three years of the filing of the tax return. See 26
U.S.C. §§ 6501(a), 6229(a). The limitations period is extended to six years when
the taxpayer “omits from gross income an amount properly includible therein .
. . in excess of 25 percent of the amount of gross income stated in the return.”
26 U.S.C. § 6501(e)(1)(A).
In the present cases, the IRS issued Final Partnership Administrative
Adjustments (FPPAs) adjusting the partnership tax returns filed by the
taxpayers on the grounds that the challenged transactions lacked economic
1
“‘BOSS’ is an acronym for ‘Bond and Option Sales Strategy.’” Kornman & Assocs., Inc.
v. United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008). Son of BOSS is an abusive tax shelter
that is a “variation of the slightly older BOSS tax shelter.” Id. (citation omitted).
3
No. 09-11061
substance.2 See Kalmath Strategic Inv. Fund ex rel. St. Croix Ventures v. United
States, 568 F.3d 537, 543 (5th Cir. 2009) (“The economic substance doctrine
allows courts to enforce the legislative purpose of the [Tax] Code by preventing
taxpayers from reaping tax benefits from transactions lacking in economic
reality.”). The FPPAs were filed more than three years but less than six years
after the taxpayers’ individual tax returns were filed with the IRS. The
taxpayers moved for summary judgment before the district court and tax court
on the grounds that the government had issued the FPAAs after the expiration
of the general three year limitations period for assessing tax against the various
partners. In both matters, the government conceded that the three year
limitations period had expired but asserted that an extended six year limitations
period applied because the partners had omitted gross income in excess of 25%
from their tax returns in violation of § 6501(e)(1)(A) when they overstated their
basis.
In United States v. Burks (09-11061), the district court held that this
court’s decision in Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968),
established that an overstatement of basis was an omission from gross income
for purposes of § 6501(e)(1)(A). The district court thus denied Burks’s motion for
summary judgment. This court granted Burks permission to file an interlocutory
appeal.
In Commissioner v. M.I.T.A. (09-60827), the tax court relied on the
Supreme Court’s decision in Colony, Inc. v. Commissioner, 357 U.S. 28, 32
(1958), and cases construing that decision to support its finding that an
overstatement of basis did not constitute an omission from gross income for
purposes of § 6501(e)(1)(A). The tax court further found that Phinney did not
2
The issue before this court is a purely legal one—whether an overstatement of basis
constitutes an omission from gross income for purposes of § 6501(e)(1)(A). The merits of the
underlying transactions are not before this court on appeal. The district court and tax court
have not yet determined that the taxpayers’ reporting positions are unsupportable.
4
No. 09-11061
directly address the issue facing the court. Because the tax court held that the
three year limitations period applied, it granted the taxpayers’ motion for
summary judgment. The government timely appealed.
II.
On appeal, the taxpayers argue that an overstatement of basis does not
constitute an omission from gross income as established by the Supreme Court
in Colony v. Commissioner and thus the three year limitations period applies.
The government argues that this court’s decision in Phinney v. Chambers
established that the six year limitations period applies to an overstatement of
basis for purposes of § 6501(e)(1)(A). The government contends that Colony
applies only in the context of a trade or business engaged in the sale of goods or
services. The government also argues that application of Colony to the revised
statute renders § 6501(e)(1)(A) subsections (i) and (ii) superfluous.3 Finally, the
government asserts that recently enacted Treasury Regulations purporting to
define “omission from gross income” as encompassing an overstatement of basis
are determinative and apply retroactively to the present matters. We consider
each in turn.
A.
This court reviews de novo a court’s determination on a motion for
summary judgment. See Staff IT, Inc. v. United States, 482 F.3d 792, 797 (5th
Cir. 2007); Ford Motor Co. v. Tex. Dep’t of Transp., 264 F.3d 493, 498 (5th Cir.
2001). Summary judgment is proper when “the movant shows that there is no
genuine dispute as to any material fact and the movant is entitled to judgment
as a matter of law.” FED. R. CIV. P. 56(a).
3
26 U.S.C. § 6501(e)(1)(A)(i), (ii) has since been amended such that subsections (i) and
(ii) now appear at § 6501(e)(1)(B)(i), (ii). There have been no amendments to the text of the
subsections and thus the amendments do not affect our analysis. All references to subsections
(i) and (ii) are as to the text of the statute prior to the recent amendments in effect at the time
of this appeal.
5
No. 09-11061
B.
The taxpayers argue that the Supreme Court’s decision in Colony v.
Commissioner, holding that an overstatement of basis was not an omission from
gross income such that the extended limitations period applied, is controlling in
the present matters.
In Colony, the Court held that an overstatement of basis did not constitute
an omission from gross income for purposes of § 275(c) of the 1939 Tax Code, the
predecessor to § 6501(e)(A)(1). 357 U.S. at 36. Section 275(c) stated that a five
year (now six year) statute of limitations applied when a taxpayer “omits from
gross income an amount properly includible therein which is in excess of 25 per
centum of the amount of gross income stated in the return.” Id. at 29.4 The
taxpayer in Colony had understated gross income by overstating the basis in
land the taxpayer had sold. Id. at 30. The Court began its analysis by focusing
on the plain language of the statute. “In determining the correct interpretation
of § 275(c) we start with the critical statutory language, ‘omits from gross income
an amount properly includible therein.’” Id. at 32.
The taxpayers argued that the term “omits” was commonly defined as “to
leave out or unmentioned; not to insert, include, or name” and thus by the plain
language of the statute only the complete omission of an item of income triggered
4
26 U.S.C. 275 stated in relevant part:
(a) General rule. The amount of income taxes imposed by this chapter shall be
assessed within three years after the return was filed, and no proceeding in
court without assessment for the collection of such taxes shall be begun after the
expiration of such period.
(c) Omission from gross income. If the taxpayer omits from gross income an
amount properly includible therein which is in excess of 25 per centum of the
amount of gross income stated in the return, the tax may be assessed, or a
proceeding in court for the collection of such tax may be begun without
assessment, at any time within 5 years after the return was filed.
Colony, Inc. v. Comm’r, 357 U.S. 28, 29 n.1 (1958).
6
No. 09-11061
application of the extended limitations period. Id. at 32-33. The Court stated it
was “inclined” to agree with the taxpayers’ argument, however it held that “it
cannot be said that [§ 275(c)] is unambiguous” and turned to the legislative
history of the statute. Id. at 33.
The court found “in that history 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.” Id. The Court
thus found that the extended limitations period did not apply where gross
receipts had been reported, despite gross income having been under-reported. Id.
The Court concluded:
We think that in enacting § 275(c) Congress
manifested no broader purpose than to give the
Commissioner an additional two years to investigate
tax returns in cases where, because of a taxpayer’s
omission to report some taxable item, the
Commissioner is at a special disadvantage in detecting
errors. In such instances the return on its face provides
no clue to the existence of the omitted item. On the
other hand, when, as here, the understatement of a tax
arises from an error in reporting an item disclosed on
the face of the return the Commissioner is at no such
disadvantage. And this would seem to be so whether
the error be one affecting ‘gross income’ or one, such as
overstated deductions, affecting other parts of the
return.
Id. at 36.
The government asserts that this court’s decision in Phinney v. Chambers
limited Colony’s holding requiring an actual omission of income pursuant to the
plain meaning of the term “omits,” because the revised statute § 6501(e)(1)(A)(ii)
established adequate disclosure as the critical factor when determining whether
there was an omission from gross income. See Grapevine Imps., Ltd. v. United
7
No. 09-11061
States, 77 Fed. Cl. 505, 509 (2007) (“In the wake of Colony, a judicial debate
erupted over whether the 1954 version of [S]ection 6501(e)(1)(A) is triggered only
where an item of income is entirely omitted from a return.”).
In Phinney, this court was tasked with determining whether misreporting
the nature of an item on a tax return constituted an omission from gross income
for the purposes of § 6501(e)(1)(A). 392 F.2d at 681-83. The transaction at issue
in Phinney involved the sale of community property owned by the taxpayer and
her deceased spouse. Id. at 681. The taxpayer and her spouse each owned a 50%
share in a note for stock, which had been sold under an installment plan. Id. at
681. The taxpayer and the fiduciary of the deceased taxpayer’s spouse each filed
tax returns. Id. at 681-82. The spouse’s tax return reported a gain from the sale
of the stock and correctly listed the transaction as an installment sale. Id. The
taxpayer’s tax return incorrectly listed the installment sale transaction as the
sale of a stock and reported no gain or loss. Id. at 682.
The question before the court was whether the taxpayer omitted from
gross income an “amount properly includible therein which is in excess of 25
percent of the amount of gross income stated in the return.” Id. at 683 (citation
omitted). Focusing on the item reported, Phinney found that the nature of the
item was misrepresented such that there was no adequate disclosure of the
transaction. Id. at 684. “The basic difficulty with the taxpayer’s position here is
that [the] taxpayer simply didn’t give the government a chance to make a
‘challenge’ to the taxpayer’s contention, because the taxpayer made no such
contention on the return it filed.” Id. The taxpayer’s return reported an
installment sale “under a different heading and under an incorrect designation.”
Id.Citing to Colony, the court held that there was “[n]o better illustration” for
the need for adequate disclosure as required in § 6501(e)(1)(A)(ii). Id. at 685.
8
No. 09-11061
[T]he enactment of [§ 6501] subsection (ii) . . . makes it
apparent that the six year statute is intended to apply
where there is either a complete omission of an item of
income of the requisite amount or misstating the nature
of an item of income which places the commissioner at
a special disadvantage in detecting errors.
Id. (internal marks omitted). The court concluded that “if an item of income is
shown on the face of the return or an attached statement that is not shown in a
manner sufficient to enable the [S]ecretary by reasonable inspection of the
return to detect the errors then it is the omission of ‘an amount’ properly
includable in the return.” Id.
We do not read Phinney as limiting Colony’s holding.5 In Colony, the court
noted that its conclusion was “in harmony with the unambiguous language of
§ 6501(e)(1)(A).” 357 U.S. at 37. A fair reading of Colony and Phinney supports
our finding that both an actual omission of an amount from the tax return or a
fundamental misstatement of the nature of an item reported in a tax return that
places the Commissioner at a disadvantage in detecting the error may result in
application of the extended limitations period. See id; Phinney, 392 F.2d at 685(“[T]he six year statute is intended to apply where there is either a complete
omission of an item of income . . . or misstating of the nature of an item of income
which places the [C]ommissioner at a special disadvantage in detecting errors.”)
(internal mark omitted) (emphasis added). The holdings in both cases support
the underlying purpose of the Code: to provide the IRS with additional time to
detect errors or omissions when the nature of the omission places the
5
The Seventh Circuit in Beard incorrectly read our decision in Phinney as limiting
Colony’s holding. See Beard v. Comm’r, – F.3d –, No. 09-3741, 2011 WL 222249, at *4-5. (7th
Cir. Jan. 26, 2011) As discussed above, the Seventh Circuit failed to note the distinct factual
pattern presented in Phinney, where the taxpayers had misstated the very nature of the item
so that the IRS would not have had any reasonable way of detecting the error on the tax
return. That is not the case here.
9
No. 09-11061
“government at a special disadvantage.” See Taylor v. United States, 417 F.2d
991, 993 (5th Cir. 1969) (“[Section 6501(e)(1)(A)] provides that an item of income
is ‘omitted’ if the item is not shown in a manner sufficient to enable the
Government, upon a reasonable inspection, to detect the error. . . . [T]he
Government is not to be penalized by a taxpayer’s failure to reveal the facts.”).
The facts in Phinney demonstrate that the taxpayer’s return did not
merely misstate an amount but rather misrepresented the very nature of the
item reported such that the IRS could not have reasonably known what was
actually being reported, an almost direct omission. Phinney, 392 F.2d at 684. We
hesitate to read Phinney as applicable to a misstatement of an amount of income
when the nature of the item is correctly reported because the error arguably
qualifies as an “omission” in that it omits the truth or accuracy of the amount
reported. Such a result renders the general three year limitations period
meaningless.
Phinney involved a distinct fact pattern not presented in this appeal. The
taxpayers in the present matters did not misstate the nature of an item such
that the IRS was at a disadvantage in detecting the error because it could not
reasonably know what was actually being reported. Rather, the nature of the
item—the basis—was included in the tax return, albeit in an incorrect amount.
This circumstance provides the IRS with sufficient notice to inquire into the
correctness and validity of the item being reported. See Colony, 357 U.S. at 36(finding that the extended limitations period applies when “the return on its face
provides no clue to the existence of the omitted item”). Absent a fundamental
alteration to the nature of the item reported, disclosure of the item, despite the
correctness of the amount, provides the IRS with reasonable notice of the item
being reported and the general limitations period should apply pursuant to
Colony.
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No. 09-11061
Our holding is consistent with other courts’ analysis regarding the
applicability of Colony in the context of Son of BOSS tax shelters. These courts
have generally found that an overstatement of basis does not constitute an
omission from gross income for purposes of § 6501(e)(1)(A) such that the
extended limitations period applied, because of the similarity of the language
and meaning of § 275(c) and § 6501(e)(1)(A). See, e.g., Home Concrete & Supply,
LLC v. United States (Home Concrete II), — F.3d —, No. 09-2353, 2011 WL
361495, *5 (4th Cir. Feb. 7, 2011) (finding that because the legislative history of
§ 275(c) is “equally compelling” with respect to § 6501(e)(1)(A) and that because
there are no material differences in the language of the statutes, “we are not free
to construe an omission from gross income as something other than a failure to
report “some income receipt or accrual”) (quotations omitted); Salman Ranch Ltd
v. United States (Salman Ranch II), 573 F.3d 1362, 1373-74, 1377 (Fed. Cir.
2009) (finding that “[t]he meaning of ‘omits’ in today’s parlance appears to be no
different than its meaning at the time of the Colony decision” and further noting
that in the years since Colony had been decided Congress had not indicated that
its holding was inapplicable to the revised statute despite ongoing debate
surrounding the decision); Bakersfield Energy Partners, LP v. Comm’r, 568 F.3d
767, 771-72 (9th Cir. 2009) (finding that the 1939 Code was so substantially
similar to the 1954 Code that Colony was controlling); UTAM, Ltd. v. Comm’r,
98 T.C.M. (CCH) 422, at *3 (2009) (rejecting the government’s reliance on
Phinney because under the facts before it the Commissioner was not at a
disadvantage in “identifying the error in the reporting of the transaction” when
the return adequately identified the nature of the item at issue); Intermountain
Ins. Serv. of Vail v. Comm’r (Intermountain I), 98 T.C.M. (CCH) 144, at *2-3
(2009) (applying Colony and holding that an overstatement of basis was not an
omission from gross income); cf. Benson v. Comm’r, 560 F.3d 1133, 1136 (9th Cir.
11
No. 09-11061
2009) (finding six year limitations period applied when failure to report “did not
result from an overstatement of basis or other technical miscalculation”);
Grapevine Imports,77 Fed. Cl. at 510 (holding that “the meaning of the word
‘omits,’ has as much application to the 1954 version of the statute, as it did the
1934 version, for, in both, that word is pivotal,” and further finding no
compelling reason to hold that the common understanding of the term “omits”
had “shifted” since Colony and revisions to the Code); but see Beard v. Comm’r,
– F.3d –, No. 09-3741, 2011 WL 222249, at *6 (7th Cir. Jan. 26, 2011) (creating
a circuit split by finding that Colony was not controlling and holding that “an
overstatement of basis can be treated as an omission from gross income”); Home
Concrete & Supply, LLC v. United States (Home Concrete I), 599 F. Supp. 2d 678,
687 (E.D.N.C. 2008) (finding that an overstatement of basis was an omission
from gross income for purposes of § 6501(e)(1)(A), rev’d, — F.3d —, 2011 WL
361495 (2011); Brandon Ridge Partners v. United States, No. 8:06-cv-1340, 2007
WL 2209129, at *8 (M.D. Fla. July 30, 2007) (unpublished) (finding that Phinney
compelled application of the extended limitations period because the taxpayers’
tax returns did not adequately disclose the relevant transactions); Salman
Ranch Ltd v. United States (Salman Ranch I), 79 Fed. Cl. 189, 201-202 (2007),
rev’d, 573 F.3d 1362 (Fed. Cir. 2009). Salman Ranch (I) and Home Concrete (I)
have subsequently been overturned by the Federal Circuit and Fourth Circuit,
respectively.
The government does not argue that these cases are distinguishable from
the present matters, but rather asserts that they were wrongly decided. We
disagree and find that Colony’s holding with respect to the definition of “omits
gross income” remains applicable in light of the revisions to the Code. As such,
an overstatement of basis that adequately appraises the Commissioner of the
nature of the item being reported does not constitute an “omission from gross
income” for purposes of § 6501(e)(1)(A). The taxpayers in the present matters
12
No. 09-11061
disclosed the nature of the items on their tax returns sufficient to notify the
Commissioner of the item being reported. We join the Fourth, Ninth, and
Federal Circuits by finding that Colony’s holding with respect to the definition
of “omits from gross income” remains applicable in light of the revisions to the
Code.
C.
The government alternatively argues that Colony does not control the
present matters because application of Colony to § 6501(e)(1)(A) subsections (i)
and (ii) would render these subsections superfluous. The government argues that
Colony’s finding that the ambiguous language found in § 275(c) was “in
harmony” with the unambiguous language found in § 6501(e)(1)(A) was
necessarily tied to these subsections.
Section 6501(e)(1)(A) was first enacted as § 275(c) of the Revenue Act of
1934, 48 Stat. 745. See Badaracco v. Comm’r, 464 U.S. 386, 392 (1984). Congress
amended the statute in 1954, renumbering it as § 6501(e)(1)(A) and adding two
subsections. See H.R. REP. NO. 83-1337, 4561 (1954).6 Although courts have held
6
At the time of the appeal the revised statute read:
(e) Substantial omission of items
(1) Income taxes.-In the case of any tax imposed by
subtitle A
(A) General rule. If the taxpayer omits from gross
income an amount properly includible therein and
which is in excess of 25 percent of the amount of
gross income stated in the return, the tax may be
assessed, or a proceeding in court for the collection
of such a tax may be begun without assessment, at
any time within 6 years after the return was filed.
For the purposes of this subparagraph
(i) In the case of a trade or business the term
‘gross income’ means the total of the amounts
received or accrued from the sale of goods or
services (if such amounts are required to be shown
13
No. 09-11061
that the language in the two statutes is virtually identical,7 there is
disagreement over the validity of Colony in light of the revisions.
Subsection (i) provides: “In the case of a trade or business, the term ‘gross
income’ means the total of the amounts received or accrued from the sale of
goods or services (if such amounts are required to be shown on the return) prior
to diminution by the cost of such sales or services.” 26 U.S.C. § 6501(e)(1)(A)(i).
Some courts have held that subsection (i) limits application of Colony to
cases involving a trade or business. See, e.g., Beard, 2011 WL 222249 at *4
(finding that subsection (i) applies only when there is an omission of a receipt or
accrual from a trade or business); Salman Ranch (I), 79 Fed. Cl. at 200 (finding
Colony applicable only in the case of business and trade income); Home Concrete
(I), 599 F. Supp. 2d at 684 (“Subsection (i) redefines gross income for purposes
of § 6501(e)(1)(A) in cases involving a trade or business.”); Brandon Ridge
Partners, 2007 WL 2209129, at *7 (finding that application of Colony outside the
context of a trade or business “would render § 6501(e)(1)(A) superfluous”); see
also CC & F W. Operations Ltd. P’ship v. Comm’r, 273 F.3d 402, 406 n.2 (1st Cir.
on the return) prior to diminution by the cost of
such sales or services; and
(ii) In determining the amount omitted from
gross income, there shall not be taken into account
any amount which is omitted from gross income
stated in the return if such amount is disclosed in
the return, or in a statement attached to the
return, in a manner adequate to apprise the
Secretary of the nature and amount of such item.
26 U.S.C. § 6501(e).
7
See, e.g., Badaracco v. Comm’r, 464 U.S. 386, 392 (1984) (noting that § 6501 was “first
introduced” as § 275(c)); Salman Ranch Ltd v. United States (Salman Ranch II), 573 F.3d
1362, 1379 (Fed. Cir. 2009) (describing § 275(c) as the predecessor to § 6501); Home Concrete
& Supply, LLC v. United States, 599 F. Supp. 2d 678, 684 (E.D.N.C. 2008) (“It is correct to say
that the language of § 275(c) is virtually identical to a portion of § 6501(e)(1)(A).”).
14
No. 09-11061
2001) (declining to reach the issue but noting that whether Colony’s “main
holding” applies in light of subsection (i) “is at least doubtful” because the
implication is that Colony does not apply to other types of income).
Other courts have found Colony applicable to all taxpayers in light of the
revised statute. See, e.g., Home Concrete (II), 2011 WL 361495, at *4 (finding
that Colony “straightforwardly construed the phrase ‘omits from gross income,’
unhinged from any dependency on the taxpayer’s identity as a trade or business
selling goods or services”); Salman Ranch (II), 573 F.3d at 1372-73 (“Colony
“interpreted the language of § 275(c) based upon what it viewed as congressional
intent and purpose, without ever mentioning the taxpayer’s trade or business.”);
Bakersfield, 568 F.3d at 778 (finding that Colony “did not even hint that its
interpretation of § 275(c) was limited to cases in which the taxpayer was
engaged in a ‘trade or business’”); UTAM, 98 T.C.M. (CCH) 442, at *3 (“Neither
the language nor the rationale of Colony can be limited to the sale of goods or
services by a trade or business.”); Intermountain (I), 98 T.C.M. (CCH) 144, at *3
n.5 (declining to “diminish” Colony’s holding); Grapevine Imports, 77 Fed. Cl. at
511 (declining to find that application of Colony was limited to transactions
involving the sale of goods or services by a trade or business).
The government argues that Congress would not have included the phrase
“in the case of a trade of business” and “amounts received or accrued from the
sale of goods or services” if it had not intended for the definition of gross income
for purposes of § 6501(e)(1)(A)(i) to apply outside the context of trade or business
engaged in the sale of goods or services. The government further asserts that
taxpayers’ construction of the term “omits” without reference to the term “gross
income” focuses only on one component of the calculation, thus excluding
consideration of one of the two figures that result in gain (the calculation of
basis) and therefore renders the gross receipts provision meaningless.
15
No. 09-11061
Bakersfield offered a comprehensive analysis when disagreeing with the
government’s argument. 568 F.3d at776. The court held that when comparing
the two amounts needed to calculate gross income for purposes of § 6501(e)(1)(A),
the gross income omitted with the gross income as stated in the return, the court
found that whether an amount was omitted was a separate issue from whether
the amount omitted exceeded 25% of the taxpayer’s gross income. Id. at 776.
Because § 6501(e)(1)(A)(i) changes the definition of
‘gross income’ for taxpayers in a trade or business, it
potentially affects both the numerator (the omission
from gross income) and the denominator (the total gross
income stated in the return). Colony’s holding, however,
affects only the numerator, by defining what constitutes
an omission from gross income.
When there is no dispute about the amount of gross
income omitted, the denominator, the total amount of
gross income stated in the return, determines whether
the omission meets the 25% threshold that triggers the
six-year limitations period. For taxpayers not in a trade
or business, the denominator is the amount of gross
income (gross receipts minus basis); for taxpayers in a
trade or business, the denominator is the total amount
of money received without any reduction for basis (gross
receipts).
Id. at 776-77. Thus, when the amount omitted (the numerator) is not in dispute,
applicability of the extended limitations period turns on whether the court was
obliged to apply subsection (i)’s definition of “gross income” for a trade or
business when determining the amount of gross income stated in the return (the
denominator). Id. at 777 (citing Hoffman v. Comm’r, 119 T.C. 148, 148, 150
(2002)). However, when the circumstances involve the sale of goods or services
by a trade or business, whether subsection (i) applies is the dispositive issue
“because it determine[s] whether the omitted amount of gross income
constitute[s] more than 25% of the gross income stated in the return, wholly
16
No. 09-11061
aside from Colony’s holding regarding what constitutes an omission from gross
income.” Id.The court further noted that Congress did not alter the language in §
6501(e)(1)(A). Id. at 775. “Although the IRS would have us infer that Congress’s
addition of subparagraph (i) casts the language in the body of § 6501(e)(1)(A) in
a different light, we can equally infer that Congress in 1954 intended to clarify,
rather than rewrite, the existing law.” Id. at 776. The court concluded:
[Congress] could have expressly added a definition of
‘omits’ if it wanted to overrule the cases that concluded,
as the Supreme Court later did in Colony, that ‘omits’
does not include an overstatement of basis. Instead,
Congress allowed the preexisting general definition of
‘omits’ to carry forward into the successor provision,
and additionally provided for a special definition of
‘gross income’ in the case of a ‘trade or business.’
Id. “[T]he fact remains that Colony represents an interpretation of the very same
language that is now found in § 6501(e)(1)(A), and in the years since Colony,
Congress has not indicated that the Court’s interpretation of the language of §
275(c) should not apply to § 6501(e)(1)(A).” Salman Ranch (II), 573 F.3d at 1373.
Salman Ranch (II) held that, by its terms, the language of subsection (i)
states how gross income is calculated for purposes of § 6501(e)(1)(A) when the
income arises from a trade or business engaged in the sale of goods or services.
573 F.3d at 1373. Colony “did not speak to the calculation of ‘gross income’ . . .
[r]ather, it identified the situations in which a taxpayer ‘omits from gross income
an amount properly includible therein.’” Id. at 1375. The court held that
subparagraph (i), “which explains how ‘gross income’ is calculated when a trade
or business is involved,” is not made superfluous simply by finding that an
overstatement of basis is not an omission from gross income. Id.17
No. 09-11061
Salman Ranch further held that the legislative history of § 6501(e)(1)(A)
supported a finding that subsection (i) was not rendered superfluous by
application of Colony. Id. at 1375-76. “Congress added subparagraph (i) to
resolve a conflict between the IRS and taxpayers about how to calculate gross
income in the case of a trade or business.” Id. (citing Hearings Before the Senate
Comm. on Finance on H.R. 8300 (part 2), 83rd Cong. 984 (1954) (letter of Harry
N. Wyatt) (discussing “disagreement evidenced by the case law between the
[IRS] and some of the courts as to whether . . . [i]n the case of a business, the
term ‘gross income’ should be construed as gross receipts and gross sales, or as
net receipts and net sales”). Salman Ranch held that, “[i]n light of this conflict,
we believe that Congress enacted subparagraph (i) . . . to assist the IRS in its
calculation of whether any omitted gross income exceeded 25% of the gross
income stated in the return.” Id. at 1376.
We agree with the analysis presented in Bakersfield and Salman Ranch
(II) and hold that a fair reading of § 6501(e)(1)(A)(i) supports our finding that
subsection (i) was intended to define gross income for the sale of goods or
services by a trade or business as gross receipts from those sales. Under the
Code, gross income of a trade or business is usually calculated by subtracting the
cost of goods sold from the gross receipts of the sale. 26 U.S.C. § 61(a).
Subsection (i) provides an alternative to this customary definition in the context
of sales of goods or services by a trade or business by defining “gross income” as
gross receipts rather than gross receipts less the cost of goods sold. See §
6501(e)(1)(A)(i). Thus, pursuant to § 6501(e)(1)(A), in order for an omission from
gross income to arise in the context of sales of goods or services by a trade or
business, the return must omit a receipt. As such, subsection (i) is not rendered
superfluous by application of Colony outside of the context of a trade or business.
D.
18
No. 09-11061
The government further argues that in enacting § 6501(e)(1)(A)(ii),
Congress intended that an item could be omitted from gross income without it
having been entirely omitted from the face of the return. See Phinney, 392 F.2d
at 685. Subsection (ii) states:
In determining the amount omitted from gross income,
there shall not be taken into account any amount which
is omitted from gross income stated in the return if
such amount is disclosed in the return, or in a
statement attached to the return, in a manner adequate
to apprise the Secretary of the nature and amount of
such item.
26 U.S.C. § 6501(e)(1)(A)(ii). Subsection (ii) thus provides a “safe harbor” for
omissions of amounts which, though not included in the gross income as stated
in the tax return, are adequately disclosed such that the IRS has sufficient
notice.
[F]rom the plain language of (ii), it is possible for an
amount to be ‘omitted from gross income’ and disclosed
on the face of the return. Subsection (ii) simply makes
it possible for a taxpayer to be protected if the taxpayer
discloses the amount in a way sufficient to alert the IRS
to the substance and size of the item omitted. If a
taxpayer omits an amount from gross income yet
includes the item which causes the amount to be
omitted on the taxpayer’s return in such a way that the
IRS is apprised of the ‘nature and amount’ of the item,
then that item is not considered ‘omitted’ for purposes
of § 6501(e)(1)(A). However, where a taxpayer includes
an item on a return in such a way that the IRS is not
apprised of the ‘nature and amount’ of the item, then
that item has been ‘omitted’ from gross income for
purposes of § 6501(e)(1)(A), even though it is included
on the face of the return.
Home Concrete (I), 599 F. Supp 2d at 686; see also Salman Ranch (II), 573 F.3d
at 1376 (finding that the adequate disclosure provision is related to Colony’s
19
No. 09-11061
expression that Congress’s intent in enacting § 275(c) was to afford the
Commissioner additional time to investigate returns where an item has been
omitted such that Colony has not been rendered moot) (citing Colony, 357 U.S.
at 36). As discussed infra, subsection (ii) is in harmony with both this court’s
decision in Phinney and the Supreme Court’s decision in Colony. Thus, it is
proper for this court to apply Colony in light of the revised statute. The
government does not assert that the taxpayers failed to report any receipt or
accrual in its computation of gross income. Rather, the government contends
only that the taxpayers overstated their basis in the sale of assets. As such, the
taxpayers’ errors do not trigger the extended limitations period.
III.
Finally, the government argues that recently promulgated Treasury
Regulations clarify that the definition of “omits from gross income” as found in
§ 6501(e)(1)(A) includes an overstatement of basis, thus the regulations are
determinative.
On September 28, 2009, the Treasury issued Temporary Regulations §§
301.6501(e)-1T(b) and 301.6229(c)(2)-1T(b), pursuant to 26 U.S.C. § 7805(a).
Section 7805(a) of the Tax Code authorizes the Treasury Department to
promulgate “all needful rules and regulations for the enforcement of this title.”
26 U.S.C. § 7805(a). The Temporary Regulations were simultaneously issued as
proposed regulations and were issued as final regulations effective December 14,
2010 (the Regulations). See Treas. Reg. §§ 301.6501(e)-1, 301.6229(c)(2)-1.8 The
Regulations define “omission from gross income” as including “an understated
amount of gross income resulting from an overstatement . . . of basis for
8
Although the Temporary Regulations were in effect at the time the government and
taxpayers sought appellate review, because any difference between the Temporary and final
Regulations are not material to our review, this opinion cites to the final version of the
Regulations.
20
No. 09-11061
purposes of sections 6501(e)(1)(A) and 6229(c)(2).” Id. at §§ 301.6501(e)-1(a)(iii)
and 301.6229(c)(2)-1(a)(iii). The Regulations provide:
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 amount realized from the
disposition of the property over the unrecovered cost or
other basis of the property. Consequently, except as
provided in paragraph (a)(1)(ii) of this section, an
understated amount of gross income resulting from an
overstatement of unrecovered cost or other basis
constitutes an omission from gross income for purposes
of section 6501(e)(1)(A)(i).
Treas. Reg. § 301.6501(e)-1(a)(iii). The Regulations limit Colony’s applicability
to circumstances where the taxpayer is a trade or business engaged in the sale
of goods or services. Id. at § 301.6501(e)-1(a)(ii), (iii); T.D. 9511, 75 Fed. Reg.
78897, 78897 (Dec. 17, 2010). The Regulations also expressly disagree with the
recent decisions in Bakersfield and Salman Ranch (II) applying Colony to the
revised statute. See 75 Fed. Reg. 78897.
The government asserts that this court must afford the Regulations force
of law deference and because the Regulations purport to apply retroactively they
control the outcome of the present matters. See Chevron, U.S.A., Inc. v. Nat’l
Res. Def. Council, Inc., 467 U.S. 837, 843-44 (1984) (setting forth the standard
for force of law deference, which affords agency regulations controlling weight,
unless they are arbitrary, capricious, or contrary to the underlying statute). The
taxpayers argue that the Regulations are an unreasonable interpretation of an
unambiguous statute and contrary to Congressional intent. See Nat’l Muffler
Dealers Ass’n, Inc. v. United States, 440 U.S. 472, 476-77 (1979) (pre-Chevron
case applying a more limited standard of reasonableness to a treasury
21
No. 09-11061
regulation). Finally, the taxpayers assert that the Regulations cannot apply
retroactively because such action would re-open previously time-barred claims.
Because we hold that § 6501(e)(1)(A) is unambiguous and its meaning is
controlled by the Supreme Court’s decision in Colony, we need not determine the
level of deference owed to the Regulations. The Regulations attempt to define
“omits from gross income” for purposes of the revised statute. However, the
government cites to no authority refuting prior case law that has held §
6501(e)(1)(A) to be unambiguous with respect to the definition of “omits.” See
Colony, 357 U.S. at 37 (finding that “without doing more than noting the
speculative debate between the parties as to whether Congress manifested an
intention to clarify or to change the 1939 Code” when Congress enacted § 6501
of the 1954 Tax Code, “we observe that the conclusion we reach is in harmony
with the unambiguous language of § 6501(e)(1)(A)); Salman Ranch (II), 573 F.3d
at 1374 (finding the phrase “omits from gross income” identical in both statutes);
Bakersfield, 568 F.3d at 775-76 (applying Colony’s definition of “omits from gross
income” because it had construed language identical to the revised statute). The
Regulations attempt to “trump” what is established precedent on what
constitutes an “omission from gross income” for purposes of § 6501(e)(1)(A). See
Home Concrete (II), 2011 WL 361495, at *7 (declining to apply the Regulations
retroactively because the Supreme Court stated in Colony that § 6501(e)(1)(A)
is unambiguous as to the very issue to which the regulation purports to speak”).
Moreover, the Regulations state that they “apply to taxable years with
respect to which the period for assessing tax was open on or after September 24,
2009.” T.D. 9511, 75 Fed. Reg. 78897, 78897 (Dec. 17, 2010). The government
argues that this provision applies to taxable years for which the limitations
period did not expire with respect to the tax year at issue before September 24,
2009. The Regulations state that “‘the applicable period’ is not the ‘general’
three-year limitation period . . . [because] the three-year period does not ‘close’
22
No. 09-11061
a taxable year if a longer period applies.” Id. at 78898. The government thus
makes a circular argument that the Regulations apply to the taxpayers because
the statute of limitations remains open under the language of the newly
promulgated Regulations. See Home Concrete (II), 2011 WL 361495, at * 6
(finding that such argument “attemps to redraft [ ] § 6501” because Congress
specifically set forth the circumstances under which the extended limitations
period applies and thus “the IRS’s argument that the period for assessing tax is
open-or indeed may be re-opened . . . so long as litigation is pending is contrary
to the clearly and unambiguously expressed intent of Congress and must fail”)
(citations omitted); Intermountain Ins. Serv. of Vail, LLC. v. Comm’r
(Intermountain II), 134 T.C. No. 11, at *1 (2010) (declining to engage in a
“hypothetical” inquiry to determine the applicable limitations period because
when urging the same argument, the government’s interpretation was
“irreparably marred by circular, result-driven logic”).9
9
Although we hold that § 6501(e)(1)(A) is unambiguous and its meaning is controlled
by the Supreme Court’s decision in Colony, we note that even if the statute was ambiguous and
Colony was inapplicable, it is unclear whether the Regulations would be entitled to Chevron
deference under Mayo Foundation for Medical Research v. United States, 131 S. Ct. 704, 711
(2011). See, e.g., Home Concrete & Supply, LLC v. United States, — F.3d —, No. 09-2353) 2011
WL 361495, *7 (4th Cir. Feb. 7, 2011) (declining to afford the Regulations Chevron deference
because the statute is unambiguous as recognized by the Supreme Court in Colony). In Mayo,
the Court held that the principles underlying its decision in Chevron “apply with full force in
the tax context” and applied Chevron to treasury regulations issued pursuant to 26 U.S.C. §
7805(a). Id. at 707. Significantly, in Mayo the Supreme Court was not faced with a situation
where, during the pendency of the suit, the treasury promulgated determinative, retroactive
regulations following prior adverse judicial decisions on the identical legal issue. “Deference
to what appears to be nothing more than an agency’s convenient litigating position” is “entirely
inappropriate.” Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, 213 (1988). The Commissioner
“may not take advantage of his power to promulgate retroactive regulations during the course
of a litigation for the purpose of providing himself with a defense based on the presumption of
validity accorded to such regulations.” Chock Full O’ Nuts Corp. v. United States, 453 F.2d 300,
303 (2d Cir. 1971).
Moreover, Mayo emphasized that the regulations at issue had been promulgated
following notice and comment procedures, “a consideration identified . . . as a significant sign
that a rule merits Chevron deference.” 131 S. Ct. at 714. Legislative regulations are generally
subject to notice and comment procedure pursuant to the Administrative Procedure Act. See
5 U.S.C. § 553(b)(A). Here, the government issued the Temporary Regulations without
23
No. 09-11061
Because the Regulations are an unreasonable interpretation of settled law,
we find that they are not applicable to the taxpayers in the present matters. As
such, we need not determine whether the Regulations may apply retroactively.
IV.
For the foregoing reasons, we affirm the tax court’s judgment in favor of
the taxpayers in matter 09-60827, Commissioner v. M.I.T.A. We reverse the
district court’s grant of summary judgment in favor of the government in matter
09-11061, United States v. Burks, and remand for further proceedings consistent
with this opinion.
subjecting them to notice and comment procedures. This is a practice that the Treasury
apparently employs regularly. See Kristin E. Hickman, A Problem of Remedy: Responding to
Treasury’s (Lack of) Compliance with Administrative Procedure Act Rulemaking Requirements,
76 GEO. WASH. L. REV. 1153, 1158-60 (2008) (noting that the treasury frequently issues
purportedly binding temporary regulations open to notice and comment only after
promulgation and often denies the applicability of the notice and comment procedure when
issuing its regulations because that requirement does not apply to regulations that are not a
significant regulatory action, while continuing to assert that the regulations are entitled to
legislative regulation level deference before the courts). That the government allowed for notice
and comment after the final Regulations were enacted is not an acceptable substitute for pre-
promulgation notice and comment. See U.S. Steel Corp. v. U.S. EPA, 595 F.2d 207, 214-15 (5th
Cir. 1979).
24