|February 16, 2011|
Previously published on February 10, 2011
Yet another appellate court has weighed in on whether an overstatement of basis constitutes an omission of gross income subject to the six-year statute of limitations under Code section 6501(e)(1)(A). Home Concrete v. United States, No. 09-2353 (4th Cir. Feb. 7, 2011). This time, the Fourth Circuit Court of Appeals sided with the Ninth (Bakersfield Energy Partners LP v. Comm’r, 568 F.3d 767 (9th Cir. 2009)) and Federal Circuits (Salman Ranch Ltd. v. United States, 573 F.3d 1362 (Fed. Cir. 2009)), as well as the Tax Court (Intermountain Insurance Services v. Comm’r, T.C. Memo 2009-195), holding that an overstatement of basis is not an omission of income that would trigger the six-year statute. The Fourth Circuit’s decision comes less than two weeks after the Seventh Circuit reached the opposite conclusion in Beard v. Comm’r, No. 09-3741 (7th Cir. Jan. 26, 2011). For our prior discussion of Beard, see here. Finally, just yesterday, the Fifth Circuit held for the taxpayer in Burks v. United States, No. 09-60827 (5th Cir. Feb. 9, 2011). (If we find that Burks adds anything new to the discussion, we’ll post our commentary in the next few days.)
Home Concrete primarily follows the rationale in Salman Ranch and Bakersfield Energy in holding that the fifty-year old Supreme Court decision Colony, Inc. v. Commissioner, 357 U.S. 28 (1958) resolves the issue, at least in the absence of controlling Treasury regulations. The Supreme Court held in Colony that the legislative history of section 6501(e)’s predecessor indicated a Congressional intent to only reach true omissions of income, not “computation” errors “arising from other causes,” such as an overstated basis. Although it interpreted section 6501(e)(1)(A)’s predecessor, the Court also said in dicta that it would interpret the successor the same way, and that it was “unambiguous.” Attempting to distinguish Colony, the government has argued in each of the recent section 6501(e)(1)(A) cases that the decision only applies when a trade or business overstates basis in the sale of its goods, but Home Concrete (like Salman Ranch and Bakersfield Energy) found no reason to distinguish Colony on these ground.
However, the government argued alternatively that it need not distinguish Colony because Treasury’s recently promulgated regulation overrides the precedent and is entitled to deference under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc.,467 U.S. 837 (1984). Consistent with the government’s litigating position, the regulation provides that, “an understated amount of gross income resulting from an overstatement of ... basis constitutes an omission ... for purposes of section 6501(e)(1)(A).” Treas. Reg. § 301.6501(e)-1(a)(1)(iii). The regulation is effective for taxable years remaining open for assessment after September 24, 2009.
The court had two responses to the government’s Chevron-deference argument. First, the effective date of the regulation preempted its applicability to the Home Concrete taxpayer. The taxpayer timely filed its 1999 tax return in April 2000. Thus, even an extended six-year statute of limitation could not remain open as of September 24, 2009, the clearly stated effective date of the regulation. The government curiously argued that, in spite of this clear effective date, the regulation operated to extend the six-year statute for any overstated-basis case currently subject to litigation, whether or not the statute for the relevant years were open as of September 24, 2009. The court said such a circular reading could operate to reopen a closed statute beyond six years, which would extend section 6501(e)’s reach beyond the unambiguous time limit set by statute. Thus, the court said the regulation didn’t apply on its face, and if it did, it would fail Chevron step one.
Second, the Fourth Circuit held that the regulation would fail even a Chevron-deference analysis. Although Chevron step two requires a court to defer to an administrative agency’s interpretation of an ambiguous statute, a court need not reach step two if the agency’s interpretation fails Chevron step one. Under step one, the unambiguously expressed intent of Congress controls the day, and an administrative rule contrary to unambiguous Congressional intent is invalid. See Nat’l Cable & Telecommunications Ass’n v. Brand X Nat’l Services, 545 U.S. 967, 982-83 (2005). In Home Concrete, the Fourth Circuit held that Colony satisfied this rule when it “declared” section 6501(e)(1)(A) unambiguous. It seems, however, that this reasoning may overstate Colony’s reach because the Supreme Court described 6501(e)(1)(A) as unambiguous in dicta, not a holding. Therefore, Brand X seems inapplicable, as it only applies to holdings, and the Supreme Court has never rigorously analyzed section 6501(e)(1)(A).
So, now that a clear circuit split exists between the Seventh and other circuits, where do we go from here? Presuming the Supreme Court grants certiorari in one of these cases, how broadly or narrowly the Court frames its holding will determine how much litigation remains. For instance, the Court could adopt Beard’s reasoning and hold that an overstated-basis case is distinguishable from Colony. That would seem to settle all of outstanding overstated-basis cases in favor of the government. On the other extreme, the Court could follow Home Concrete and hold that Colony recognized Congress’s “unambiguous” intent that section 6501(e)(1)(A) only apply to true omissions (not overstatements), which would foreclose both the government’s litigating position and invalidate its regulation, a total win for taxpayers.
Finally, the Supreme Court could hold that Colony controls pre-regulation cases, but that its characterization of section 6501(e)(1)(A) as unambiguous is unpersuasive dicta. Thus, the regulation provides a valid agency interpretation of an ambiguous statute under Chevron step two. This third foreseeable holding would leave open the reach of the regulation’s retroactive effective date. If the issue evolves in this manner, its feasible that the government’s aggressive reading of the regulation’s effective date could come back to haunt it. As recognized in Home Concrete, the government’s position that the regulation reaches all cases subject to litigation at the time that it was promulgated clearly reaches beyond the face of section 6501(e)(1)(A), as this reading of the effective date could extend the statute of limitations beyond the statutorily capped six years.