Income omission triggers 6-year limitation period

Reporting of some S corporation gross receipts is not adequate disclosure of all receipts, the Tax Court holds.
By Charles J. Reichert, CPA

The Tax Court held that the six-year statute of limitation applied to three years of tax returns of a married couple, due to their omission of more than 25% of their reported gross income in each of those years. According to the court, the taxpayers did not adequately disclose the omitted income on their tax returns for the three years to avoid the application of the six-year limitation period.

Facts: Robert Manashi owned 100% of the stock of Flight Vehicles Consulting Inc. (FVC), an S corporation. During 2006, 2007, and 2008, Manashi maintained a business bank account and two personal bank accounts and deposited gross receipts from FVC into all three accounts. Only the receipts deposited into the business account were reported on Form 1120S, U.S. Income Tax Return for an S Corporation, for the three tax years, resulting in the omission of $800,164, $840,795, and $810,490 of income on Form 1120S for 2006, 2007, and 2008, respectively. This omission of income also caused the same amounts to be omitted from the taxpayers' Form 1040, U.S. Individual Income Tax Return, for those three tax years. For each year, the omission exceeded 25% of the gross income reported on Form 1040.

After the three-year statute of limitation had expired, the IRS issued notices of deficiency totaling $786,745, plus penalties totaling $157,349, for tax years 2006, 2007, and 2008. The taxpayers petitioned the Tax Court for a redetermination of the deficiencies.

Issues: Generally, the IRS must mail a notice of deficiency within three years of the filing date of a tax return. However, when a taxpayer omits gross income that exceeds 25% of the gross income reported on the return, a six-year statute of limitation applies. Under Sec. 6501(e)(1)(B)(iii), the amount of omitted gross income (for purposes of the limitation period) does not include any amount that "is disclosed in the return, or in a statement attached to the return, in a manner adequate to appraise the Secretary of the nature and amount of such item." Disclosure is adequate if the return offers a clue regarding the existence, nature, and amount of the omitted income, and the disclosed income must be apparent to a reasonable person. When an individual tax return refers to another tax return, such as Form 1120S, the information on that return must also be considered when determining whether there was adequate disclosure. The taxpayers argued that they had provided adequate disclosure because FVC reported some gross income for the years in question and that FVC's banks and clients filed Forms 1099 that should have made the IRS aware of the omitted income.

Holding: The Tax Court held that the six-year limitation period applied because the omitted income was not adequately disclosed. The court rejected the taxpayers' contention that reporting some gross income provides adequate disclosure because reporting some income provides "no clue" that other income was not reported. The court also rejected the taxpayers' argument that the Forms 1099 filed by banks and clients should have made the IRS aware of the unreported income because those forms, if they were actually filed, were not attached to the taxpayers' tax returns. As a result, any omitted income that might have been reported on the Forms 1099 could not have been disclosed in the tax return, according to the court.

  • Manashi, T.C. Memo. 2018-106

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

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