United States v. Home Concrete & Supply, LLC (11-139)
Oral argument: January 17, 2012
Appealed from: United States Court of Appeals for the Fourth Circuit (Feb. 7, 2011)
In 2006, the IRS adjusted Respondent Home Concrete’s 1999 tax return, claiming that Home Concrete overstated its basis in sold assets. The Fourth Circuit found that this adjustment was untimely under the general three year statute of limitations for IRS actions, concluding that overstatements of basis are not omissions that would trigger an extended six year statute of limitations. Petitioner, the United States, argues that the language and purpose behind the statute clarify that overstating a sold asset’s basis triggers the extended period, and that the Fourth Circuit should have deferred to the IRS's statutory interpretation contained within a Treasury Department regulation finalized during the appeal. Home Concrete argues that Supreme Court precedent applies here, eliminating ambiguity in the statutory interpretation. The Supreme Court’s decision will resolve a circuit split over the proper limitations period; the decision will also address the degree of deference due to a Treasury regulation that may be interpreted as conflicting with Supreme Court precedent, and that may be viewed as applying retroactively. The Court’s decision may affect the IRS’s timeframe to detect certain complex tax schemes, and the time period within which taxpayers are subject to audits.
As a general matter, the Internal Revenue Service (IRS) has three years to assess additional tax if the agency believes that the taxpayer's return has understated the amount of tax owed. 26 U.S.C. § 6501(a). That period is extended to six years, however, 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 [taxpayer's] return." 26 U.S.C. § 6501(e)(1)(A). The questions presented are as follows:
1. Whether an understatement of gross income attributable to an overstatement of basis in sold property is an "omi[ssion] from gross income" that can trigger the extended six-year assessment period.
2. Whether a final regulation promulgated by the Department of the Treasury, which reflects the IRS's view that an understatement of gross income attributable to an overstatement of basis can trigger the extended six-year assessment period, is entitled to judicial deference.
Whether the Internal Revenue Service may benefit from an extended six year statute of limitations, provided for in cases of income omissions under 26 U.S.C. 6501(e)(1)(A), to assess additional taxes when the taxpayer reports understated income due to inflation of basis from a property transaction.
In 1999, Respondent Robert Pierce sought to sell his ownership in the Home Oil and Coal Company (“Home Oil”). See Home Concrete & Supply, LLC et. al. v. United States, 634 F.3d 249, 251 (4th Cir. 2011). Based on professional financial advice, Pierce engaged in transactions with fellow respondents, Stephen Chandler and Home Oil, designed to reduce their tax liability from the sale. See id. The transactions followed a structure called a Bond and Option Sales Strategy (“Son-of-BOSS”) transaction to decrease taxes from selling assets by initially increasing their tax basis to ultimately decrease reported capital gains. See Brief for Petitioner, United States at 3–4. They received this higher basis by transferring to newly-formed Home Concrete & Supply, LLC (“Home Concrete”) proceeds from the short selling of treasury bonds, which Home Concrete later closed and sold back on the market. See Home Concrete, 634 F.3d at 251. Having created a large outside basis in Home Concrete, they then consolidated their interest in Home Oil, which transferred its assets to Home Concrete for sale to an outside party. See id. at 251–52. The end result was a higher reported basis for Pierce and the other taxpayers from the sold Home Concrete assets, resulting in reduced capital gains and tax liabilities. See id. at 252. In April 2000, Home Concrete filed their 1999 tax returns showing the parts of the above transaction. See id.
In 2000, the Internal Revenue Service (“IRS”) issued a notice stating that schemes which create an artificially high basis in assets are not valid under the Internal Revenue Code. See IRS Notice 2000-44, “Tax Avoidance Using Artificially High Basis.” In June 2003, the IRS audited Home Concrete’s 1999 tax returns. See Home Concrete, 634 F.3d at 252. The IRS concluded its investigation in September 2006 with a Final Partnership Administrative Adjustment, which removed the claimed basis for the assets sold in 1999 and increased Home Concrete’s taxable income. See id. The IRS justified their decision by claiming that Home Concrete was formed solely to avoid taxes through artificially overstating tax basis in assets, and that the transaction lacked economic substance. See id.
Home Concrete disputed the adjustment in the United States District Court for the Eastern District of North Carolina. See Home Concrete, 634 F.3d at 252–53. The district court denied Home Concrete’s claim that the three-year general statute of limitations time-barred the adjustment, and accepted the IRS’s view that overstatements of basis resulting in a substantial reduction in gross income trigger a longer six year limitations period. See id. at 253. The United States Court of Appeals for the Fourth Circuit reversed, holding that an overstatement of basis in partnership interest does not trigger the extended limitations period. See id. at 255. The Fourth Circuit also refused to apply a Treasury Department regulation, finalized during the appeal, which stated that any overstatement of basis is an omission from gross income. See id. at 255–56. The Fourth Circuit held that the regulation did not apply to this case by its own text, and further held that the regulation did not bind it because the law was clear. See id. at 256–58.
The Supreme Court granted certiorari on Sept. 27, 2011 to decide whether an overstatement of basis may trigger the extended limitations period, and the applicability of treasury regulations promulgated during appeal. See United States v. Home Concrete & Supply, LLC, et. al., 132 S.Ct. 71 (2011).
This case presents an opportunity to resolve a circuit split regarding the proper limitations period for the Internal Revenue Service (“IRS”) to act on tax returns overstating the basis of sold property. See United States v. Home Concrete & Supply, LLC, et. al., 132 S. Ct. 71 (2011). The Supreme Court’s decision will affect the time the IRS has to detect such errors, and will address any possible retroactive effects of IRS rules regarding such overstatements. See id.
Petitioner, the United States, argues that an extended limitations period is necessary to combat tax schemes involving an overstatement of basis, due to the difficulty of detecting such schemes in tax returns. See Brief for Petitioner, United States at 24–25. The United States contends that the IRS cannot immediately determine from the face of a tax return whether the taxpayer has overstated their investment in sold assets or understated the proceeds from those assets. See id. at 25. The United States asserts that an extended limitations period is required to properly investigate such transactions, and to prevent people from avoiding tax liability through such tax schemes. See id. The United States argues that, if only the standard three-year limitations period was applied, then the tax system would reward individuals who hide overstatements of basis in complicated ways on their tax return, since the IRS would not be able to detect such acts within the short timeframe. See id. at 27.
Respondent, Home Concrete, counters that an extended limitations period is not necessary because Congress intended such periods to apply only where the IRS is at a ‘special disadvantage’ in detecting errors on a return. See Brief for Respondents, Home Concrete & Supply, Inc., et al. at 24. Home Concrete contends that, because returns that overstate basis disclose the information used to compute capital gains, the IRS is not 'specially disadvantaged' to detect any miscalculation. See id. at 24–26. Further, Home Concrete contends that accepting the United States view would create a nonsensical result, since it would count overstatements of basis in property as omissions, but not overstatements of basis in goods, even though property sales require greater disclosures on returns than sales of goods. See id. at 25–26. Lastly, Home Concrete contends that the extended limitations period was not necessary in this case because the IRS failed to act in time, not due to any complexity in the return, but rather due to a failure to examine the returns until nearly 6 years after the initial filing. See id. at 29.
Treasury Regulation’s Retroactive Effect
The United States asserts that, if the Supreme Court holds the final Treasury regulation does not apply here, then the decision will not resolve the issue regarding overstatements of income. See Brief for Petitioner, United States at 37. The United States argues that, if the regulation’s text prevents it from applying in this case, then it would not apply to any of the similar current pending cases. See id. at 36. The United States claims that such a denial would defeat one of the purposes of the regulation—settling the meaning of “omits from gross income” for pending cases. See id. According to the United States, denying the regulation retroactive effect would only serve to forestall final resolution on whether the regulation is controlling regarding overstatements of basis. See id. at 37.
The National Association of Home Builders contends that giving the regulation retroactive effect on cases closed under existing law serves only to bolster the United States’ unsuccessful litigating position, and to strip taxpayers of their defense in later appeals. See Brief of Amicus Curiae National Association of Home Builders in Support of Respondents at 7–9. Further, the American College of Tax Counsel (“the College”) argues that allowing the IRS to use regulations in this manner would deter taxpayers challenging unlawful IRS actions. See Brief of Amicus Curiae American College of Tax Counsel in Support of Respondents at 24. The College further asserts that retroactive application of regulations like the one at issue here harms the tax system because it undermines the perception of fairness necessary for taxpayers to participate in a self-reporting system. See id. at 29.
Taxpayers must report as income gains derived from property transactions, determined using appropriate basis. See 26 U.S.C. § 61(e)(3). 26 U.S.C. § 6501(e)(1)(A) provides the Internal Revenue Service (“IRS”) with an extended six year period to levy additional tax should it find a failure to report any income. See 26 U.S.C. § 6501(e)(1)(A). Petitioner United States argues that both the plain language of § 6501(e)(1)(A) and the Supreme Court's 1958 Colony, Inc. v. Commissioner decision indicate application of the extended period, even if income omission occurred via basis overstatement. See Brief for Petitioner, United States at 14. The United States further argues that Final Treasury Regulation 301.6501(e)-1, which specifically provides for the extended period for basis overstatement omissions, applies here and should be afforded judicial deference. See id.at 27–28. Respondent Home Concrete objects, arguing that Colony forecloses the United States’ interpretation of 6501(e)(1)(A), and that the final regulation is invalid and should not be given deference. See Brief for Respondent at 22, 44–45.
Interpreting the Statutory Language of 26 U.S.C. 6501(e)(1)(A)
The United States first asserts that Home Concrete’s basis adjustment for its sale transaction is essentially the same “omi[ssion] from gross income” as understating the sale price, thus triggering the extended assessment period under the plain language of § 6501(e)(1)(A). See Brief for Petitioner, United States at 18–20. The United States next points to § 6501(e)(1)(A)(i), which provides that, for property sold in the course of business, the extended period applies only for specific items of sale price understatements. See id. at 20–21. The United States argues that subparagraph (i)—to avoid superfluity—must be an exception to the general rule of § 6501(e)(1)(A) that provides for the extended period for all omissions of income, which would include those from basis overstatements. See id. at 21–23. The United States further distinguishes §6501(e)(1)(A) by pointing to § 6501(e)(2), a mirror provision that provides for an extended period for omission of “items” from gross income. See id. at 23. The United States argues that, because § 6501(e)(1)(A) uses the word “amounts” rather than “items,” it should be read to include all types of income understatements, including basis overstatements, and not just discrete “items.” See id. at 23–24.
Home Concrete argues that, although Colony recognized that an overstated basis has the same effect as an omitted item, the word “omits”—used instead of alternatives like “reduces”—denies basis overstatements' inclusion within § 6501(e)(1)(A)’s meaning. See Brief for Respondent, Home Concrete & Supply, LLC, et al. at 23–24. Home Concrete also asserts that subparagraph (i) is not an exception but a special rule, and thus that, rather than reinventing what the general rule does not cover, it spells out the application of the general rule to specific cases of trade or business sales. See id. at 30–31. Home Concrete contends that, because subparagraph (i) would not have applied to the Colony facts, the Colony Court’s statement that its interpretation of former § 275 was “in harmony with” § 6501(e)(1)(A) could not be one that adopts the United States’ reading of § 6501(e)(1)(A): as a general rule with a trade or business exception. See id. at 32. Home Concrete also points to the 1965 change of § 6501’s heading to “Substantial Omission of Items” to show congressional intent to include only omitted discrete items for the extended period. See id. at 35.
The United States then addresses the Colony case, which held that § 6501(e)(1)(A)’s predecessor—Section 275 of the 1939 Code—did not include omissions in the form of basis overstatement. See Brief for Petitioner, United States at 44. The United States first argues that the Colony Court neither addressed potential congressional intent to change § 275 with § 6501(e)(1)(A) nor performed a contextual analysis of former § 275 relevant to § 6501(e)(1)(A) because of new provisions like subparagraph (i)—facts that render Colony moot here. See id. at 48–50. The United States further claims that Colony’s conclusion does not run parallel with § 6501(e)(1)(A) generally, but only with subparagraph (i) for two reasons: First, because the Colony Court stated that the language in § 6501(e)(1)(A) was ambiguous, its later reference to the “unambiguous language of § 6501(e)(1)(A)” must point only to subparagraph (i) to avoid contradiction; second, although the taxpayers in Colony sold land and ostensibly would not fall under subparagraph (i), they were actually in the business of selling land as real estate developers. See id. at 51–52.
Home Concrete first points out that, since Colony actually involved a real estate sale not held as inventory, Colony cannot be said to limit its holding solely to overstatements of sales costs. See Brief for Respondent, Home Concrete & Supply at 25. Home Concrete next notes that Congress has had ample opportunity to overrule Colony’s interpretation, and that its later actions on this matter, such as the reenactment of § 6501 in the 1986 Code revisions, point to its ratification of Colony. See id. at 33–34. Home Concrete seeks to refute the United States’ contention that the Colony Court found the statutory language both ambiguous and unambiguous at the same time by pointing out that the Court, after first recognizing a possible ambiguity in the text, then proceeded to analyze available evidence to find the text unambiguous. See id. at 36–37. Finally, Home Concrete argues that Colony applies with full force in this case because Colony provided the backdrop for Congress to enact the 1954 Tax Code; the parties relied on the 1954 amendments, which led the Court to reject Section 275(c)’s application to the facts of the case. See id. at 33–34.
Applicability of Treasury Regulation 301.6501(e)-1
Home Concrete argues that the regulation's statutory interpretation is invalid because the Colony Court already determined that Congress spoke directly to the issue at hand. See Brief for Respondent, Home Concrete & Supply at 37. Home Concrete contends that the regulation does not actually clarify the existing unambiguous law of Colony—it retroactively changes it. See id. at 41–42. Home Concrete asserts that the IRS is generally prohibited from enacting retroactive statutory provisions—including related regulations—and that such an ambiguously retroactive change of law constitutes an abuse of discretion. See id. at 46–48. Home Concrete further argues that, even if § 6501(e)(1)(A) were subject to interpretation, the regulation substantively alters grounded case law, and that any attempt to formalize this alteration as a “clarification” would allow agencies to make end-runs around case law interpretations. See id. at 42–43. Finally, Home Concrete points out that the regulation was issued without a notice-and-comment period—a procedural defect. See id. at 50.
The United States first asserts that the regulation was validly promulgated because the Treasury Department followed all required procedures—including notice-and-comment periods. See Brief for Petitioner, United States at 28–29. Alternatively, the United States argues that the procedural compliance argument is irrelevant because the challenged regulation was temporary, and was replaced by the final regulation currently in force. See id. at 29–30. The United States contends that the regulation is not impermissibly retroactive and is actually a clarification, arguing that—as a procedural rather than substantive provision—the regulation pronounces the true nature of § 6501(e)(1)(A), rather than reconfiguring it. See id. at 40–42. The United States further asserts that, even if it were retroactive, the regulation represents a permissive exercise of Treasury Department interpretive power. See id. at 42–43. Finally, the United States asserts that it does not matter that the Treasury Department promulgated the regulation in response to litigation because the suits indicated the need for administrative guidance. See id. at 40.
Home Concrete notes that Colony—the law at the time of the regulation’s 2009 passage—calls for a three year assessment period, which would no longer be “open” when the regulation took effect. See Brief for Respondent, Home Concrete & Supply at 39–40. Home Concrete further notes that this expired assessment period cannot “reopen” just because a case is pending on the matter, otherwise the government could always circumvent a statute of limitations by filing another claim post-expiration. See id. at 40. Home Concrete argues that the regulation, even if valid, should not be given deference. See id. at 48. First, Home Concrete contends that the regulation was impermissibly issued to bolster the litigation position of the IRS—a major party in this pending litigation. See id. Second, Home Concrete argues that the regulation is based on faulty interpretations of the underlying statutory language, contradicting both Colony and its subsequent legislative ratifications. See id. at 49.
The United States contends that the IRS challenge to Home Concrete’s returns in 2006 constituted a “pending case” that falls under the regulation’s province because the suit was still pending when the regulation became applicable on September 24, 2009. See Brief for Petitioner, United States at 29–31. The United States next argues that, to the extent that §6501(e)(1)(A) is ambiguous, the regulation—as a reasonable interpretation of the underlying statutory language—must be granted deference. See id. at 37–38. The United States further asserts that, although the taxable year in question is 1999 - and thus a six year period would expire in 2006 - the issuance by the IRS of a final partnership administrative adjustment in 2006 to the taxpayer stalled the period, bringing this dispute within the bounds of the regulation. See id. at 33–34. Finally, the United States worries that the regulation’s purpose - to clarify several other similar disputes in various courts of appeal - would be rendered moot under Home Concrete’s reading of the applicability provision, without reference to what the regulation actually says. See id. at 34–37.
In this case, the Supreme Court will decide whether 26 U.S.C. § 6501(e)(1)(A) provides the IRS with an extended six year period to assess additional taxes for cases in which the taxpayer has allegedly understated gross income by overstating basis in sold property. The United States argues that both the plain language of § 6501(e)(1)(A), as well as a final regulation promulgated by the Treasury Department, favor a six year assessment period, and that the Colony case is distinguishable on several grounds. Respondent Home Concrete retorts that the Colony case controls here and renders moot the United States’ interpretation of the statutory provision. Home Concrete further argues that the final regulation, even if applicable due to statutory ambiguity, is invalid and cannot be afforded deference. The Court’s decision here could enhance the IRS’s ability to catch hard-to-spot tax-shelter transactions, such as that found here, and settle a circuit split regarding the appropriate assessment period for levying additional taxes in the case of income omission from basis understatement.
Edited by: Eric Schulman
Wex: Chevron Deference
Journal of Accountancy, Karyn Friske and Darlene Pulliam: Circuit Split Deepens on Six-Year Period for Basis Overstatements (May 2011).
Martindale, Dustin Covello: Even after Mayo, Fourth Circuit’s Home Concrete Opinion May Have Paved the Way for Invalidating the 6501(e) Regs (Feb. 16, 2011).