Partnership Argues FPAA Properly Barred by Statute of Limitations

Prior to April 1, 1998, BEP owned an interest in an oil and gas property with Harcor, an unrelated company. After a proposed sale of the oil and gas property to another unrelated entity, Seneca Resources, fell through, the Partners decided to restructure the ownership of BEP. To effect this new structure, on April 1, 1998, the Partners sold their partnership interests in BEP to Bakersfield Resources, LLC ("BRLLC"), an entity that had been formed by the Partners.

The Partners recognized the gain from the sale of the BEP partnership interests under the installment method. For all tax years beginning in 1998, the Partners have reported the gain from this sale under the installment method.

The sale of the Partners' BEP partnership interests caused a termination of BEP's tax year pursuant to I.R.C. § 708. BEP made an election under I.R.C. § 754 to adjust the basis of the partnership assets (the "inside basis") to equal BRLLC's basis on its newly acquired BEP partnership interests (the "outside basis") pursuant to I.R.C. § 743(b). As set forth below, the § 754 election and the § 743(b) basis adjustments were disclosed in statements attached to BEP's partnership return for the short period from April 1 through December 31, 1998 ("BEP's 9812 Form 1065").

On BEP's 9812 Form 1065, the gain on the sale of the royalty interests constituted $1,993,054 out of total income reported of $2,266,296. (ER 61) The computation of the gain was disclosed in BEP's 9812 Form 1065 on IRS Form 4797, Sales of Business Property. This Form 4797 disclosed that a total gain of $7,383,417 resulted from a gross sales price of $23,898,611 minus basis of $16,515,194. (ER 65-66)

Attached to BEP's 9812 Form 1065 was a Statement Regarding a Partnership Technical Termination as follows:

After filing a timely Tax Court petition, the Partners filed a motion for summary judgment on the ground that the FPAA was issued after the applicable period of limitations had expired. The normal period of limitations set forth in I.R.C. § 6229(a) is three years after the partnership return has been filed. The IRS opposed the Partners' motion and filed a cross-motion seeking a determination from the Tax Court that a six-year period of limitations applied because BEP "omitted" an amount in excess of 25% of the amount of gross income actually reported on BEP's 9812 Form 1065.

After receiving numerous filings and holding oral argument on the parties' motions for summary judgment, the Tax Court held that nothing was omitted from BEP's 9812 Form 1065 because the basis claimed by BEP on that return was prominently disclosed and, therefore, was not omitted. The IRS filed a timely appeal from this ruling.

The IRS Brief (at p. 10) states that the Tax Court, "Ruled that an overstatement of basis is not an omission of gross income within the meaning of the statute." This misstates the Tax Court's holding. The Tax Court actually held that "omits means omits," and that there was nothing "left out" of BEP's 9812 Form 1065 and therefore the extended period of limitation did not apply.

The IRS Brief similarly misstates the holding of Colony. The IRS Brief suggests that Colony is a case about the definition of gross income in the former version of a parallel statute. To the contrary, Colony is a case that establishes that "omits means omits" in the context of this statutory scheme. Colony, therefore, holds that an overstatement of basis (such as the IRS alleges exists in our case) does not constitute an omission that triggers an extended period in which the IRS may audit the applicable return.

The remaining errors in the argument set forth in the IRS Brief flow from the fundamental error in misconstruing the holding in this case and in Colony. The IRS Brief asserts tertiary rules of statutory construction in a misguided attempt to avoid the plain meaning of the critical word in the statute, "omits." It is true that cases exist which define "gross income" in I.R.C. § 6229(c)(2) or the parallel I.R.C. § 6501(e)(1)(A). These cases are only relevant to determine the amount reported on the return against which the omission is judged to determine if the omission was greater than 25%. Nothing in these cases in any way detracts from the holding in Colony that an omission must be an omission. It is only when the amount is "left out" of the applicable return that the plain meaning and the statutory purpose of the extended period of limitations is applicable.

Finally, the IRS Brief (at footnote 6) incorrectly contends that the issue of the adequacy of BEP's disclosure was not ripe for summary judgment. The only fact necessary for this determination is BEP's 9812 Form 1065. There is no dispute as to the contents of this return. If it is determined that there was 25% omission of gross income in this case, summary judgment must still be granted to the Partners because the omission was adequately disclosed and the six-year period of limitations cannot apply.

The Partners agree with the standard of review set forth in the IRS Brief. This Court reviews the grant of summary judgment by the Tax Court de novo. Talley Industries, Inc. v. Commissioner, 116 F.3d 382, 385 (9^th Cir. 1997).

B. The Definition of "Gross Income" Does Not Matter, the Real Issue in this Case is the Definition of "Omits."

Almost all of the argument in the IRS Brief is devoted to an exhaustive statutory construction and case law interpretation of the meaning of "gross income." Unfortunately for the IRS, this analysis is entirely irrelevant. The Partners could concede whatever definition of "gross income" the IRS wishes to assert. The Partners will still prevail because nothing was omitted from BEP's 9812 Form 1065.

As is conceded in the IRS Brief at p. 18, it is useful to illustrate the operation of I.R.C. § 6229(c)(2) in the form of an equation. In this equation, the omitted amount equals "0," and the reported gross income equals "GI." This six-year period of limitations, therefore, applies when 0 ÷ GI > 25%.

This equation illustrates the importance of the two definitions. First, it must be determined what amount is "omitted" for the purpose of the numerator. Then it must be determined what amount constitutes the "gross income" for the purpose of the denominator. All of the analysis in the IRS Brief addresses the definition of the denominator. This case, however, is a case about the definition of the numerator. The numerator was defined in Colony and was determined in this case by the Tax Court. The numerator in this case is zero because nothing was omitted from BEP's 9812 Form 1065. The IRS Brief can ramble all day on esoteric theories of statutory construction with respect to the denominator. None of this analysis can deflect the inquiry from the real issue in this case, the definition of "omits" in the numerator. "Omits" means omits. The $16,515,194 basis amount disclosed on a separate line item on BEP's 9812 Form 1065 (ER 68) was not omitted. Virtually all of the argument in the IRS Brief can be ignored as a red herring.

C. "Omits" Plainly Means Omits.

The primary axiom of statutory construction dictates the outcome of this case. The words in statutes are to be construed according to their plain meaning. There is no need to resort to legislative history or other principles of statutory construction if the plain meaning of the words is clear. United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241 (1989). See also, Gitlitz v. Commissioner, 531 U.S. 206, 213-215 (2001).

The entire controversy in this case can be resolved by addressing whether omits means omits. The dictionary definition of "omits" is exactly as everyone understands it to be: "to fail to include or mention; leave out." The American Heritage Dictionary of the English Language, 1227 (4^th Ed. 2000). This is not a technical term. This is an everyday word which has its everyday meaning. The extended period of limitations when a taxpayer omits an amount greater than 25% of gross income was first implemented in § 275 of the Revenue Act of 1934. 48 Stat. 680. Congress has left "omits" in the applicable statutory provision for over 70 years without revision. Nothing in this history suggests that anything other than the common definition applies. "Omits" means something left out.

Both the Tax Court below and the Court of Federal Claims in Grapevine Imports, Ltd. v. United States, 77 Fed. Cl. 505 (2007) ("Grapevine") focused on the appropriate inquiry. Both courts interpreted "omits" and found the plain meaning to be something "left out." Bakersfield Energy, 128 T.C. at 215; Grapevine, 77 Fed. Cl. at 510-511. The Grapevine court even noted that the dictionary definition of "omits" is essentially the same as it was in 1958 when Colony was decided. Grapevine, 77 Fed. Cl. at 510, n. 6. "Omits" has a plain meaning. "Omits" means something that was "left out,"

BEP's 9812 Form 1065 omits nothing. The adjustment which the IRS seeks to make in the FPAA is the disallowance of $16,515,194 of claimed basis from the sale of the oil and gas interests. This exact number appears on a separate line on BEP's 9812 Form 1065. (ER 68) The IRS asserts that this number should have been zero. (ER 111, 113) Regardless of the merits of this assertion, the argument that a number expressly disclosed on the return should be a smaller number could in no way be interpreted as being omitted. It could be argued that BEP "inflated" the basis amount. It could be argued that BEP "overstated" the basis amount. By no stretch of the imagination, however, can it be argued that BEP "omitted" an amount.

The meaning of "omits" is plain. Omits means omits.

D. Even if there is Ambiguity, the Legislative History Dictates that Omits Means Omits.

If it is determined that some ambiguity exists concerning the meaning of "omits," a reference to the legislative history should resolve any doubt. The IRS is generally allowed a three-year period after the return is presumed filed in which to make assessments of additional tax. I.R.C. § 6501(a). Dating back to § 275(c) of the Revenue Act of 1934, however, additional time was allowed in the applicable period of limitations in the event that material items were omitted from the return.

The purpose for this additional time on the period of limitations was to allow the IRS additional time to assess tax when the tax return itself did not disclose the item which the IRS might wish to question. A Report of a House Ways and Means Subcommittee explained the purpose of the extended period of limitations as follows:

When the Internal Revenue Code was reissued in its entirety in 1954, the statute of limitations was renumbered to I.R.C. § 6501. At that time, I.R.C. § 6501(e)(1)(A)(ii) was added to create a specific exception from an amount that was "omitted from gross income . . . if such amount is disclosed in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature and amount of such item." This reinforces the central theme of providing extra time when the taxpayer's omission puts the IRS at a disadvantage. Pursuant to the adequate disclosure exception, even if the amount is "omitted" (i.e., left out of the tax computation), the amount will not constitute an omission for the purpose of the extended period of limitations if the taxpayer discloses the amount in a fashion on the return that gives the IRS adequate notice of the claimed tax benefit.

The legislative history relating to this change reinforces the central purpose. As set forth in S. Rep. No. 83-1622 at 584, reprinted in 1954 U.S. Code Cong. & Admin. News 5233:

The existence of a slightly different definition of an omission for estate tax purposes is also consistent with the overriding statutory purpose. On an estate tax return, the measure of tax is based on the valuation of assets. See I.R.C. § 2031. The IRS is not placed at a special disadvantage if an asset is listed on an estate tax return but is undervalued, because the claimed valuation is the primary focus of an IRS examination of an estate tax return. It is only when the IRS is placed at a special disadvantage by the failure to disclose the existence of the asset altogether that the undisclosed item is considered to be an "omission" for the purpose of triggering this extended period of limitations.

Based on this statutory scheme and legislative history, it is clear that Congress has defined "omits" consistently with its plain meaning. "Omits" means omits. It is only when the item is left out in a manner that would place the IRS at a special disadvantage in detecting the item by examining the return that an extended period of limitations should apply. In our case, not only is the $16,515,194 challenged basis amount included in an item that appears on the applicable return, this basis amount is a separate line item on this return. (ER 68) To make this item even more obvious, the $16,515,194 basis amount is by far the most material item on BEP's 9812 Form 1065. This amount literally leaps off the page. The suggestion under these facts that the IRS is somehow at a special disadvantage in detecting this as a possible audit item is simply absurd. The legislative history compels the conclusion that "omits" means omits and that the allegedly overstated basis amount on BEP's 9812 Form 1065 was not an omission.

E. If Any Doubt Still Remains, United States Supreme Court Precedent Holds that "Omits" Means Omits.

If it is not enough that the plain meaning of the statute and the legislative history make it clear that only items "left out" of the return are "omitted," we have United States Supreme Court precedent directly on point that establishes that "omits" means omits. The Colony case holds:

F. If Any Doubt Could Still Remain, the Tax Court Clearly Held Under the Facts in Our Case That "Omits" Means Omits.

In our case, BEP's 9812 Form 1065 lists the challenged basis item on a separate line item on the return and references in two different statements the circumstances which gave rise to an adjustment to that basis. (ER 68, 70, 71) This claimed $16,515,194 basis amount literally leaps off of the return. It is not surprising, then, that the Tax Court appeared to have little difficulty deciding that under the specific facts of this case that this basis amount was not "left out" of the return.

Some deference should be allowed to the Tax Court in this interpretation of the meaning of "omits." The Tax Court is an Article I court established expressly to address the sometimes-technical interpretations of the Internal Revenue Code. By far the greatest amount of the tax litigation is conducted in the Tax Court. The Tax Court is given a statutory preference for conducting tax litigation in that it is the only court in which the merits of proposed IRS assessments may be contested prior to payment. Compare I.R.C. § 6213(a) with § 6402 & § 7422. In addition, the judge in the case below, Judge Mary Ann Cohen, has been a Tax Court judge since 1982. Judge Cohen served as chief judge of the Tax Court from 1996 to 2000. A Lexis search discloses that Judge Cohen has issued more than 250 opinions in Tax Court cases. Accordingly, it is appropriate to give greater deference to the interpretation of the Tax Court, which deals with tax issues exclusively, than to another court which may deal with tax issues only sporadically.

The wisdom of this deference to the expertise of the Tax Court is illustrated in the contrary cases cited in the IRS Brief. The IRS Brief cites Brandon Ridge Partners v. United States, 2007-2 U.S.T.C. (CCH) ¶ 50,573 (M.D. Fla. 2007) as authority for a result contrary to the Tax Court's holding in our case. The district court judge in Brandon Ridge adopted the government's obtuse statutory construction arguments and rejected the prior holdings in our case and in Grapevine. Individual proclivities of isolated district court judges aside, one must be left to question whether the outcome of this case would have changed if the Brandon Ridge district court judge had recognized that Grapevine was not in fact a case that was decided by the Tax Court, but rather, the Court of Federal Claims. See Brandon Ridge, 2007-2 U.S.T.C. at 89,232. The judge in Brandon Ridge skipped the first two rules of statutory construction (i.e., plain meaning and direct legislative history) in favor of tortured interpretation of words in other sections. More importantly, however, Brandon Ridge fails to acknowledge the meaning of "omits" that is specifically set forth in the statute, legislative history and Supreme Court precedent. Brandon Ridge is poorly reasoned, sloppily drafted, and entitled to no weight.

The other authority cited in the IRS Brief is the somewhat remarkable case of Salman Ranch, Ltd. v. United States, 79 Fed. Cl. 189 (2007). Like Brandon Ridge, Salman Ranch ignores the controlling issue of the meaning of "omits" and engages in extensive analysis of the definition of "gross income," ultimately siding with the tortured IRS statutory construction argument. More remarkably, however, Salman Ranch apparently flouts the principles of stare decisis and effectively ignores the prior holding of its own court in Grapevine. Grapevine expressly adopts the reasoning of the Tax Court in our case in reaching the same conclusion, that "omits" means omits. Salman Ranch cites Grapevine but makes no attempt to distinguish it in any fashion. Salman Ranch simply ignores the precedent of its own court and decides the exact issue in a contrary manner. This is the hallmark of a judge who simply does not care what the law is. As with Brandon Ridge, Salman Ranch is entitled to no deference.

Based on the foregoing, the interpretation of the Internal Revenue Code by the Tax Court, a specialized court devoted to interpretations of the Internal Revenue Code, should be entitled to great deference. This deference is enhanced by the adoption of the Tax Court's interpretation in Grapevine. The contrary interpretations of isolated judges who are either unaware of the identity of the Claims Court or deliberately ignore the precedent of the Claims Court do not detract from the force of the interpretation of the Tax Court. The Tax Court has held under the facts of this case that "omits" means omits. This holding by a specialized court is entitled to more weight that any of the contrary authorities cited in the IRS Brief.

Both Brandon Ridge and Salman Ranch make the same mistake. Each of these judges cite cases defining "gross income" as authority for suggesting that the plain meaning, legislative history, and the Supreme Court precedent and Tax Court interpretation of "omits" is somehow no longer valid. Both of these judges are defining the wrong term, which leads them to the wrong result.

As set forth in I.R.C. § 6501(e)(1)(A)(ii):

A. The Disclosure Must Give the IRS a Clue.

For an adequate disclosure to exist, the return must reasonably inform the IRS of the taxpayer's reporting position so that the IRS has a "clue" with respect to the existence of a possible error. George Edward Quick Trust v. Commissioner, 54 T.C. 1336, 1347 (1970), aff'd per curiam, 444 F.2d 90 (8^th Cir. 1971).

A good illustration of this rule is set forth in University Country Club, Inc. v. Commissioner, 64 T.C. 460 (1975), acq. 1976-2 C.B. 3. In University Country Club, Inc., a taxpayer reported amounts received from the sale of class B stock as a nontaxable capital contribution even though the IRS asserted that the amount was income from the sale of a license for the privilege of using the taxpayer's facilities. The court held that the disclosure by the taxpayer of the amount as a capital contribution on the balance sheet included in the corporate tax return adequately apprised the IRS of the taxpayer's characterization of the transaction and, therefore, adequate disclosure existed and the six-year period of limitations did not apply. See also Benderoff v. United States, 398 F.2d 132 (8^th Cir. 1968) (disclosure on balance sheet attached to Form 1120-S constituted adequate disclosure on shareholders' Form 1040 of an unreported dividend distribution); Walker v. Commissioner, 46 T.C. 630 (1966) (disclosure of installment sale on partnership return constitutes adequate disclosure on partner's Form 1040 of amount of gain deferred).

B. BEP's Disclosure Was Detailed, Complete and Repetitive.

BEP's 9812 Form 1065 "beats the IRS over the head" with disclosures of the grounds for BEP's claim of basis. BEP's claimed basis results from a transfer of partnership interests during the 1998 tax year which triggered a technical termination of the partnership and basis adjustments pursuant to I.R.C. § 704(b), § 743(b) and § 754. BEP's 9812 Form 1065 makes multiple disclosures of the nature of the transaction, including the following:

(1) Page 1 indicates the return is a short period initial return. (ER 61) The attachment to BEP's 9812 Form 1065 clarifies that the short period is the result of a technical termination of the old partnership and the same taxpayer identification number is being used as provided in the Regulations. (ER 70)

(2) Schedule B, Question 11, of BEP's 9812 Form 1065 answers "Yes," indicating there was a transfer of partnership interests during the tax year. (ER 62)

(3) Schedule M-1, Line 2, indicates that the income included on Schedule K but not recorded on the books was $5,419,983 (ER 64), referencing supporting statement 3 which states that the item resulted from "704(b) adjustments recognized in income." (ER 74)

(4) Form 4797 attached to the 9812 Form 1065 reflected gross sales price of $23,898,611, the entire consideration for the properties sold. The basis reported for the sale was $16,515,417, and recaptured intangible drilling costs recorded as ordinary income in the amount of $5,390,383 was also disclosed on Form 4797. (ER 67-68) These amounts were, hugely material and clearly disclosed.

(5) The Statement Regarding a Partnership Technical Termination attached to BEP's 9812 Form 1065 disclosed that the capital accounts reflected restatement of the partnership books:

These were not merely clues. BEP's 9812 Form 1065 gave the IRS a road map in the event the IRS chose to audit the return. The IRS did not take this opportunity in the three-year period provided by law and now seeks to torture the language of I.R.C. § 6229(c) and § 6501(e) to overcome the IRS's failure to act in a timely manner.

C. The IRS Seeks to Apply an Improper Standard to BEP's Disclosure.

Faced with an overwhelming array of disclosures on almost every page of BEP's 9812 Form 1065, the IRS in its Amendment to Answer in the case below initially asserted standards for BEP's disclosure that did not exist. The IRS argued that the verbiage on BEP's 9812 Form 1065 may not have fully complied with every aspect of the IRS's regulations concerning the § 754 election and § 743(b) basis adjustment.

Ultimately, the IRS was forced to retrench because the argument was based on a regulation that did not exist for the 1998 tax year. The IRS's Amendment to Answer addressed at length the perceived discrepancies between BEP's disclosure and the requirements of Treas. Reg. § 1.743-1(k). The problem with this argument is that this regulation was adopted December 14, 1999, and specifically only applied to transfers of partnership interests after December 15, 1999. BEP's 9812 Form 1065 was filed on October 15, 1999. As a result, the IRS was forced to withdraw this argument.

A review of the actual disclosure requirements is illuminating, however. The version of Treas. Reg. § 1.743-1 that did apply to BEP's 9812 Form 1065 has no disclosure requirement with respect to a § 743(b) basis adjustment. Similarly, the 1998 Instructions for Form 1065 published by the IRS has no specific disclosure requirement. BEP fully complied with all regulations and instructions that actually existed at the time BEP's 9812 Form 1065 was filed. By the IRS's logic, this fully compliant disclosure should constitute adequate disclosure for purposes of I.R.C. § 6229(c) and § 6501(e).

Perhaps the greater problem with the IRS's argument, however, is that it completely misses the point. As set forth in the cases above, this is not a question of literal compliance with the IRS's procedural regulations. This is a question of reasonable notice. BEP's 9812 Form 1065 not only provides the IRS clues concerning BEP's basis claimed, BEP repeatedly and plainly discloses BEP's reporting position. BEP's obligation is not to make disclosure in a manner that the IRS subsequently determines is satisfactory to the IRS. BEP's obligation is to advise the IRS of the substance of BEP's position so that the IRS is on notice to inquire further if it so chooses. In this case, the IRS simply chose not to inquire further in spite of repeated disclosures that permeated BEP's 9812 Form 1065. The IRS's nitpicking, hypertechnical objections to BEP's disclosures are based on nonexistent obligations and are factually unfounded.

A. Introduction.

For the sake of clarity, it is important to understand a distinction with respect to the adjustment of a partnership's tax reporting. There are actually two separate statutory schemes that can apply to adjustments to the items appearing on partnership returns. Historically, adjustments to items reported on a partnership return were made by adjusting the individual returns of each partner. The period of limitations for making these adjustments was the separate I.R.C. § 6501 period of limitations for each partner's individual return.

The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") implemented a separate statutory scheme for the adjustments of the "partnership items" of certain partnerships which are subject to its provisions (so-called "TEFRA partnerships"). In general, a partnership is subject to this separate statutory scheme as a TEFRA partnership if the partnership has more than 10 partners or has partners that are themselves flow-through entities. See, I.R.C. § 6231(a)(1). If the partnership is not a TEFRA partnership, the old partner-by-partner determination must still be made. It is acknowledged by both parties in this case that BEP is a TEFRA partnership.

As a TEFRA partnership, a special minimum period of limitations set forth in I.R.C. § 6229 becomes applicable. This minimum period of limitations is three years from the date the partnership return (i.e., BEP's 9812 Form 1065) was filed. I.R.C. § 6229(a). This minimum § 6229(a) period of limitations is extended by a 25% omission of gross income on the partnership return. As set forth in I.R.C. § 6229(c)(2), the operative rule is as follows:

B. The Broad Definition of "Gross Income" is Meaningless in this Case.

The IRS Brief at pages 20 to 27 engages in an exhaustive analysis of "gross income." This analysis is meaningless. The issue before this Court is the definition of "omits." There is no authority in support of the IRS interpretation of "omits" and, therefore, the IRS is left to define a term which has nothing to do with the outcome of this case.

Remarkably, the IRS Brief cites the axiom that the plain language of the statute must control the outcome in this case and then proceeds to argue for a plain meaning of the statute which eliminates the most critical word. As set forth in detail above, the statute is plainly worded, designed and interpreted to apply in cases in which there is an omission. Only when there is an omission is the IRS placed at the special disadvantage that caused Congress to allow the IRS more time to complete an examination. The IRS Brief attempts to bastardize the entire purpose of the statute by focusing on the definition of "gross income" to suggest that an overstatement of basis could somehow constitute an omission of gross income. This argument is made notwithstanding the fact that the $16,515,194 basis amount is separately stated on its own line on BEP's 9812 Form 1065 (ER 68) and the circumstances giving rise to that claimed basis amount are narratively disclosed in two different places on that same return. (ER 70, 71) Under these circumstances, it is remarkable that the IRS Brief can even argue this as an omission. It is even more remarkable that the IRS Brief can make this argument under the supposed guise of the plain meaning of the statute. The only thing plain about the argument in the IRS Brief is that it is plainly unsupportable.

The IRS Brief also seeks to rely on the district court judge's ruling in Brandon Ridge and the second, contradictory opinion in Salman Ranch. As set forth above, these obscure opinions are poorly reasoned efforts to sustain the government at all costs. These judges were distracted from the real issue by the IRS arguing the meaning of "gross income" ad nausea. No tortured statutory construction analysis can change the plain meaning, legislative purpose and Supreme Court and Tax Court interpretation, however. "Omits" means omits. The definition of "gross income" is simply irrelevant to the determination in this case.

As set forth above, the six-year period of limitations applies when O ÷ GI > 25%. The IRS Brief goes wrong in citing cases that address the method for determining gross income ("GI") as somehow having relevance in determining in the omission ("O"). The IRS Brief cites Schneider v. Commissioner, T.C. Memo. 1985-139 ("Schneider"); Northern Ind. Pub. Serv. Co. & Subs. v. Commissioner, 101 T.C. 294 (1993) ("Northern") and Insulglass Corp. v. Commissioner, 84 T.C. 203 (1985) ("Insulglass"), as cases that suggest a different definition for gross income may apply for capital asset transactions than for trade or business asset transactions. However, Northern deals with an obscure issue of the definition of gross income on a withholding tax return. Northern offers no guidance on the issue in our case. In Schneider and Insulglass, the issue before the court was the definition of gross income ("GI") for purposes of the denominator in the equation. Neither of these cases determine the numerator, i.e., the omission ("O"). Nevertheless, the IRS Brief suggests that these "denominator" cases are relevant in the determination in the amount of the "numerator." This is a fundamental conceptual flaw in the IRS position that was rejected by the Tax Court when the IRS made these same arguments in the case below. These cases provide no authority on the real issue in this case, the definition of "omits."

C. The Code's Definition of "Gross Income" Serves a Purpose in the Statutory Scheme, but Does Not Serve a Purpose in the Context of the Issue to be Decided in this Case.

The IRS Brief at pages 27-33 presents a number of convoluted statutory interpretation arguments to suggest that an overstatement of basis can constitute an omission of gross income in the context of our case. Apart from arguing the wrong definition, these arguments do not support the contention for which they are cited.

The IRS Brief argues that the specific definition of gross income for trade or business assets somehow implies that a different definition of gross income applies for property transactions that are not trade or business assets. The premise underlying this assumption is that the definition of gross income would have no meaning if it was not used to define what constitutes an omission. That is simply not the case. As is acknowledged by the IRS, the formulaic expression of the six-year statute of limitation rule for omission is, O ÷ GI > 25% = 6-year statute of limitations. It is therefore necessary to define gross income so that the denominator in this equation can be computed. Gross income can mean one thing in the context of a trade or business and a different thing in the context of a capital asset transaction. These are simply computational rules to determine the "GI" denominator in the equation.

The IRS Brief next suggests that "gross income" in § 6229(c) must have the same meaning as the pre-existing definition of "gross income" in § 6501(e)(1)(A). That may be. The important point is that "omits" in § 6229(c) has the same meaning as "omits" in § 6501(e)(1)(A) and its predecessor § 275(c) of the Revenue Act of 1934. Colony holds that "omits" means omits. The definition of "gross income" is of no consequence.

The IRS Brief also attempts to seek comfort by defining the word "amount" by reference to the special rule applicable to estate tax returns. The IRS argument appears to be that "omits" does not mean "omits" because "items" does not mean "amounts" in context of an estate tax return. As is set forth more fully in Section I.D. above, however, the special rule that excludes overstated valuations of items otherwise disclosed on estate tax returns is an extension of the fundamental purpose of the six-year period of limitations as it applies to a return for which the tax is computed by a different measure. Requiring that the item be omitted entirely on an estate tax return for the IRS to be placed at the special disadvantage that results in an extended period of limitations is entirely consistent with the legislative purpose of the statute. The valuation amount of a disclosed asset determines the measure of the tax. The valuation of assets is the primary issue the IRS examines on an estate tax return. Only when the asset is not disclosed at all does the IRS need more time for the audit. This is simply a different rule for a different type of tax. The IRS cannot compare apples to oranges to escape the plain meaning, legislative purpose, and Supreme Court and Tax Court precedent that establishes that "omits" means omits in our case.

The IRS Brief also makes the same mistake in this section as it makes in the preceding section. The IRS Brief cites to the "denominator" cases and suggests that they have relevance in the determination of the "numerator." The Partners can concede the IRS arguments on the definition of the denominator. The definition of the denominator, however, has no relevance in the determination of the amount of the numerator. In our case, BEP's 9812 Form 1065 omits nothing. Therefore, the equation O ÷ GI yields a result of zero, not a result that is greater than 25%, and the six-year period of limitations does not apply.

D. The Tax Court Correctly Held that Colony Still Dictates that "Omits" Means Omits.

As a final effort to distinguish the directly controlling holding in Colony, the IRS Brief at pages 33-41 engages in a series of strained arguments in an effort to avoid the inevitable. The Supreme Court in Colony held that "omits" means omits. The Tax Court correctly ruled that nothing since Colony has changed this result.

The IRS Brief starts by incorrectly arguing that the holding of the Supreme Court in Colony somehow related to the interpretation of "gross income" for a trade or business. It is not even clear that the factual premise for this argument is accurate. The assets at issue were lots held by a real estate development company. Real estate can often have a "dual" status, i.e., constituting an ordinary trade or business assets for loss purposes but a capital asset for gain purposes. See, I.R.C. § 1231. There is no holding in Colony that indicates that the lots at issue in that case constituted inventory that would be subject to the trade or business treatment.

Even if the Partners were to concede that Colony involved trade or business assets, the holding in Colony is in no way based on that fact. Colony holds that, to constitute an omission, an item must be "left out" of the return. 357 U.S. at 32-33, 35. It is only in that circumstance that the IRS is placed at the special disadvantage that warrants a longer period of limitation in which to make the assessment of any tax related to an incorrect reporting of the item. Whether or not trade or business assets are at issue, the holding of Colony is that "omits" means omits.

The IRS Brief next argues that the fact that the Supreme Court in Colony believed that the result under § 275 of the Internal Revenue Code of 1939 would be the same as the result in the interveningly-enacted § 6501(e) of the Internal Revenue Code of 1954 suggests that the result should now be somehow different than it would have been under the former version of the law. This is a remarkable contortion. The Supreme Court's suggestion that the result would be the same under the current version of § 6501 means nothing more than "omits" still means omits and "gross income" for a trade or business still means gross receipts minus cost of goods sold. The Internal Revenue Code of 1954 added more specific rules for interpreting when the six-year period of limitation applies. The Supreme Court suggested that the rulings in Colony were consistent with these more specific rules. The IRS Brief then postulates that the specific rules actually changed the prior version and so, therefore, the Supreme Court's consistent interpretation is actually inconsistent and therefore overruled. This is truly mind-numbing.

As set forth in more detail in Section I.D. above, there is absolutely nothing inconsistent with retaining the plain meaning of "omits" in light of an express adequate disclosure provision. An amount can be "omitted" from gross income and still be adequately disclosed so that it is no longer included in the numerator in the equation. Similarly, there is still a reason to define "gross income" for purposes of the denominator. Enacting more specific rules on how to compute the denominator does not suggest any revision of the definition of the numerator.

The fact is, Colony defined "omits" 50 years ago. Congress has not changed the operative phrase "omits from gross income" in any of the literally dozens of revisions of the Internal Revenue Code since Colony was decided. When TEFRA was enacted in 1982, Congress again used the "omits from gross income" language that had been interpreted by Colony decades earlier. Rather than eroding the precedent of Colony, the numerous statutory changes since Colony was decided in 1958 reinforce that Congress continues to accept the holding in Colony that "omits" means omits. The fact that Congress has not chosen to change the law in the face of a longstanding precedent suggests that Congress accepts that interpretation. Flora v. United States, 357 U.S. 63 (1958) (longstanding use of similar terms through many changes in operative statute shows consistent interpretation intended).

The IRS Brief also asserts that subsequent cases erode the force of Colony. This is simply not true. In CC&F Western Operations, Ltd. v. Commissioner, 273 F.3d 402 (1^st Cir. 2001), ("CC&F Western"), the holding in the case was that $52,928,095 of omitted gross receipts constituted an omission for purposes of the extended period of limitations:

The final IRS case cited in the IRS Brief, Phinney v. Chambers, 392 F.2d 680 (5^th Cir. 1968) ("Phinney") also deals with an omitted gross receipt. The issue in Phinney was that an income item was characterized incorrectly so that the entire amount of the gross receipt as correctly characterized was "omitted." Again, the court found Colony instructive and held that the omitted item caused the extended period of limitations to apply even though the transaction was disclosed on the return, albeit in an incorrect manner. Phinney adds no support to the IRS position in this case.

Based on the foregoing, the convoluted contortions of statutory interpretation argued in the IRS Brief must be wholly disregarded. Colony interpreted "omits" 50 years ago. The exact same language that Colony interpreted continues to this day in I.R.C. § 6501(e) and was expressly adopted in the controlling language of I.R.C. § 6229(c)(2) in 1982. Any suggestion that subsequent legislative changes have in any way impaired the effect of Colony is virtually frivolous. The holding in Colony 50 years ago, and the holding of the Tax Court in this case, is that "omits" means omits. Nothing detracts from those holdings.

DATED: April 7, 2008