Bakersfield Energy Partners, LP, Robert Shore, Steven Fisher Gregory Miles and Scott McMillan, Partners Other Than Tax Matters Partner v. Commissioner , 128 T.C. No. 17 ( 2007 )

128 T.C. No. 17UNITED STATES TAX COURT
BAKERSFIELD ENERGY PARTNERS, LP, ROBERT SHORE, STEVEN FISHER,
GREGORY MILES AND SCOTT MCMILLAN, PARTNERS OTHER THAN THE TAX
MATTERS PARTNER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4204-06. Filed June 14, 2007.
A Notice of Final Partnership Administrative
Adjustment (FPAA) for the year 1998 was sent in 2005,
determining that the basis of property sold by P was
overstated. R contends that the overstatement of basis
is an omission of gross income and that, therefore, the
6-year period of limitations in sec. 6501(e)(1)(A),
I.R.C., applies. There are no other exceptions to the
normal 3-year period of limitations applicable to the
individual partners.
Held: The overstatement of basis is not an
omission of gross income for purposes of sec.
6501(e)(1)(A), I.R.C. Colony, Inc. v. Commissioner,
357 U.S. 28 (1958), followed.
- 2 -
Steven Ray Mather and Elliott Hugh Kajan, for petitioners.
Lloyd T. Silverzweig, for respondent.
OPINION
COHEN, Judge: In a Notice of Final Partnership
Administrative Adjustment (FPAA) sent October 4, 2005, respondent
determined that Bakersfield Energy Partners, LP (BEP), had
overstated its basis in certain gas reserves sold during the
taxable year 1998, thus causing an understatement of partnership
income by more than 25 percent of the amount stated in the
return. The issue for decision is whether, under those
circumstances, the overstatement of basis constitutes an omission
of income giving rise to an extended 6-year period of
limitations. This issue has been presented by petitioners’
motion for summary judgment and respondent’s motion for partial
summary judgment. Unless otherwise indicated, all section
references are to the Internal Revenue Code in effect for the
year in issue.
Background
For purposes of the pending motions, the following facts
have been assumed. The petitioning partners are all partners in
BEP. BEP’s principal place of business was in California at the
time the petition was filed. Prior to April 1, 1998, BEP owned
an interest in an oil and gas property with Harcor, an unrelated
- 3 -
company. After a proposed sale of the oil and gas property to
another unrelated entity, Seneca Resources, fell through, the
petitioning partners decided to restructure the ownership of BEP.
To effect this new structure, on April 1, 1998, the petitioning
partners sold their partnership interests in BEP to Bakersfield
Resources, LLC (BRLLC), an entity that had been formed by the
petitioning partners.
The petitioning partners recognized the gain from the sale
of their BEP partnership interests under the installment method.
For all tax years beginning in 1998, the petitioning partners
have reported the gain from this sale under the installment
method.
The sale of the petitioning partners’ BEP partnership
interests caused a termination of BEP’s tax year pursuant to
section 708. BEP made an election under section 754 to adjust
the basis of the partnership assets (the inside basis) to equal
BRLLC’s basis on its newly acquired BEP partnership interest (the
outside basis) pursuant to section 743(b). The section 754
election and the transaction resulting in the section 743(b)
basis adjustments were disclosed in statements attached to BEP’s
partnership return for the short-year period from April 1 through
December 31, 1998 (the 9812 Form 1065).
On the 9812 Form 1065, U.S. Partnership Return of Income,
BEP reported total income as follows:
- 4 -
1 a Gross receipts or sales
b Less returns and allowances
2 Cost of goods sold
3 Gross profit
4 Ordinary income (loss) from
other partnerships . . . . . . . . $273,262
5 Net farm profit (loss)
6 Net gain (loss) from Form 4797 . . 1,993,034
7 Other income (loss)
8 Total income (loss) . . . . . . . . 2,266,296
On Form 4797, Sales of Business Property, BEP reported sale of
the oil and gas properties in issue as follows:
20 Gross sales price . . . . . . . . $23,898,611
21 Cost or other basis
plus expense of sale . . . . . . 16,515,194
22 Depreciation (or depletion)
allowed or allowable
23 Adjusted basis . . . . . . . . . . 16,515,194
24 Total gain . . . . . . . . . . . . 7,383,417
* * * * * * *
28 If sec. 1254 property:
a Intangible drilling and
development costs, expenditures
for development of mines and
other natural deposits, and
mining exploration costs . . . . 1,993,034
b Enter the smaller of
line 24 or 28a . . . . . . . . 1,993,034
* * * * * * *
30 Total gains for all properties . . 7,383,417
31 [From line 28] . . . . . . . . . . 1,993,034
32 Subtract line 31 from line 30 . . 5,390,383
Attached to BEP’s 9812 Form 1065 was a Statement Regarding a
Partnership Technical Termination as follows:
Pursuant to IRC Sec. 708(b)(1)(B) and the regulations
thereunder, Bakersfield Energy Partners, LP terminated
on April 1, 1998. On that date, certain partners sold
over a 50% ownership interest in the partnership’s
capital and profits to Bakersfield Resources, LLC
- 5 -
* * *. On April 7, 1998, Bakersfield Resources, LLC
acquired additional partnership interests through
purchases. These transactions resulted in a new
partnership for federal income tax purposes (the “new”
partnership retains the same federal employer
identification number).
As reflected within the capital accounts, the
partnership books were restated to reflect the value of
the assets as required in the regulations under IRC
704. As reflected within this return, in the event of
a sale of these assets, proper adjustments have been
made to reflect the tax basis and the proper taxable
gain.
Also attached was a Section 754 Election Statement as follows:
The partnership hereby elects, pursuant to IRC Section
754, to adjust the basis of partnership property as a
result of a distribution of property or a sale or
exchange of a partnership interest as provided in IRC
Sections 734(b) and 743(b).
The FPAA in this case was sent October 4, 2005. The notice
adjusted BEP’s ordinary income as follows:
a. Portfolio income (loss) interest
(1) Adjustment $0
(2) As reported 381,998
(3) Corrected 381,998
b. Net gain (loss) under sec. 1231 not casualty/theft
(1) Adjustment 16,515,194
(2) As reported 5,390,383
(3) Corrected 21,905,577
The adjustment was explained as follows:
Bakersfield Energy Partners, LP has failed to establish
that it had a basis greater than $0 in the gas reserves
it sold during the taxable year 1998. It has been
determined that any optional basis adjustment under
section 743(b) was the result of a sham transaction, a
transaction lacking economic substance that had no
business purpose and no economic effect and/or was
- 6 -
availed for tax avoidance purpose and should not be
respected for tax purposes.
Petitioners filed a motion for summary judgment on the
ground that the FPAA was issued after the applicable period of
limitations had expired. Petitioners contend that overstatement
of basis is not an omission from gross income for purposes of the
extended period of limitations under section 6501(e)(1)(A) or, in
the alternative, that the amount omitted was “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.” Sec. 6501(e)(1)(A)(ii). Respondent has moved for
partial summary judgment, agreeing that the material facts
necessary to determine whether the overstatement of basis is an
omission from gross income are not in dispute. Respondent
contends, however, that the question of adequate disclosure on
the return involves a dispute as to material facts.
The parties have now stipulated facts as to each partner in
the partnership, to the effect that they are unaware of any
exception to the normal 3-year period of limitations on
assessment other than the issue addressed in this Opinion.
Discussion
Under the general rule set forth in section 6501, the
Internal Revenue Service is required to assess tax (or send a
notice of deficiency) within 3 years after a Federal income tax
return is filed. See sec. 6501(a). For this purpose, the
- 7 -
“return” does not include a return of a person, such as a
partnership, from whom the taxpayer (i.e., a partner) has
received an item of income, gain, loss, deduction, or credit.
Id. In the case of a tax imposed on partnership items, section
6229 sets forth special rules to extend the period of limitations
prescribed by section 6501 with respect to partnership items or
affected items. See sec. 6501(n)(2); Rhone-Poulenc Surfactants &
Specialties, L.P. v. Commissioner, 114 T.C. 533, 540-543 (2000).
Section 6229 provides in pertinent part:
SEC. 6229. PERIOD OF LIMITATIONS FOR MAKING
ASSESSMENTS.
(a) General Rule.–-Except as otherwise provided in
this section, the period for assessing any tax imposed
by subtitle A with respect to any person which is
attributable to any partnership item (or affected item)
for a partnership taxable year shall not expire before
the date which is 3 years after the later of--
(1) the date on which the partnership return
for such taxable year was filed, or
(2) the last day for filing such return for
such year (determined without regard to
extensions).
* * * * * * *
(c) Special Rule in Case of Fraud, Etc.--
* * * * * * *
(2) Substantial omission of income.–-If any
partnership omits from gross income an amount
properly includible therein which is in excess of
25 percent of the amount of gross income stated in
its return, subsection (a) shall be applied by
substituting “6 years” for “3 years”.
- 8 -
In drafting section 6229, Congress did not create a completely
separate statute of limitations for assessments attributable to
partnership items. See AD Global Fund, LLC v. United States, 481
F.2d 1351 (Fed. Cir. 2007); Rhone-Poulenc Surfactants &
Specialties, L.P. v. Commissioner, supra at 545. Instead,
section 6229 merely supplements section 6501.
In Rhone-Poulenc Surfactants & Specialties, L.P. v.
Commissioner, supra at 539, the Court analyzed sections 6229 and
6501 as applicable to an FPAA. The Court stated in pertinent
part:
The Internal Revenue Code prescribes no period
during which TEFRA partnership-level proceedings, which
begin with the mailing of the notice of final
partnership administrative adjustment, must be
commenced. However, if partnership-level proceedings
are commenced after the time for assessing tax against
the partners has expired, the proceedings will be of no
avail because the expiration of the period for
assessing tax against the partners, if properly raised,
will bar any assessments attributable to partnership
items. [Id. at 534-535.]
* * * * * * *
* * * Any income tax attributable to partnership
items is assessed at the partner level. Thus, any
statute of limitations provisions that limit the time
period within which assessment can be made are
restrictions on the assessment of a partner’s tax.
[Id. at 539.]
See AD Global Fund, LLC v. United States, 481 F.2d 1351 (Fed.
Cir. 2007); G-5 Inv. Pship. v. Commissioner, 128 T.C. ___
(May 30, 2007).
- 9 -
If respondent’s position in this proceeding is correct, the
FPAA was sent within the 6-year period of limitations, and the
FPAA, by reason of section 6229(d), would suspend the period of
limitations applicable to assessment of the liabilities of the
partners. If we adopt petitioners’ position in this case, the
applicability of the period of limitations requires analysis of
the situation of each partner, i.e., whether the partner’s tax
year is open to assessment. If the period of limitations is open
with respect to any partner in the partnership, the adjustments
made in the FPAA in issue would have to be examined on the
merits. However, the parties have stipulated that they know of
no other exceptions to the normal 3-year period with respect to
the individual partners, and respondent has conceded that, if the
Court determines that petitioners’ failure to include net gain
from the sale of property does not constitute an omission from
gross income, the Court should grant petitioners’ motion for
summary judgment.
Although section 6229 does not repeat all of the terms and
provisions already set forth in section 6501, the precedents
interpreting section 6501(e)(1)(A)(ii) have been held equally
applicable to section 6229(c)(2), and that principle is not
disputed here. In this case, however, respondent implies that an
interpretation under the Internal Revenue Code of 1939 should not
apply to the current Code provisions.
- 10 -
In Colony, Inc. v. Commissioner, 357 U.S. 28, 37 (1958), the
Supreme Court, interpreting section 275(c), I.R.C. 1939, the
predecessor of section 6501(e), specifically stated that the
result that it reached is in harmony with the language of section
6501(e)(1)(A):
We think that in enacting section 275(c) Congress
manifested no broader purpose than to give the
Commissioner an additional two years [now three] 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. * * * [Id. at 36.]
The precise holding of the Supreme Court in Colony, Inc. v.
Commissioner, supra, was that the extended period of limitations
applies to situations where specific income receipts have been
“left out” in the computation of gross income and not when an
understatement of gross income resulted from an overstatement of
basis. The Supreme Court stated:
In determining the correct interpretation of sec.
275(c) [now sec. 6501(e)] we start with the critical
statutory language, “omits from gross income an amount
properly includible therein.” The Commissioner states
that the draftsman’s use of the word “amount” (instead
of, for example, “item”) suggests a concentration on
the quantitative aspect of the error–-that is, whether
or not gross income was understated by as much as 25%.
This view is somewhat reinforced if, in reading the
above-quoted phrase, one touches lightly on the word
“omits” and bears down hard on the words “gross
income,” for where a cost item is overstated, as in the
case before us, gross income is affected to the same
- 11 -
degree as when a gross-receipt item of the same amount
is completely omitted from a tax return.
On the other hand, the taxpayer contends that the
Commissioner’s reading fails to take full account of
the word “omits,” which Congress selected when it could
have chosen another verb such as “reduces” or
“understates,” either of which would have pointed
significantly in the Commissioner’s direction. The
taxpayer also points out that normally “statutory words
are presumed to be used in their ordinary and usual
sense, and with the meaning commonly attributable to
them.” De Ganay v. Lederer, 250 U.S. 376, 381. “Omit”
is defined in Webster’s New International Dictionary
(2d ed. 1939) as “To leave out or unmentioned; not to
insert, include, or name,” and the Court of Appeals for
the Sixth Circuit has elsewhere similarly defined the
word. Ewald v. Commissioner, 141 F.2d 750, 753.
Relying on this definition, the taxpayer says that the
statute is limited to situations in which specific
receipts or accruals of income items are left out of
the computation of gross income. For reasons stated
below we agree with the taxpayer’s position. [Id. at
32-33.]
Although the numbering of the sections as part of recodifications
of the Internal Revenue Code has changed, we see little change in
the rationale of the applicable statute. Thus, the Supreme Court
holding would apply equally to BEP’s return.
Respondent’s memorandum brief in support of motion for
partial summary judgment maintains that BEP:
properly reported the gross sales price of $23,898,611
on the Form 4797, but that it only reported $5,390,383
of the related net gain under I.R.C. sec. 1231
(understating the net gain by $16,515,194). * * * On
its return for the 1998 Taxable Year, * * * [BEP]
reported gross income totaling $8,038,677, including
the reported net I.R.C. sec. 1231 gain of $5,390,383,
portfolio (interest) income of $381,998, and trade or
business income of $2,266,296. * * * Therefore, the
amount of gross income omitted by * * * [BEP] which was
properly includible therein (i.e. $16,515,194) exceeded
- 12 -
the amount of income stated in the return (i.e.
$8,038,677) by 205 percent.
Respondent argues:
Overstating deductions is not considered an
omission of gross income for purposes of I.R.C. secs.
6229(c)(2) and 6501(e)(1)(A). However, overstating the
basis resulting in underreporting net I.R.C. sec. 1231
gain is not considered overstating deductions. Rather,
the underreporting (or omitting) of I.R.C. sec. 1231
gain is the omission of gross income regardless of
whether the gross sales price is underreported (or
omitted) or the basis is overstated. The relevant
issue is not whether an income item was completely
omitted from the return, but whether, for purposes of
I.R.C. secs. 6229(c)(2) and 6501(e)(1)(A), gross income
is omitted when a taxpayer underreports the gain from
the sale of property used in a trade or business as the
result of overstating the cost or other basis of such
property. [Emphasis added.]
Respondent relies on cases defining “gross income” for general
purposes of section 6501(e) by reference to section 61.
Respondent cites section 6501(e)(1)(A)(i), which defines gross
income in the context of sale of goods or services, and argues:
Any uncertainty in analyzing the sales of business
property under I.R.C. sec. 6501(e)(1)(A) results only
from trying to apply statements in Colony, Inc. v.
Commissioner, 357 U.S. 28 (1958), concerning the
extended period for omissions in the I.R.C. of 1939 to
the revised provision of the I.R.C., and from taking
statements about equating gross receipts with gross
income in the case of a trade or business out of
context. * * *
Respondent continues:
In Colony, Inc., the taxpayer understated the gross
profits on the sales of certain lots of land for
residential purposes as a result of having overstated
the basis of such lots by erroneously including in
their cost certain unallowable items of development
expense. Colony, Inc., 357 U.S. at 30. Respondent
acknowledges that Colony, Inc. suggests that an
- 13 -
overstated basis, in contrast to the omission of sales
proceeds, provides something for the Service to
check.4/ However, in Colony, Inc., the Supreme Court
had before it a case of a sale of goods or services, as
the taxpayer’s principal business was the development
and sale of lots in a subdivision. See Colony, Inc. v.
Commissioner, 26 T.C. 30, 31 (1956), aff’d, 244 F.2d 75(6th Cir. 1957), rev’d, 357 U.S. 28 (1958). In cases
not concerning a sale of goods or services, Colony,
Inc.’s approach would conflict with I.R.C. sec.
6501(e)(1)(A). See CC&F Western Operations L.P., 273
F.3d at 406, in which the First Circuit questions
whether Colony’s main holding carries over from the
1939 Internal Revenue Code for land sales in general
(“Gross income on land sales is normally computed as
net gain after subtracting basis. 26 U.S.C. secs.
61(a)(3), 1001(a); 26 C.F.R. sec. 1.61-6 (2001).”).
Accordingly, respondent maintains that Colony,
Inc. does not provide any authority for treating gross
receipt as gross income for the sale of land or other
property; rather, under the current I.R.C., that
treatment depends on whether the property sold is a
good or service. The sale of business property
reported on Form 4797 is not the sale of a good or
service; rather it is the sale of an item that is used
by a business to sell goods or services.
__________________________
4 Petitioner notes that although the Supreme Court
applied the 1939 I.R.C., it stated “that the conclusion
is in harmony with the unambiguous language of sec.
6501(e)(1)(A).” Colony, Inc., 357 U.S. at 37. The
Supreme Court did not purport to explain how an
interpretation under the I.R.C. 1954 should incorporate
its analysis. It appears that this observation was
only made because each party had looked to the I.R.C.
1954 Code for support as indicated by the following
phrase which prefaces the observation: “And 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,
* * *.” Colony, Inc., 357 U.S. at 37.
We are unpersuaded by respondent’s attempt to distinguish
and diminish the Supreme Court’s holding in Colony, Inc. v.
Commissioner, 357 U.S. 28 (1958). We do not believe that either
- 14 -
the language or the rationale of Colony, Inc. can be limited to
the sale of goods or services by a trade or business. As
petitioners point out, the Supreme Court held that “omits” means
something “left out” and not something put in and overstated.
We apply the holding of Colony, Inc. v. Commissioner, supra,
to this case and conclude that the 6-year period of limitations
set forth in section 6501(e) does not apply. Thus, we need not
determine whether the amounts in dispute were disclosed on the
return in a manner adequate to apprise the Secretary of the
nature and amount of the omitted item.
Because of the stipulation that no other exception to the
normal 3-year period applies to any of the individual partners
and to reflect the foregoing,
An order and decision will be
entered granting petitioners’
motion for summary judgment and
denying respondent’s motion for
partial summary judgment.