Nelson Jefferson was the majority owner of Florida Electronic Supply Inc. (FES), an S corporation. To sell his low-basis stock, he engaged in a tax shelter the IRS has labeled “Son of BOSS”—a variation on an earlier scheme known as Bond and Options Sales Strategy. In simple terms, these transactions use a new partnership, a contingent liability and a section 754 election to create an increase in basis to eliminate gain.
In November 1998, Jefferson formed Brandon Ridge Partners and Brandon Ridge Inc., an S corporation. He contributed to the partnership his FES stock and the $3.2 million proceeds of a short sale of Treasury securities, along with an obligation to cover the sale. The partnership in turn contributed an interest in nearly all its assets to Brandon Ridge Inc., which Jefferson claimed allowed the partnership to increase its basis by $3.2 million. Then the partnership sold the FES shares to a third party for $3.3 million, on which it claimed only a $31,000 gain on its 1998 return, which it filed in September 1999. Jefferson filed his individual return that October.
In February 2006, the IRS adjusted the gain to $3.2 million. (An earlier summons to the now-defunct law firm of Jenkins & Gilchrist allowed the Service to meet the six-year limit.) Jefferson argued that the three-year statute of limitations barred the adjustment, pointing out that the Tax Court in Bakersfield Energy Partners and Court of Federal Claims in Grapevine Imports had ruled in taxpayers’ favor on this issue this year (see “ You Say Omit, I Say Understate,” JofA, Sept. 07, page 83). In these cases, the courts based their opinions on the Supreme Court’s decision in Colony Inc. v. Commissioner that the extended period requires an omission of gross income, and that a basis overstatement is not an omission.
In the current case, the district court ruled in favor of the IRS based on three factors: First, the language in section 6501 has been changed since the 1958 Colony decision to apply only to sales of goods or services by a business, the court said. Second, the court noted that section 6501 refers to an income amount for income tax, versus an item for estate and gift tax. It reasoned that since increased basis leading to understated income is part of the amount of reported income, the extended statute could apply. Third, the court addressed Jefferson’s alternate argument that the stock sale was adequately disclosed and thus the three-year period should apply. But in this case, neither the partnership nor the individual return disclosed the contingent liability—the completion of the short sale—which was the real reason for the adjustment, the court said.
The court’s conclusion puts taxpayers on notice that adequate disclosure of a tax planning (shelter) transaction will include every aspect of the transaction and not just its general code provisions. If other courts follow this part of the decision, taxpayers may want to increase their disclosures.
Brandon Ridge Partners v. U.S. , 100 AFTR2d 2007-5347
Prepared by Edward J. Schnee , CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.