Can Mere Basis Overstatement Extend the Statute of Limitations on Assessment to 6 Years?

By: Tyler B. Korn, Esq.

Seeking an end-run against its recent losses in court, the Internal Revenue Service has issued temporary Treasury Regulation, Section 301.6229(c)(2)-1T. Under the new temporary Treasury Regulation, an understated amount of gross income that results from an overstatement of un-recovered cost or other basis is deemed to constitute an “omission” of gross income for purposes of the statute of limitations on assessment.

By way of background, Section 6501(a) of the Internal Revenue Code generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date that the tax return was filed or the due date of the tax return. However, this 3-year period is extended to a period of 6 years when a taxpayer “omits” from gross income an amount in excess of 25% of the amount of gross income stated on the tax return.

Several courts, including the Ninth Circuit Court of Appeals and the United States Tax Court, recently held that an “omission” does not occur by an overstatement of basis, and thus that the longer period for the statute of limitations cannot apply. The U.S. Tax Court in particular relied on a United States Supreme Court decision that interpreted the predecessor of Section 6501 of the Code. In that case, the Supreme Court held that the plain meaning of the term “omits” (as used in the applicable subsection of the Internal Revenue Code) is that something has been “left out” and not that something has been put in and overstated.

The new Treasury Regulations, however, now clarify what constitutes an “omission from gross income” under the Internal Revenue Code. By formally altering the definition of a term contained in the Internal Revenue Code, the Internal Revenue Service expects that its new Treasury Regulation will be entitled to deference by the courts – even though the Regulation’s interpretation of the Internal Revenue Code runs contrary to that made by courts in several jurisdictions.

Until such time as this issue is fully resolved by the courts, taxpayers who are challenged by the Internal Revenue Service should generally (depending on their jurisdiction) continue to dispute the applicable statute of limitations on assessment when it hinges on an expansive definition of the term “omission.” It should also be noted that for purposes of the applicable statute of limitations, the amount omitted from gross income does not include any amount disclosed on the return, or in a statement attached to the return, in a manner adequate to apprise the Internal Revenue Service of the nature and amount of the item. This disclosure exception applies to omissions from gross income resulting from basis overstatements, so taxpayers who adequately disclosure the nature and amount of the omissions from gross income will generally not be subject to the extended 6-year statue of limitations in the first place.

If you have any questions about applicable statutes of limitation on assessment or collection, or about basis overstatements, please feel free to call our office.

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