The Supreme Court ruled in favor of the taxpayer in a 5-4 vote concluding that an overstatement of basis is not considered an omission of gross income for the purposes of the six year limitation rules.
Generally, the IRS has three years to make an adjustment to an annual tax return. For example, the 2011 annual tax return was due on 4/17/12. The IRS has until 4/17/15 to make an adjustment. However, if the IRS reviewed a 2011 annual return and there was a gross income omission of more than 25%, then the IRS would have six years (until 4/17/18) to make an adjustment. If the 2011 annual tax return originally reported gross income of $100,000 but the actual gross income is found to be $126,000, this would be considered an omission of more than 25%.
Prior to the Supreme Court ruling, the IRS considered an overstatement of basis to be an omission of gross income for the purposes of the six year rule. The following is an example.
o Stock is purchased for $10,000. This would be the basis.
o The stock is then sold for $46,000.
o On the tax return, the purchase price or basis is erroneously recorded as $40,000 instead of $10,000. This would result in a $6,000 tax gain reported on the tax return. ($46,000 – $40,000 = $6,000)
o The tax return is audited and the basis error is found. The IRS concludes that the basis was incorrectly reported. The overstatement is $30,000 ($40,000 – $10,000 = $30,000)
o The IRS concludes that the $30,000 of additional taxable income should have been reported on the tax return.
o If the original tax return reported $100,000 of gross income but due to the error the actual income was $130,000, this would be considered a 30% omission of income.
o The position of the IRS was that it should be able to audit the last six years of tax returns instead of just the last three years because the 30% omission is greater than the 25% omission threshold.
The Supreme Court concluded that the overstatement of basis is not an income omission for six-year limitations period. Therefore in the example provided, the IRS will be able to audit the last three years only. This decision will have an impact on the IRS’s collection efforts in similar cases.
If your return is being audited and there is an omission of income, ALG Tax Solutions, P.C. can help. Call us at 855-MI-TaxHelp. (855-648-2943)
IRS Circular 230 Disclosure: To the extent this writing contains advice on a federal tax issue, the advice is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed in this communication.