A Word on Statute of Limitations for Basis Overstatement

This blog entry concerns United States v. Home Concrete, 2012 U.S. LEXIS 3274 (2012), a recent Supreme Court case, which held that one’s basis overstatement is not an omission of income for which the extended six-year statute of limitations in IRC § 6501(e) applies.

Background.

Generally, when you sell something, you must report the “taxable gain.” The less taxable gain you have, the less taxes you pay. This is because the gain is the “amount realized” (the amount you receive in a sale/exchange) minus your “adjusted basis.” IRC §1001(a). One way people may try to reduce their amount of gain is by overstating their “basis” in the property they sold. Your basis is usually “cost”–the amount you paid for the property, but it can be decreased or increased for various reasons (after the adjustments it’s called your “adjusted basis”). For example, if you depreciate the property, your tax basis goes down and, when you sell the item, you’ll have more taxable gain, more taxes. So, generally, taxpayers desire to have a higher–rather than lower–basis in the property they sell.

What happens, however, in an effort to have less taxable gain, a taxpayer overstates his basis in the property he sold? How long does the government have to prosecute you? The Supreme Court recently made a taxpayer favorable ruling on this question (more on that below).

Statute of limitations: 3 year, 5 year, 6 year, and unlimited.

The statute of limitations in a case varies with what the government seeks to prove you committed. A person may be tried under the Internal Revenue Code (“Title 26″), Title 18, or, in many cases, both.

Title 18 Offenses. The general statute of limitations for a Title 18 offense is 5 years. 18 U.S.C. §3282. After this time, no person may be “prosecuted, tried, or punished.” As mentioned above, often the same conduct may serve as both a basis for a Title 18 violation and a Title 26 violation. In particular, three are noteworthy: the aiding and abetting statute (18 USC §2), the conspiracy statute (18 USC §371), and the false statement statute (18 USC §1001). I mention these in passing and to provide an overview.

 

Title 26 (IRC) Offenses Generally, under IRC § 6531, the statue of limitations for the government to criminally prosecute someone is 3 years. However, IRC §6531 specifically provides for a 6 year statute of limitations in eight cases, which may be quickly summarized as a conspiracy to (1) defraud or attempt to defraud the United States, or (2) to attempt in any manner to defeat any tax or it payment. IRC §§6531(1), 6532(2). The 6 year limitation period is significant because it covers the most frequently used tax offenses: evasion, failure to file, and making false statements to the government.

It is crucial to realize that these periods only limit the time for the government to prosecute a taxpayer for the crime; if proven guilty, he will still be liable for the tax he evaded–as well as for interest and civil penalties–even if it extends beyond 6 years.

Assessments. A special limitation exists for assessments. Under IRC § 6501(a), the government must make an assessment within a 3 year period. But there are a number of exceptions to this. In particular, one’s filing a fraudulent return, engaging in a willful attempt to evade tax, or failing to file a return results in an unlimited statute of limitations. IRC § 6501(c).

What Statute of Limitations Applies for Basis Overstatement? Now, the question we want to know is: Does overstating your basis fall within the 6 year, 3 year, 5 year, or an unlimited statute of limitations?

Ignoring Title 18 for the moment (which generally has a longer statute of limitations), the government must assess a taxpayer’s deficiency within “3 years after the return was filed.” IRC §6501(a). But, this 3-year period is extended to 6 years when a taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return.” §6501(e)(1)(A). In other words, if you failed to include more than 25% of your actually gross receipts, the government has 6 years to catch you. Does overstating your basis constitute an “omi[ssion] from gross income” for purposes of analyzing the statute of limitations in IRC §6501(e)?

Surprisingly, the Court said No. It stated that the 6 year period would not apply, but that only the 3 year period would. The Court held that if you overstate your basis in property, it is not an omission of income subject to the extended six-year statute of limitations in IRC §6501(e). The opinion reads:

Ordinarily, the Government must assess a deficiency against a taxpayer within “3 years after the return was filed.” 26 U. S. C. §6501(a) (2000 ed.). The 3-year period is extended to 6 years, however, when a taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return.” §6501(e)(1)(A). The question before us is whether this latter provision applies (and extends the ordinary 3-year limitations period) when the taxpayer overstates his basis in property that he has sold, thereby understating the gain that he received from its sale. Following Colony, Inc. v. Commissioner, 357 U. S. 28 (1958), we hold that the provision does not apply to an overstatement of basis. Hence the 6-year period does not apply.

http://www.supremecourt.gov/opinions/11pdf/11-139.pdf

Tax evasion defined. Recall that tax fraud is the willful attempt in any manner to evade or defeat tax or the payment of such tax. It is punishable by a fine of up to $100,000 in the case of individuals (and up to $500,000 in the case of corporations) or imprisonment up to five years, or both, plus the costs of prosecution. It is also described as a felony  in IRC § 7201 (See, e.g., http://www.law.cornell.edu/uscode/text/26/7201).

The above definition of tax evasion is broad–maximally broad. The language of “any manner” would include a person’s overstating his basis, thus making it a felony to do so; and it would also mean that the unlimited statute of limitations applies. However, the above case was not decided on fraud. What is so surprising is that it seems that the IRS could have brought a fraud case for one’s basis overstatement. For more on related crimes and their statute of limitations, visit: what-crimes-as-set-forth-in-the-federal-criminal-code-can-apply.html

Two take-away lessons. The take-away lesson from all this is two-fold. First, it not clearly impossible for the IRS to bring a fraud claim–and thus may avail itself of the unlimited statute of limitations–for overstatement of basis. Furthermore, as mentioned, the above case did not answer the question: “What statute of limitations is appropriate for a basis overstatement in violation of Title 18?” Thus, it is wide open to the government to challenge basis overstatement offenses under different legal theories, thus extending the time period it may come after you.

Second, remember the limited holding of the case. Even after the 3 year mark, even though a taxpayer may not be prosecuted for the crime, he may still be liable for the tax he evaded–as well as for interest and civil penalties.

These are tricky issues. If you know someone who has overstated the basis in his property in a sale or transaction (thereby reducing his taxable gain), he may be liable. To help minimize his liability exposure, and to have the best chance at avoiding tax fraud status, he should retain competent legal counsel from a tax attorney. We’d love to help.