Beard v. Comm'r

MEMORANDUM OPINION

HAINES, Judge: In a notice of deficiency sent April 13, 2006, respondent determined that petitioner Kenneth Beard (Mr. Beard) had overstated his basis in two S corporations sold during the taxable year 1999, thus causing an understatement of gross income by more than 25 percent of the amount stated in petitioners' return. ¹ The issue for decision is whether, under those circumstances, petitioners omitted income, giving rise to an extended 6-year period of limitations. This issue has been presented by petitioners' motion for summary judgment under Rule 121 and respondent's notice of objection, and supplemental briefs from both parties.

For purposes of the pending motion, the following facts have been assumed. At the time they filed their petition, petitioners resided in Illinois. Mr. Beard was a majority shareholder in two S corporations, *186 MMCD, Inc. (MMCD), and MMSD, Inc. (MMSD). Mr. Beard had a 76-percent stock ownership interest in each entity.

On August 24, 1999, petitioners entered into short sales whereby they borrowed U.S. Treasury notes from a third party and sold them for cash to another third party. These sales generated $ 12,160,000 in cash.

On August 25, 1999, petitioners used this cash to buy more Treasury notes in two transactions of $ 5,700,000 and $ 6,460,000. On the same day petitioners transferred to MMCD and MMSD the purchased Treasury notes of $ 5,700,000 and $ 6,460,000, respectively, together with the short positions (the obligation following the short sale to replace the borrowed securities). On the same day MMCD and MMSD sold their Treasury notes and closed the short positions on the Treasury notes for $ 7,500,000 and $ 8,500,000, respectively.

On August 29, 1999, Mr. Beard sold his entire interest in MMCD and in MMSD to Unicom, an unrelated third-party purchaser, for $ 6,574,939 and $ 7,638,211, respectively.

On April 11, 2000, petitioners jointly filed their 1999 Federal income tax return. On their Schedule D, Capital Gains and Losses, petitioners claimed a cost basis of $ 6,161,351 in MMCD and *187 $ 7,638,463 in MMSD and net gains from the sales of the shares of $ 413,588 and $ 992,748, respectively. Petitioners also reported gross proceeds from the sale of Treasury notes of $ 12,125,340, a cost basis of $ 12,160,000, and a resulting net loss of $ 34,660. There is no indication on Schedule M-2, Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholders' Undistributed Taxable Income Previously Taxed, of the 1999 income tax return of either MMCD or MMSD that the S corporations had assumed the liability to cover the short position in Treasury notes.

On April 13, 2006, respondent issued a notice of deficiency reducing petitioners' bases in the MMCD and MMSC stock by $ 5,700,000 and $ 6,460,000, respectively. ² The result was a $ 12,160,000 increase in the capital gain from the sale. Respondent contends that the bases in the MMCD and MMSC stock were inflated because they were not reduced by the liability to close the short position.

On July 11, 2006, petitioners filed a timely petition with this Court. On September 11, 2007, petitioners filed a motion for summary judgment on the *188 ground that the notice of deficiency was issued after the period of limitations had expired. Petitioners contend that overstatement of basis is not an omission from gross income for purposes of the extended period of limitations under section 6501(e)(1)(A).

On February 19, 2008, respondent filed his notice of objection to petitioners' motion, agreeing that the material facts necessary to determine whether petitioners actions constitute an omission from gross income are not in dispute. Respondent contends, however, that there is a genuine issue of fact as to whether the notice of deficiency was timely issued under section 6501(e).

Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant summary judgment when there is no genuine issue of material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner, 90 T.C. 753, 754 (1988). The moving party bears the burden of proving that there is no genuine issue of material fact. Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985); *189 Naftel v. Commissioner, 85 T.C. 527, 529 (1985). The Court will view any factual material and inferences in the light most favorable to the nonmoving party. Dahlstrom v. Commissioner, supra at 821; Naftel v. Commissioner, supra at 529.

Under the general rule set forth in section 6501(a), the Internal Revenue Service is required to assess the tax (or send a notice of deficiency) within 3 years after a Federal income tax return is filed. Section 6501(e)(1)(A) extends the limitations period to 6 years "If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return".

Section 6501(e)(1)(A) was first enacted as section 275(c) of the Revenue Act of 1934 (1934 Revenue Act), Ch. 277, 48 Stat. 745. See Badaracco v. Commissioner, 464 U.S. 386, 392, 104 S. Ct. 756, 78 L. Ed. 2d 549 (1984). In 1954 Congress made several changes to this provision. See H. Rept. 1337, 83d Cong., 2d Sess. A414 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 584-585 (1954). Section 6501(e)(1)(A)(i) provides an exception to the general definition of gross income, stating that

In the case of a trade or business, the term 'gross income' means the total of the amounts *190 received or accrued from the sale of goods or services * * * prior to the diminution by the cost of such sales or services.

Also, section 6501(e)(1)(A)(ii) provides a "safe harbor" for a taxpayer who otherwise has made a substantial omission, stating that

In determining the amount omitted from gross income, there shall not be taken into account any amount which is omitted from gross income stated in the return if such amount is disclosed in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item.

Respondent argues that the overstatement of basis in a context outside of the sale of goods or services should constitute an omission from gross income and thus trigger the 6-year limitations period under section 6501(e)(1)(A). ^3*191

In Colony, Inc. v. Commissioner, 357 U.S. 28, 33, 37, 78 S. Ct. 1033, 2 L. Ed. 2d 1119, 1 C.B. 1005 (1958), the Supreme Court, interpreting section 275(c) of the 1934 Revenue Act, the predecessor of section 6501(e), held that the extended period of limitations applies to situations where specific income receipts have been "left out" in the computation of gross income and not when an understatement *192 of gross income resulted from an overstatement of basis. The facts of Colony dealt with a taxpayer who developed and sold lots in a subdivision. Id. at 30-31.

In Bakersfield Energy Partners, LP v. Commissioner, 128 T.C. 207 (2007), affd. 568 F.3d 767 (9th Cir. 2009), a partnership (Bakersfield) which owned oil and gas property used the Internal Revenue Code's partnership termination and transfer provisions to increase its basis in that property before selling it to a third party in 1998. ^4*193 The Commissioner issued a notice of final partnership administrative adjustment (FPAA) almost 6 years after Bakersfield filed its return for 1998, and Bakersfield contended that the FPAA was untimely under Colony. Because Bakersfield did not omit any income receipt or accrual in its computation of gross income, we held that the Supreme Court's decision in Colony applied and Bakersfield's overstatement of basis did not trigger the extended limitations period. Bakersfield Energy Partners, LP v. Commissioner, supra at 215-216. As part of our holding, we stated that neither "the language or the rationale of Colony, Inc. can be limited to the sale of goods or services by a trade or business." Id. at 215.

Respondent contends that Bakersfield was wrongly decided and that Colony should be limited to cases where the taxpayer is involved in the sale of goods and services. ^5*195 First, respondent *194 argues that Colony's interpretation of section 275(c) of the 1934 Revenue Act is not binding because its successor statute, section 6501(e)(1)(A), is materially different (the materiality argument). Second, respondent argues that Colony interpreted section 275(c) of the 1934 Revenue Act as having the same meaning as section 6501(e)(1)(A)(i) and thus Colony should apply only to taxpayers who realize gross receipts from sales or services in the course of a trade or business (the interpretation argument).

The Commissioner raised these same arguments with regard to Bakersfield in the Court of Appeals for the Ninth Circuit. Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d at 775. Addressing the materiality argument, the Court of Appeals for the Ninth Circuit noted that Congress did not change the language in the body of section 6501(e)(1)(A), which is identical to the language in section 275(c) of the 1934 Revenue Act that the Supreme Court construed in Colony.^6*196 Id. at 775-776. Addressing the interpretation argument, the Court of Appeals noted that the Supreme Court expressly avoided construing the 1954 Code and "did not even hint" that its interpretation of section 275(c) of the 1934 Revenue Act was limited to cases in which the taxpayer was engaged in a trade or business. Id. at 778.

We believe that it would be inappropriate to "distinguish and diminish the Supreme Court's holding in Colony". Bakersfield Energy Partners, LP v. Commissioner, 128 T.C. at 215. The principles of Colony apply where a taxpayer overstates his basis. In both Colony and Bakersfield the taxpayers artificially inflated their bases in assets that were subsequently sold. Although *197 Colony dealt with the sale of land and Bakersfield with the sale of oil and gas property, in neither case did the taxpayer fail to report gross income on a return for purposes of the extended limitations period.

We assume that petitioners overstated the bases of their S corporations on their 1999 return. UnderColony andBakersfield, petitioners did not omit income from their return such as would subject them to the extended period of limitations. Accordingly, petitioners' motion for summary judgment will be granted.

In reaching these holdings, the Court has considered all arguments made and, to the extent not mentioned, concludes that they are moot, irrelevant, or without merit.

To reflect the foregoing,

An appropriate order and decision will be entered.