Gains as gross income unaffected by Home Concrete

Taxpayers’ reported gross income included the gains from investment sales, not the gross proceeds, when determining the applicability of the six-year statute of limitation.

The Tax Court held that taxpayers’ gross income was understated by more than 25%, triggering the six-year statute of limitation, because the taxpayers’ gains from the sale of investment property, not the sales proceeds, should be used to compute the 25% threshold.

Facts: G. Douglas Barkett and Rita Barkett filed their 2006 federal income tax return on Sept. 17, 2007, and their 2007 return on Oct. 2, 2008. They reported gross income of $271,440 and $340,591 for the two years, respectively, that included capital gains from the sale of investments on reported amounts realized of more than $7 million in 2006 and $4 million in 2007. On Sept. 26, 2012, the IRS sent the taxpayers a notice of deficiency for tax years 2006 to 2009, claiming they omitted from gross income compensation for services they provided to a C corporation they wholly owned of $629,850 and $431,957, for 2006 and 2007, respectively. The taxpayers brought suit in Tax Court, arguing the notice of deficiency was invalid with respect to 2006 and 2007 because the normal three-year statute of limitation had expired for those years and the six-year statute of limitation was inapplicable.

Issues: Sec. 6501(e)(1) extends the normal three-year statute of limitation to six years when a taxpayer omits from gross income an amount that exceeds 25% of the gross income stated in the return. With respect to investments or other assets giving rise to capital gain or loss, the Tax Court in Insulglass Corp., 84 T.C. 203 (1985), held that the gain or loss from the sale, not the gross proceeds, should be used to compute the gross income stated in a return for purposes of Sec. 6501(e)(1).  

This position was adopted by the IRS in Regs. Sec. 301.6501(e)-1, in which the IRS also provided rules for determining whether gross income has been omitted from a return. Under the regulations, an understatement of gross income related to a disposition of property that is due to an overstatement of the basis of the property is an omission of gross income for purposes of Sec. 6501(e). These regulations were contrary to the Supreme Court’s opinion in Colony, Inc., 357 U.S. 28 (1958), in which the Court held that underreported gain due to overstated basis of property sold was not omitted gross income for purposes of the predecessor statute to Sec. 6501(e). In 2012, the Supreme Court invalidated the portion of the regulations dealing with omitted income in Home Concrete & Supply, LLC, 132 S. Ct. 1836 (2012), because they were contrary to its holding in Colony (see “Home Concrete Decision Offers Limited Guidance,” JofA, March 2013, page 58).

The Barketts argued that in Home Concrete the Supreme Court had invalidated Regs. Sec. 301.6501(e)-1 in its entirety, including the part of the regulations governing the calculation of gross income stated in the return. By extension, the taxpayers claimed that Home Concrete invalidated the Tax Court’s holdings in previous cases on this point. Based on the Court’s holding that an understatement of gain due to a basis overstatement of property sold was not omitted income for Sec. 6501(e) purposes, the taxpayers argued that gross income stated in a return should include the proceeds from a sale of investment property, not the gain from the sale for purposes of the statute.

Holding: The court rejected the taxpayers’ argument, holding that the Home Concrete decision did not address how to calculate income for purposes of Sec. 6501(e). Therefore, the Supreme Court’s decision invalidated only the portion of Regs. Sec. 301.6501(e)-1 that relates to what constitutes an omission from gross income and had no impact on the regulation’s instructions for calculating gross income stated in a return or the Tax Court’s previous decisions that were consistent with the regulations. Furthermore, according to the Tax Court, although the Supreme Court did not address the issue of the calculation of gross income directly, a dictum from the Home Concrete case supported its position that gross income from the sale of investment property includes only gain from the sale.

• Barkett, 143 T.C. No. 6

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.