January 4, 2012
(Editor’s note: With January comes the start of tax season. Throughout the month, we’ll be looking at current and possible future developments in tax law.)
It’s the start of the New Year, and tax season along with it.
As people are preparing their own tax filings (or others’), they will inevitably be looking at ways to lower their tax bills.
As a Headnote of the Day from last year pointed out, this is perfectly legal.
The caveat here, though, is that the method used to reduce tax liability must also be legal.
However, sometimes the tricky part is figuring out exactly what is legal.
Take the case of Home Concrete and Supply, LLC.
The entity was created in 1999 in anticipation of the sale of another business, Home Oil and Coal Company, to secure a higher basis for Home Oil.
“Basis” is relevant for capital gains tax computations, and represents the price at which a property was originally purchased at.
Basis is subtracted from the final sale price to compute the “capital gains” (though a bit oversimplified, that’s the gist of it).
The short version of the Home Concrete story is, through several short sales and other transactions, the entity was able to reduce its profit from the sale of Home oil to $69k down from somewhere in the neighborhood of several millions of dollars.
Apparently, despite consulting with several financial planning firms, something wasn’t done quite right and the IRS called foul and issued a subpoena in June 2003 (and paid the difference in tax liability – almost $1.4 million).
The dispute has continued since, and the Supreme Court agreed to take the case in its current term.
The question isn’t whether what Home Concrete did was legal (at least, the entity doesn’t seem to be disputing that point).
The issue is whether a three- or six-year statute of limitations applies.
If the misstated basis is an “overstatement,” the statute of limitations is three years, and it’s six for an “omission from gross income.”
According to the appeals court, the case is conclusively decided by the Supreme Court’s 1958 decision Colony v. Commission of Internal Revenue, which first interpreted the overstatement/omission distinction that seems to apply squarely here.
At first glance, it’s easy to agree with the appeals court’s logic.
The fact that Supreme Court agreed to hear the case should raise some questions, though.
Indeed, it’s what led me to actually read Colony, which revealed something interesting: the Supreme Court explicitly stated that the question before it was resolved by the 1954 version of the tax code, and that it was only interpreting terms in the earlier 1939 version.
We’ve actually gone through several more tax code revisions since (we’re now based on the 1986 version), so the weight of Colony is a little less clear.
Although earlier I said the question is what statute of limitations applies, the Supreme Court won’t actually be making that decision (at least not overtly).
Instead, if Colony is found to not apply, it then must decide under the factors from Chevron v. NRDC whether it has to defer to the IRS’s interpretation (that the six-year statute of limitations applies).
With oral arguments scheduled for January 17, we may get some insight into how the Court will rule before the decision is handed down several months later.
Although that $1.4 million (plus interest) may be worth the nine-year legal fight to Home Concrete, there’s still the distinct possibility that it could lose.
Nevertheless, as mentioned in the beginning of this article, you should always try to find ways to reduce your tax bill.
The lesson of Home Concrete, though, is that you shouldn’t engage in business transactions whose sole purpose is tax avoidance.