May 17, 2011

Statute of Limitations: Big Win for the IRS

By Virginia Boyce, Manager

Statute of Limitations: Big Win for the IRS

In Grapevine Imports, Ltd. v U.S., the Court of Appeals reversed a lower court decision and held that an overstated basis is an omission of gross income for purposes of determining if the six year statute of limitations period applies.This was a huge win for the IRS since previous cases, such as Colony, Inc. v. Commissioner, were determined for the taxpayer and only allowed a three year statute of limitations. Although courts normally follow precedent case law, this court had a contrary decision due to the intervening facts.

Generally, the Internal Revenue Code provides that the IRS can only assess taxes within three years of the later of the date the tax return was filed or the due date of the tax return.However, that period can be increased to six years if the taxpayer omits gross income of more than 25%.“Gross Income” is defined as the total of the amounts received or accrued from the sale of goods or services.

In the Grapevine case, a husband and wife and a small general partner were partners in Grapevine Imports, Ltd.Both the partnership and the couple filed their tax returns on time. The IRS later made an adjustment to the partnership return which decreased the partners’ basis and thus disallowed a portion of the original losses. After the IRS issued a final partnership adjustment, the couple filed a complaint with the Court of Federal Claims for readjustment of partnership items. The taxpayers requested that the court either declare the adjustments invalid or order the IRS to reverse the claim since it was issued after the normal statute of limitations. The taxpayers argued that additional tax couldn’t be assessed because it had been longer than three years after their personal tax returns were due and filed. The IRS argued that the original overstatement of basis qualified as an omission of gross income and therefore the six year statute applied.

Grapevine won in Federal Claims Court because the decision was based on prior case law which indicated that an overstated basis didn’t represent an omission of gross income, but merely a misstatement. The IRS appealed and during the time it took to settle the case, another case was settled with the same conclusion. However, after this case settled, the IRS issued new regulations.

The Court of Appeals now had to determine if the IRS could retroactively apply the new regulations to this case. As determined in a previous case, the IRS regulations are to be interpreted under the Chevron standards which state that there must be enough ambiguity in the statute to allow interpretation and the IRS’ interpretation must be a reasonable interpretation of Congress’ intent. The court found that the IRS had met both of these tests and therefore allowed the six year statute to apply. The court further found that the new regulations could be applied to this case even though they were finalized after the return was filed because the statute remained open as long as the limitations period wasn’t closed. The court agreed with the IRS.

Grapevine was an important case for the IRS because it allowed the IRS to retroactively apply the new regulations. The regulations extended the definition of “omission of gross income” to include an overstated basis and thereby allowed an extension of the statute of limitations.