Ranch v. Comm'r of Internal Revenue

• Decision Date: 31 May 2011
• Docket Number: No. 09–9015.,09–9015.
• Citation: 647 F.3d 929
• Parties: SALMAN RANCH, LTD.; Frances Koenig, Tax Matters Partner, Petitioners–Appellees,v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellant.Bausch & Lomb Incorporated, Amicus Curiae.
• Court: U.S. Court of Appeals — Tenth Circuit

647 F.3d 929

107 A.F.T.R.2d 2011-2359

2011-1 USTC P 50,405

SALMAN RANCH, LTD.; Frances Koenig, Tax Matters Partner, Petitioners–Appellees,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellant.Bausch & Lomb Incorporated, Amicus Curiae.

No. 09–9015.

United States Court of Appeals, Tenth Circuit.

May 31, 2011.

Gilbert S. Rothenberg, Acting Deputy Assistant Attorney General (John A. DiCicco, Acting Assistant Attorney General; and Michael J. Haungs and Joan I. Oppenheimer, Attorneys, Tax Division, Department of Justice, with him on the briefs), Washington, D.C., for Respondent–Appellant.Alan Poe (Adam M. Cohen with him on the brief) of Holland & Hart LLP, Greenwood Village, Colorado, for Petitioners–Appellees.Roger J. Jones of Latham & Watkins LLP, Chicago, Illinois, and Kim Marie Boylan of Latham & Watkins LLP, Washington, D.C., filed a brief for Amicus Curiae Bausch & Lomb Incorporated.Before LUCERO, SEYMOUR, and TACHA, Circuit Judges.SEYMOUR, Circuit Judge.

The Commissioner of the Internal Revenue Service appeals a decision of the Tax Court granting summary judgment in favor of Salman Ranch, Ltd. (“Partnership”), holding that the IRS's administrative adjustments of the Partnership's 2001 and 2002 tax returns were barred by the three-year limitations period in I.R.C. § 6501(a). We have jurisdiction pursuant to I.R.C. § 7482(a)(1). Because we conclude the IRS's adjustments were timely under the six-year limitations period in I.R.C. § 6501(e)(1)(A), we reverse.

I.

The Partnership owns a ranch in Mora County, New Mexico. This dispute arises from the Partnership's treatment of various transactions, including sales of parts of the ranch, on its 2001 and 2002 tax returns.¹ Because the underlying transactions have been described in connection with prior litigation, see Salman Ranch Ltd. v. United States (Salman Ranch I), 79 Fed.Cl. 189, 190–92 (2007); Salman Ranch Ltd. v. United States (Salman Ranch II), 573 F.3d 1362, 1363–65 (Fed.Cir.2009), we discuss them here only briefly.

In October 1999, the Salman Ranch partners individually entered into short sales involving United States Treasury Notes, generating cash proceeds totaling $10,982,373.² Salman Ranch II, 573 F.3d at 1364. Five days later, the partners transferred those cash proceeds to the Partnership, along with the corresponding obligation to close the short sales. Id. The Partnership satisfied that obligation within weeks, buying replacement bonds for $10,980,866. Id.

In November 1999, after the short-sale transactions, the partners caused a technical termination of the Partnership under I.R.C. § 708(b)(1)(B), which allowed them to adjust the basis in the ranch pursuant to I.R.C. §§ 754 and 743(b)(1). Salman Ranch II, 573 F.3d at 1364. In making this adjustment, the Partnership increased its basis to reflect proceeds from the short sales, without reducing its basis to account for the offsetting obligation to close the short sales. See id.

In December 1999, the Partnership sold a portion of the ranch for $7,188,588 and granted the purchasers an option to purchase most of the remainder. Id. at 1364–65. The buyers exercised that option in 2001. They purchased a second portion of the ranch for an additional $7,260,084, making payments to the Partnership in 2001 and 2002.

The Partnership's 2001 and 2002 tax returns reported basic components of these transactions.³ The 2001 return listed the $7,260,084 selling price for the 2001 sale of the ranch, a basis of $6,832,230, and other sale expenses of $386,029, for a gross profit of $41,825. The 2001 and 2002 returns also listed installment sale income from the 2001 sale of $11,468 and $30,357, respectively. The partners reported their proportionate shares of the income on their individual returns. Neither the Partnership's return nor the partners' individual returns explained the relationship between the stepped-up basis and the short-sale transactions.

Components of the underlying transactions had been reported on the Partnership's 1999 tax returns.⁴ Those returns listed proceeds from the 1999 sale, a stepped-up basis in the ranch, and the Partnership's election to adjust its basis following the technical termination. Salman Ranch II, 573 F.3d at 1364–65. Like the 2001 and 2002 returns at issue in this case, the 1999 return apparently did not explain the connection between the stepped-up basis and the short-sale transactions. See id. at 1365.

The IRS eventually determined these transactions amounted to a “Son of BOSS” tax shelter.⁵ In particular, it concluded the partners had used the short-sale transactions to artificially inflate the Partnership's tax basis in the ranch by the amount of the offsetting obligation to close the short sales. Without the overstated basis, the IRS calculated the gross (potentially taxable) income on the Partnership's returns would increase by $4,567,949 in the 1999 tax year, by $1,331,281 in the 2001 tax year, and by $3,524,010 in the 2002 tax year.

Accordingly, the IRS issued Notices of Final Partnership Administrative Adjustments (FPAAs) seeking to adjust the Partnership's 1999, 2001 and 2002 tax returns to correct for the alleged overstatement of basis.⁶ The FPAAs were issued more than three years, but fewer than six years, after the returns were filed.⁷

The timeliness of the 1999 FPAA was the subject of the prior litigation in the Federal Circuit. See Salman Ranch II, 573 F.3d at 1363. The issue in Salman Ranch II, as in this case, was whether a three-year or six-year statute of limitations governed the administrative adjustment. Although the IRS normally must issue an FPAA within three years after a return is filed, see I.R.C. § 6501(a), the period is extended to six years “[i]f the 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....” I.R.C. § 6501(e)(1)(A).⁸ The IRS contended the six-year limitations period applied to the 1999 FPAA because the Partnership's alleged overstatement of basis was an omission from gross income sufficient to trigger the extended limitations period. The Partnership claimed it was not. The Court of Federal Claims found in favor of the IRS, ruling that by overstating its basis in the ranch, the Partnership had “omit[ed] from gross income an amount” on its return, thereby triggering the six-year limitations period. Salman Ranch I, 79 Fed.Cl. at 193–94, 204. The Federal Circuit, however, reversed. Salman Ranch II, 573 F.3d at 1377.

In ruling for the Partnership, the Federal Circuit relied on Colony v. Commissioner, 357 U.S. 28, 78 S.Ct. 1033, 2 L.Ed.2d 1119 (1958). Colony was a statutory construction case. Although it was argued and decided after the enactment of the 1954 Tax Code, it involved construction of § 275(c) of the 1939 Tax Code. That subsection, which was the predecessor to § 6501(e)(1)(A) (1954), allowed the IRS five years, rather than three years, for assessing deficiencies when a taxpayer “omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return.” ⁹ I.R.C. § 275(c) (1939). The taxpayer in Colony was a real estate company that sold land. The company's 1946 and 1947 tax returns included unallowable development costs in calculating its basis in certain lots. Colony, 357 U.S. at 30, 78 S.Ct. 1033. The question was whether the IRS had three years or five years to assess the resulting deficiencies on the company's 1946 and 1947 tax returns. Id. at 31, 78 S.Ct. 1033.

In determining whether the phrase “omits from gross income an amount” included an overstated basis, the Court observed, “[I]t cannot be said that the language is unambiguous. In these circumstances, we turn to the legislative history of § 275(c).” Id. at 33, 78 S.Ct. 1033. Turning to legislative history, the court found “persuasive indications that Congress merely had in mind failures to report particular income receipts and accruals, and did not intend the five-year limitation to apply whenever gross income was understated.” Id. at 35, 78 S.Ct. 1033.

The Court concluded the purpose of the five-year period in § 275(c) was to give the IRS extra time to investigate returns in which a taxable item is omitted in its entirety from a return, not where an item is included in the return but miscalculated. Id. at 35–36, 78 S.Ct. 1033. On this rationale, the Court held that an overstatement in basis was not an omission from income subject to the extended limitations period in § 275(c). Id. at 36, 78 S.Ct. 1033. In so holding, the Court noted its conclusion was “in harmony with the unambiguous language of § 6501(e)(1)(A).” Id. at 37, 78 S.Ct. 1033.

In the Federal Circuit, the IRS argued Colony was inapplicable because its holding was limited to the trade-or-business context of the case before the Court. See Salman Ranch II, 573 F.3d at 1371–72. The IRS based its argument on differences between § 275(c) and its modern version, § 6501(e)(1)(A). See id. Among such differences, the IRS emphasized the addition of subparagraph (i) to § 6501(e)(1)(A). Subparagraph (i) was added to the former § 275(c) by the 1954 Tax Code. As noted above, it provides that, “[i]n the case of a trade or business, the term ‘gross income’ means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to diminution by the cost of such sales or services.” I.R.C. § 6501(e)(1)(A)(i); see also supra note 8 (discussing the evolution of § 6501(e)). The IRS argued that subparagraph (i) set forth a gross receipts test similar to that adopted in Colony and reflected Congress's intent to make this test applicable only “[i]n the case of a trade or business.” Salman Ranch II, 573 F.3d at 1371 (internal quotation marks omitted) (alteration in original). According to the IRS, applying Colony's gross receipts test to every type of sale...