Tax Break

The tax code ‘ambiguous’? Supreme Court to decide

January 18, 2012

A $6 million tax bill landed before the Supreme Court on Tuesday, leaving the justices to determine the will of Congress and the high court’s own decisions from more than 50 years ago. (See the Reuters  preview here.)

The case centers on a law from 1954 in which Congress granted the Internal Revenue Service an extended statute of limitations to ferret out tax cheats when the taxpayer “omits from gross income” more than 25 percent of his or her tax liability.

The tax shelter at issue – known as Son of Boss transaction – claimed fake tax losses, or an “overstatement of basis.”

The IRS tried to argue X equaled Y – that an overstatement of basis was the same as an omission of gross income.

Lower courts were not kind to that IRS argument. So in 2009, the IRS wrote a regulation stating that an overstatement of basis was the same as an omission of income. Taxpayers balked, saying the regulation overstepped the service’s authority.

On Tuesday, the IRS argued Congress and the courts had been ambiguous on the issue, and its regulation simply tidied up the law.

The justices seemed to view the IRS argument as dubious.

“It depends on what the meaning of ‘ambiguous’ is, right?” asked Justice Antonin  Scalia. Laughter ensued.

Justice Sonia Sotomayor agreed. “My problem with your argument…,” she said, referring to the IRS position, “it’s a bit convoluted.”

The $6 million tax bill at issue involved a once-popular tax move called a Son of Boss transaction that was engineered for two North Carolina businessmen. They paid their taxes in April 2000, but were not sent a bill for unpaid taxes until 2006. The typical statute of limitations for tax bills is three years.

Justice Stephen Breyer summed it up this way:

“The IRS lost in court and then argues, ‘we told everybody this is ok at the time they filed the return, now we are going to pass a new reg and we are going to penalize them, taking all back, this money, nine years later. That seems to me pretty unfair.’”

Tax professionals who have been following this case said the court could make a narrow decision, giving a simple interpretation of the 1950s-era tax law. If the court finds the six-year statute of limitations does not apply, then the taxpayer wins.

The question of tax shelter abuse was not at issue. “A child of two would have known this was a loophole,” Breyer said.

The court also might rule more broadly to say the IRS overreached in its attempt to write a regulation retroactively after it lost court cases.

Son of Boss transactions were popular, and all told, about $1 billion in uncollected tax revenues is at stake, the government said in court documents. About 30 other Son of Boss tax shelter cases await the Supreme Court’s decision.

For more, check out this preview to the oral arguments by Alan Horowitz, an attorney with Miller & Chevalier in Washington.

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