U.S. Supreme Court: Six-Year Statute of Limitations Does Not Apply to An Overstatement of Basis

In a huge win for the taxpayers in this case and many other similarly situated taxpayers, the U.S. Supreme Court handed down its opinion in United States v. Home Concrete & Supply, LLC yesterday. The Supreme Court affirmed the decision of the 4th Circuit Court of Appeals holding that the six-year statute of limitations applicable to unreported income, IRC 6501(e), did not apply when a taxpayer overstated basis, and thus understated income. The Supreme Court embraced the principle of stare decisis and followed its opinion in Colony, Inc. v. Commissioner, 357 U. S. 28 (1958) to decide the question.

The case was selected for consideration to resolve a split in the circuits that ostensibly began with the 9th Circuit’s decision in Bakersfield Energy Partners, LP v. Commissioner, 128 T.C. 207 (2007), affd. 568 F.3d 767 (9th Cir. 2009) but soon became known as the “Intermountain issue” after the Tax Court’s decision in Intermountain Insurance Service of Vail LLC v. Commissioner, 134 T.C. 211 (2010) which followed Bakersfield. The Intermountain decision came to exemplify a series of cases that received disparate treatment in the Courts of Appeals. The Court of Appeals came down in favor of the government in the 7th Circuit, the D.C. Circuit and the Federal Circuit though for different reasons. The 4th and 5th Circuit sided with the Tax Court and the 9th Circuit deciding that the 6 year statute of limitations did not apply to overstated basis. These cases attracted particular attention from both tax practitioners and the government because the overstated basis in each instance was the product of tax strategies (mostly Son of Boss transactions) that the government had listed or deemed abusive as a tax shelter.

The Supreme Court’s decision determined the straightforward question of whether an understatement of basis extends the traditional 3-year statute of limitations to 6 years under IRC 6501(e). It does not. However, many scholars and tax procedure wonks were hoping that the court would provide some guidance on the procedural validity and applicability of Treasury Regulation 301.6501(e)-1. Treas. Reg. 301.6501(e)-1 was promulgated as a temporary regulation in 2009 with a retroactive date of application to “correct” the 6-year statute of limitations controversy. The Temporary Regulation was published simultaneously with a Proposed Regulation to the same effect but without a pre-publication comment period. Some argued that such a move violated the Administrative Procedures Act (APA), notably among them Tax Court Judges Halpern and Holmes. (See their concurrence in the Tax Court’s Intermountain opinion.) The concern of many observers was not only the procedural validity of the regulation as promulgated but also whether an agency could promulgate a regulation that would have the effect of invalidating a Supreme Court interpretation of an ambiguous statute (which presumably this regulation would have done). The Supreme Court’s decision in National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967 (2005), certainly suggested that the latter outcome was possible and the parties and amici briefed that issue extensively.

In the end, the Supreme Court invalidated the regulation on the narrow ground that did not apply because of the precedent established in Colony, Inc. It did not address the validity of the regulation’s promulgation under the APA or the broader question of whether a regulation could invalidate a Supreme Court interpretation. Presumably those questions will be left for another day.

Read the Supreme Court Opinion here:
U.S. v. Home Concrete & Supply, LLC., Docket No. 11-139 (April 25, 2012)

Donald Duck says Pay Your Taxes!

It’s that time of year when taxes are on everybody’s mind. It might seem hard to imagine but there was a time when the annual ritual of filing taxes was still a new idea. That was the case during World War II and Donald Duck helped out with this little bit of propaganda.

And just as a reminder, you’ve got one week to file your return or automatic extension. The deadline for filing individual returns this year is Tuesday, April 17.

Thanks to NPR’s Planet Money Podcast for bringing the story and the video to our attention.

The Taxman Cometh: IRS Announces Plans to Focus Audit Resources on Middle Market Companies

In a recent speech at the mid-year conference of the Tax Executives Institute, IRS Deputy Commissioner Steven T. Miller laid out the framework for the future of IRS corporate audits. To borrow Mr. Miller’s own assessment, this is bad news for large corporate taxpayers in the CIC (Coordinated Industry Case) program (i.e., the IRS is not going away) and it is also bad news for so-called middle market companies because they will be the new focus of the Internal Revenue Service’s audit scrutiny.

The new strategy Mr. Miller announced will use existing programs geared at CIC taxpayers, such as the IIR (Industry Issue Resolution) program, CAP (Compliance Assurance Process) and Schedule UTP (Uncertain Tax Positions), to increase transparency among large companies and thereby reduce the resources required to examine those companies. The strategy is to take revenue agents currently assigned to large corporations (those with over $1 billion in assets) and redeploy them to auditing taxpayers with revenues or assets between $10 million and $250 million. Miller went on to outline in some detail the steps the IRS will be taking to accomplish this new mission.

There are a number of takeaways here. At least three changes can be expected immediately. The incremental changes that large corporate taxpayers have been experiencing in recent years will continue. The IRS will expect more information, sooner, and more quickly. Mr. Miller was clear. If information requested in an IDR (Information Document Request) is not forthcoming, the IRS Summons power will be used to enforce revenue agent’s demands. Second, the IRS intends to bring its influence to bear upon the Office of Appeals. The IRS will request that Appeals Officers return cases to exam where new facts or arguments are raised for the first time in an Appeals Conference. This signals a further encroachment on the autonomy of an Appeals function that is already restricted in its consideration of coordinated issues, tiered issues and issues of interest. Third, The importance of Schedule UTP will only grow as the IRS reviews and refines its use of this tool to encourage taxpayer disclosures. Mr. Miller noted that those taxpayers who provided inadequate concise descriptions of positions on their 2010 Schedule UTP will be contacted by the IRS and should expect to have future returns reviewed.

The changes will not all be immediate however. The IRS is a large vessel and it cannot turn on a dime. However, once this ship changes course, as it appears it has committed to do, then the impact on the middle market will be significant. Mr. Miller mentioned a focus on companies with operations and assets of less than $250 million but there are still a number of companies in the $250 million to $1 billion range that also should expect to see increased audit activity. These likely will be the first companies to face new IRS examinations if only because they have already filed at least one Schedule UTP giving the IRS a good starting point. Once those companies with less than $100 million in assets are required to include a Schedule UTP with their Form 1120 (beginning in 2012 for those with $50 million in assets), many more corporate taxpayers can expect to hear from revenue agents wanting to open multi-year audits. The new direction is not limited to middle market corporate filers. Mr. Miller also made it clear that the new direction for LB&I will include an emphasis on pass through entities and financial products. Change is on the horizon.