Academic journal article Journal of Accountancy

You Say Omit, I Say Understate

Academic journal article Journal of Accountancy

You Say Omit, I Say Understate

Article excerpt

The Tax Court recently held that an understatement of gain by a partnership due to overstating its basis on a section 754 election did not result in an omission of gross income. Thus a proposed gain adjustment by the IRS was not timely, since it occurred after the expiration of the normal three-year statute of limitations period. The extended six-year limitations period of IRC [section][section] 6501(e)(1)(a) and 6229(c)(2) did not apply because there was no substantial omission of gross income, the court said.

Generally, the IRS must assess additional tax within three years of the later of the due date of the return or the date of its filing. A substantial omission of gross income--defined as exceeding 25% of reported gross income--extends the period to six years. (No time limit applies to a fraudulent return or failure to file.)

Bakersfield Energy Partners sold oil and gas properties in 1998, reporting a gain of nearly $5.4 million. In 2005, before the six-year statute of limitations period had expired, the IRS issued a Notice of Final Partnership Administrative Adjustment reducing the basis of the property to zero, thereby increasing Bakersfield's gain by more than $16 million. The IRS claimed the understated gain was a substantial omission of Bakersfield's gross income, which permitted the application of the six-year period.

Bakersfield argued the 1998 tax year was closed, based on Colony Inc. v. Commissioner, 357 U.S. 28 (1958), in which the Supreme Court held that the longer statute of limitations period did not apply when a taxpayer in the land development business understated its income from the sale of lots in a subdivision by overstating their basis. …

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