Attorney-at-Law

Carpenter, Colony, Chevron and Mayo

In Uncategorized on 04/26/2011 at 21:29

Or, When is a Regulation Not a Regulation?

 This was the riddle with which Tax Court grappled in Carpenter Family Partnership, 136 T.C. 17, released 4/25/11, with Judge Wherry for the majority and Judges Halpern, Hughes and Thornton concurring.

The issue was which statute of limitations (hereinafter the “SOL”) applied–either the three-year statute of limitations (hereinafter “3SOL”) applied to the partnership’s return for tax year 2000, or the substantial understatement six-year statute (hereinafter the “6SOL”). Taxpayer agreed to an extension of time to assess in 2007; if 3SOL applied, it had already run and there was nothing to extend, as an extension is valid only if made prior to running of the applicable SOL. See Section 6501(c)(4).

The underlying tax issue was the phony stock or foreign currency transaction, whereby a low basis in property is inflated by contributing it to a partnership, with a simultaneous but unrecognized offsetting contribution. The basis thus increased, the property is sold, and gain minimized. See my blog for January, 2011, for Stobie Creek and its offspring.

But the heart of the question is the SOL. 3SOL or 6SOL? IRS claims it issued temporary regulations in 2009, clarifying that overstatement of basis equals understatement of tax, other than in a trade or business, neither of which taxpayer concededly is, and therefore 6SOL. Of course, Tax Court struck down the temporary regulations, so IRS made them permanent and is trying to apply them here.

No way, says Judge Wherry. Ditto, say Judges Halpern and Hughes, and “Amen” says Judge Thornton, though their reasoning differs.

To begin with, the applicability date of the permanent regulations was circular, as it applied the regulations to unclosed years, which were rendered unclosed solely by virtue of those self-same regulations. Treasury tries to solve the problem with a semantic song-and-dance, which Tax Court brushes aside.

Tax Court parses the Colony decision (Colony, Inc. v. Commissioner, 357 U.S. 28 (1958)), the Supreme Court’s Chevron decision (Chevron USA Inc. v. Natural Res. Def. Council, 467 U.S.837 (1984), and the most recent Supreme Court pronouncement, Mayo Foundation for Medical Education and Research v. United States, 562 U.S.___, 131 S.Ct. 704 (2011). Did Congress leave a gap for the agency to fill? If Congress did and the agency fills the gap, “arbitrary or capricious in substance, or manifestly contrary to the statute”, are the only grounds upon which a court can set a regulation aside.

Tax Court says, however you slice it, the regulations cannot extend 6SOL to this case. I leave a detailed analysis of Judge Wherry’s 43-page exegesis, and Judges Halpern, Hughes and Thornton’s 15-page concurrences, to the law review writers. I am a simple practitioner. The takeaway–until Congress or the Supreme Court say otherwise, the 3SOL controls substantial understatement anywhere but in a trade or business.

And you may be sure there will be an appeal.

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