OVERSTATED BASIS IS NOT AN “OMISSION” FOR 6 YEAR STATUTE OF LIMITATIONS

The IRS does not have forever to pursue taxpayers for errors or omissions on their income tax returns. For income tax purposes, the IRS must assess additional income taxes within 3 years after the later of the date the tax return was filed or the due date of the tax return.

There are some exceptions to the 3 year limit. One major exception is found in Code Sec. 6501(e)(1)(A) ,which provides for a 6 year period of limitations if the taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return. For example, if a taxpayer reports $100,000 of income, but the IRS find that the taxpayer did not report a $35,000 gain on the sale of property, the taxpayer has omitted more than 25% of his or her gross income and the IRS can assess additional tax for up to 6 years.

What if the taxpayer overstated his or her tax basis of an asset, and this resulted in income of more than 25% of the reported income not being reported on the income tax return? Is this an "omission," or some type of error that does not allow the use of the 6 year statute of limitations? Tax basis is the "adjusted cost" of an item of property, and is used to compute net gain or loss on sale for income tax purposes. It may also affect other items, such as depreciation deductions.

This was the issue in a recent Tax Court case – the IRS was arguing that when a taxpayer overstated his basis in an asset, which resulted in a more than 25% omission in gross income, that the IRS had a 6 year period of limitations to assess more income tax. The Tax Court ruled with the taxpayer on this one. The Tax Court noted that the Supreme Court held that "omits" means something "left out" and not something put in and overstated (such as additional basis), and thus the 6 year statute does not apply. Bakersfield Energy Partners, LP, Robert Shore, Steven Fisher, Gregory Miles and Scott McMillan, Partners other than the Tax Matters Partner, 128 TC No. 17 (2007.

Coincidentally, the Claims Court also recently interpreted Code Section 6229(c) in a similar manner. Code Section 6229(c) has a similar 6 year extended statute of limitations for 25% omissions, but applies in the partnership audit area. Grapevine Imports Ltd. v. U.S., 100 AFTR 2d ¶2007-5065 (Ct Fed Cl 7/17/2007)