Ridge L. Harlan and Marjory C. Harlan v. Commissioner

116 T.C. No. 4
UNITED STATES TAX COURT
RIDGE L. HARLAN AND MARJORY C. HARLAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
THEODORE S. OCKELS AND ROSEMARIE G. OCKELS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 21214-92, 24609-92. Filed January 17, 2001.
Ps are partners in partnerships (the 1st-tier
partnerships); some of the 1st-tier partnerships are
partners in other partnerships (the 2d-tier partnerships).
R maintains that the 6-year period of limitations under sec.
6501(e)(1)(A), I.R.C. 1986, applies to notices of deficiency
sent in 1992 with respect to Ps’ 1985 tax year. In
determining the applicability of sec. 6501(e)(1)(A), I.R.C.
1986, R includes in Ps’ “gross income stated in the return”
Ps’ distributive shares of the gross incomes of the 1st-tier
partnerships, but does not take account of the 1st-tier
partnerships’ distributive shares of the gross incomes of
the 2d-tier partnerships. Ps contend to the contrary.
Held: In determining the amount of “gross income
stated in the return” (the denominator in the 25-percent
test of sec. 6501(e)(1)(A), I.R.C. 1986) for petitioners,
the 2d-tier partnerships’ information returns are treated as
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adjuncts to, and parts of, the 1st-tier partnerships’
information returns, which in turn are treated as adjuncts
to, and parts of, petitioner’s tax returns.
Craig A. Etter, Timothy J. Jessell, and Michael I. Sanders,
for petitioners.
Carol E. Schultze, for respondent.
OPINION
CHABOT, Judge: This matter is before us for determination
as to whether, in applying the 6-year period of limitations (sec.
6501(e)(1)(A))1, when a petitioner’s tax return reflects income
from a partnership (hereinafter sometimes referred to as the 1st-
tier partnership) that is itself a partner in another partnership
(hereinafter sometimes referred to as the 2d-tier partnership),
the statutory phrase “gross income stated in the return” (the
denominator in the 25-percent test) requires a tracing of the
flow of gross income from not only the 1st-tier partnership’s
information return but also from the 2d-tier partnership’s
information return in order to determine petitioners’ appropriate
1
Unless otherwise indicated, all subtitle, chapter,
subchapter, and section references are to subtitles, chapters,
subchapters, and sections of the Internal Revenue Code of 1954 as
in effect for 1985; except that references to section 6501 are to
section 6501 of the Internal Revenue Code of 1986 as in effect
for notices of deficiency mailed in 1992.
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distributive share of partnership gross income from the 1st-tier
partnership’s tax return.2
Respondent determined deficiencies in individual income tax
and additions to tax under sections 6653(a) (negligence, etc.)
and 6661 (substantial understatement) against (1) petitioners
Ridge L. Harlan (hereinafter sometimes referred to as Ridge) and
Marjory C. Harlan (hereinafter sometimes referred to as Marjory)
(Ridge and Marjory are hereinafter sometimes referred to
collectively as the Harlans) and (2) petitioners Theodore S.
Ockels (hereinafter sometimes referred to as Theodore) and
Rosemarie G. Ockels (Theodore and Rosemarie G. Ockels are
hereinafter sometimes referred to collectively as the Ockels) for
1985 as follows:
2
On brief, petitioners state that this is a jurisdictional
issue. However, the instant cases are deficiency cases; thus,
the statute of limitations is an affirmative defense and not a
jurisdictional issue. See sec. 7459(e); Rule 39; Davenport
Recycling Associates v. Commissioner, 220 F.3d 1255, 1259-1260
(11th Cir. 2000), affg. T.C. Memo. 1998-347 (in deficiency cases,
assertion of the bar of the statute of limitations is an
affirmative defense, not a jurisdictional question); Columbia
Building, Ltd. v. Commissioner, 98 T.C. 607, 611 (1992) (same);
compare Commissioner v. Lundy, 516 U.S. 235 (1996) (in refund
cases in the Tax Court, the statute of limitations is a
jurisdictional question).
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure.
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Additions to Tax
Petitioners Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6661
1
The Harlans $548,186 $27,409 $137,047
2
The Ockels 62,490 3,125 15,623
1
50 percent of interest due on $548,186.
2
50 percent of interest due on $62,490.
The instant cases have been severed from docket Nos. 15653-
92 and 15654-923 for briefing and opinion on the 2d-tier
partnership issue.
The 2d-tier partnership issue has been submitted fully
stipulated; the stipulations and the stipulated exhibits are
incorporated herein by this reference.
Background
When the respective petitions in the instant cases were
filed, the Harlans resided in Hillsborough, California, and the
Ockels resided in Lafayette, California.
3
Cases of the following petitioners had originally been
consolidated: (1) Alan B. Steiner and Barbara W. Steiner, docket
No. 28182-92; (2) Estate of James Beaton, deceased, Shirley
Beaton, Executrix, and Shirley Beaton, docket No. 28181-92; (3)
James F. Ottinger and Bonnie J. Ottinger, docket No. 15654-92;
(4) Theodore S. Ockels and Rosemarie G. Ockels, docket No. 24609-
92; (5) Ridge L. Harlan and Marjory C. Harlan, docket No. 21214-
92; and (6) Estate of William H. Abildgaard, deceased, William
Abildgaard, Jr., Executor, and Marlene Abildgaard, docket No.
15653-92. See Steiner v. Commissioner, T.C. Memo. 1995-122. The
Beaton, docket No. 28181-92, and Steiner, docket No. 28182-92,
cases were severed from the group and were disposed of on another
issue. See Beaton v. Commissioner, T.C. Memo. 1997-140.
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A. The Harlans
The Harlans filed their joint 1985 tax return on or about
August 12, 1986. On June 26, 1992, respondent issued a notice of
deficiency to the Harlans for 1985.
The 3-year period of limitations for assessment of tax under
section 6501(a) with respect to the Harlans for 1985 expired
before the notice of deficiency was mailed. The Harlans did not
execute any extensions of the period of limitations on assessment
with respect to 1985.
The Harlans’ 1985 tax return has attached to the Form 1040,
the following: Schedules A, B, C, D, E, and SE; Forms 3468,
3800, 4136, 4797, 4868, 6251, 1116, 2210, 4562, 4835, 4952; 27
numbered “statements”; and a Treasury Department Form TD F 90-
22.1.
The Harlans’ 1985 tax return shows an ordinary loss of
$56,069 from several partnerships, identified by name, address,
and employer identification number. The record includes 1985
partnership information returns, or parts of those returns, from
each of the identified partnerships, as well as stipulations as
to the Harlans’ shares of the partnerships’ gross incomes,
determined without regard to the 2d-tier partnership gross
incomes.
During 1985, Ridge was a partner in three single-tier
partnerships, and Marjorie was a partner in one single-tier
partnership.
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During 1985, Ridge was a partner in two multiple tier
partnerships: (1) Pacific Real Estate Investors Partnership
(hereinafter sometimes referred to as Pacific) and (2) Carlyle
Real Estate Limited Partnership-VI (hereinafter sometimes
referred to as Carlyle).
Pacific was a partner in at least one other partnership.
Pacific’s 1985 information return shows an ordinary loss of
$7,705 from another partnership, identified by name and employer
identification number. The record does not include information
as to the amount of the gross income stated on this 2d-tier
partnership’s 1985 information return.
Carlyle was a partner in several other partnerships.
Carlyle’s 1985 information return shows ordinary income of
$674,791.81 from four other partnerships, each identified by name
and employer identification number. The record does not include
information as to the amounts of Carlyle’s shares of the gross
incomes stated on these 2d-tier partnerships’ 1985 information
returns.
On one of the schedules attached to their 1985 tax return,
the Harlans show their gross income as $1,216,099. This schedule
is for purposes of Form 1116, part I, line 2.d.(v), and is an
element of the formula used in the computation of their foreign
tax credit. Nevertheless, the parties have stipulated that the
gross income for purposes of section 6501(e) that is “reflected
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on the Harlan’s 1985 Form 1040 and on the first-tier partnership
returns of the partnerships in which Ridge or Marjory Harlan
owned a direct interest”, i.e., excluding “the flow of gross
income from” the 2d-tier partnerships, is $1,410,077.
B. The Ockels
The Ockels filed their 1985 joint tax return on October 15,
1986. On August 11, 1992, respondent issued a notice of
deficiency to the Ockels for 1985.
The 3-year period of limitations for assessment of tax under
section 6501(a) with respect to the Ockels for 1985 expired
before the notice of deficiency was mailed. The Ockels did not
execute any extensions of the period of limitations on assessment
with respect to 1985.
The Ockels’ 1985 tax return has, attached to the Form 1040,
the following: Schedules A, B, C, D, E, and SE; Forms 2688,
3468, 4797, 6198, 6251, 4684, 8283, 4255, 4562, 4868, 4952, 8082,
6248; and numerous schedules, attachments, and other documents.
The Ockels’ 1985 tax return shows net income of $7,900 from
several partnerships and one independent oil producer, identified
by name and employer identification number. The record includes
1985 partnership information returns, or parts of those returns,
from each of the identified partnerships, and a 1985 windfall
profit tax information return (Form 6248) from the oil producer,
as well as stipulations as to Theodore’s shares of the
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partnerships’ gross incomes, and the oil producer’s gross sales
price, determined without regard to the 2d-tier partnerships’
gross incomes.
During 1985, Theodore was a partner in nine single-tier
partnerships.
During 1985, Theodore was a partner in one multiple tier
partnership, Mission Resources Development Drilling Program -
Belridge II (hereinafter sometimes referred to as Mission
Resources). Mission Resources was a partner in at least one
other partnership. Mission Resources’ 1985 information return
shows ordinary income of $286,137 from another partnership,
identified by name but not otherwise. The record does not
include information as to the amount of the gross income stated
on this 2d-tier partnership’s 1985 information return.
The Ockels do not claim a foreign tax credit on their 1985
tax return, and so do not have any equivalent of the Harlans’
above-noted schedule. The parties have stipulated that the gross
income for purposes of section 6501(e) that is “reflected on the
Ockels’ 1985 Form 1040 and on the first-tier partnership return
[sic] of the partnerships in which the Ockels owned a direct
interest”, i.e., excluding “the flow of gross income from” the
2d-tier partnerships, is $407,819. This total includes
Theodore’s share of the gross receipts of the independent oil
producer.
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C. The VeloBind Stock
At the start of 1985, Ridge owned 80,000 shares of junior
common stock in VeloBind that he had bought in 1983 for $3 per
share. In 1985, Theodore owned 7,500 shares of junior common
stock in VeloBind that he had bought in 1983 for $3 per share.
In Steiner v. Commissioner, T.C. Memo. 1995-122, we determined
that these shares converted to VeloBind common stock in 1985.
The VeloBind common stock traded at $17 per share on February 12,
1985.
In the respective notices of deficiency, respondent
determined that the Harlans4 and the Ockels5 received 1985 income
from the stock conversion.
Discussion
I. The Parties’ Contentions; Summary of Court’s Conclusion
Petitioners have properly raised in their petitions the
affirmative defense of the statute of limitations for 1985. See
Rule 39.
The parties have stipulated that the 3-year period of
limitations (sec. 6501(a)) expired for both the Harlans and the
4
In the notice of deficiency, respondent determined that the
Harlans’ income from the VeloBind stock conversion was
$1,275,200. However, in respondent’s answer and on brief,
respondent asserts the correct income amount was $1,120,000.
5
In the notice of deficiency, respondent determined that the
Ockels’ income from the VeloBind stock conversion was $119,550.
However, in respondent’s answer and on brief, respondent asserts
the correct income amount was $105,000.
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Ockels before respondent issued the respective notices of
deficiency.
Respondent contends that the instant cases fall within an
exception to the 3-year rule--the 6-year statute of limitations
set forth in section 6501(e)(1)(A)--because each set of
petitioners has omitted from gross income more than “25 percent
of the amount of gross income stated in the return” for that set
of petitioners.
Petitioners contend that the income that respondent contends
was omitted from their 1985 tax returns6 is less than 25 percent
of the amounts of gross income stated in their respective tax
returns because (1) their tax returns are treated as having set
forth their shares of the gross incomes set forth on the
information returns of their 1st-tier partnerships and (2) the
information returns of their lst-tier partnerships should be
treated as setting forth their 1st-tier partnerships’ respective
shares of the gross incomes set forth on the information returns
of their 2d-tier partnerships.
Respondent argues that the 2d-tier partnerships’ information
returns are to be ignored because (1) “The plain language of the
Code and the regulations” require consideration of only
6
The question of whether petitioners omitted any gross
income--whether the 1985 conversions of the Velobind stock
produced gross income and, if so, then in what amounts--has been
set aside for determination at a later date.
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petitioners’ tax returns and not the partnerships’ information
returns, (2) the regulations’ concept of setting forth on a tax
return applies only to what is set forth on petitioners’ tax
returns, and (3) a contrary interpretation “would impose an
excessive administrative burden on the Service and on taxpayers.”
Petitioners maintain that section 702(c) and the regulations
plainly require that whenever it is necessary to determine the
amount of a partner’s gross income, that amount is to include the
partner’s distributive share of the partnership’s gross income.
As applied to the instant cases, in order to determine the amount
of petitioners’ gross income from the 1st-tier partnerships,
there must first be determined the amount of each 1st-tier
partnership’s gross income. Section 702(c)’s rule then applies,
petitioners contend, so that in order to determine the amount of
any 1st-tier partnership’s gross income, there must first be
determined the amount of each 2d-tier partnership’s gross income.
Petitioners maintain that this rule is consistent with the “look-
through” approaches of other subchapter K provisions (e.g., in
secs. 1.704-3(a)(8), 1.704-2(k), and 1.752-4, Income Tax Regs.),
and provisions outside subchapter K, such as sections
108(a)(1)(C) and 904(d).
Under section 6501(e)(1)(A), the denominator of the 25-
percent fraction is “the amount of gross income stated in the
return”. But the taxpayer ordinarily does not state the amount
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of gross income anywhere on the tax return.7 As a result, we
must look through the various forms, etc., attached to the
taxpayer’s basic tax return form in order to identify the
components of gross income that must be added together in order
to determine the total amount of gross income stated in the
taxpayer’s tax return. It has long been accepted that, for these
purposes, the information return of the taxpayer’s properly
identified 1st-tier partnership is treated as part of the
taxpayer’s tax return. But the 1st-tier partnership’s
information return suffers from the same “defect” in that we must
look through the various forms, etc., attached to the 1st-tier
partnership’s information return in order to identify the
components of gross income that must be added together in order
to determine the total amount of gross income stated in the 1st-
tier partnership’s information return. Every explanation that
has been drawn to our attention, or that we have discovered, as
to why we must treat the properly identified 1st-tier
partnership’s information return as part of the taxpayer’s tax
return applies with equal force to treating the properly
identified 2d-tier partnership’s information return as part of
the 1st-tier partnership’s information return.
Accordingly, we agree with petitioners’ conclusion.
7
As is the case in the Harlan’s docket, even if the taxpayer
does state such an amount and clearly labels it as such, that may
not be the correct amount for purposes of sec. 6501(e)(1)(A),
even if it is the correct amount for other purposes.
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II. Overview
In general, section 6501(a)8 bars assessment of an income
8
Sec. 6501 provides, in pertinent part, as follows:
SEC. 6501. LIMITATIONS ON ASSESSMENT AND COLLECTION.
(a) General Rule.--Except as otherwise provided in this
section, the amount of any tax imposed by this title shall
be assessed within 3 years after the return was filed
(whether or not such return was filed on or after the date
prescribed) * * * and no proceeding in court without
assessment for the collection of such tax shall be begun
after the expiration of such period.
* * * * * * *
(e) Substantial Omission of Items.--Except as otherwise
provided in subsection (c)--
(1) Income Taxes.--In the case of any tax imposed
by subtitle A [relating to income taxes]--
(A) General rule.--If 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, the tax may be
assessed, or a proceeding in court for the
collection of such tax may be begun without
assessment, at any time within 6 years after the
return was filed. For purposes of this
subparagraph--
(i) In 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; and
(ii) In determining the amount omitted
from gross income, there shall not be taken
into account any amount which is omitted from
gross income stated in the return if such
(continued...)
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tax deficiency more than 3 years after the later of the date the
tax return was filed or the due date of the tax return. The
parties stipulated that the 3-year general period of limitations
on assessment under section 6501(a) expired for petitioners’ 1985
tax year before the respective notices of deficiency were sent.
Respondent has the burden of proving the applicability of an
exception to the general limitations period. See Rule 142; Reis
v. Commissioner, 142 F.2d 900 (6th Cir. 1944), affg. 1 T.C. 9, 12
(1942), as modified by a Memorandum Opinion of this Court dated
June 4, 1943. In particular, as respondent acknowledges, in
order for the 6-year period of limitations under section 6501(e)
to apply, respondent must show that the taxpayer has omitted an
amount of gross income which is more than 25 percent of the
amount of gross income stated in the tax return. See Davenport
v. Commissioner, 48 T.C. 921, 928 (1967) (taxpayers’ tax returns
showed net losses from a partnership; 6-year statute of
limitations did not apply because the Commissioner “has not shown
whether a partnership return was filed for those years and if so
the gross income reported thereon”); Hurley v. Commissioner, 22
T.C. 1256, 1264-1265 (1954), affd. 233 F.2d 177 (6th Cir. 1956)
8
(...continued)
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.
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(using net worth method, Commissioner showed omission of net
income; held, Commissioner failed to carry burden of proving how
much of this omission was due to omission of gross income);
Seltzer v. Commissioner, 21 T.C. 398, 402-403 (1953)
(Commissioner failed to prove taxpayer’s basis in a sold capital
asset, and so “has not sustained his burden of proof to show”
that taxpayer omitted gross income which was more than 25 percent
of the gross income stated in her tax return); see also Colestock
v. Commissioner, 102 T.C. 380, 383, 390-391 (1994); Estate of Fry
v. Commissioner, 88 T.C. 1020, 1023 n.8 (1987); Stratton v.
Commissioner, 54 T.C. 255, 289 (1970), and cases there cited;
Philipp Bros. Chemicals, Inc. v. Commissioner, 52 T.C. 240, 254-
255 (1969), affd. 435 F.2d 53 (2d Cir. 1970); Rhombar Co. v.
Commissioner, 47 T.C. 75, 85 (1966), affd. 386 F.2d 510 (2d Cir.
1967); Bardwell v. Commissioner, 38 T.C. 84, 92 (1962), affd. on
another issue 318 F.2d 786 (10th Cir. 1963); Green v.
Commissioner, 7 T.C. 263, 277 (1946), affd. 168 F.2d 994 (6th
Cir. 1948).
The test for the extended limitations period under section
6501(e) may be expressed as a fraction. The numerator is the
amount of properly includable gross income that was omitted from
a taxpayer’s return, and the denominator is “the amount of gross
income stated in the return”. Sec. 6501(e)(1)(A). If the
fraction exceeds 25 percent, then the 6-year limitations period
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under section 6501(e) applies. In the instant cases, the
parties’ dispute focuses on the denominator.
Two aspects of this dispute make it clear that more is
involved than meets the eye, as follows:
Firstly, although the statutory language is “the amount of
gross income stated in the return” (emphasis added), both sides
agree that, where the taxpayer is a partner in a 1st-tier
partnership, the language is treated as including amounts that do
not appear anywhere on the only document that has been filed as
the taxpayer’s tax return.
Secondly, although the potential for the parties’ dispute
herein has existed since the 1934 enactment of the predecessor of
section 6501(e)(1)(A), both sides agree that this is a matter of
first impression.
In light of the foregoing, we start our analysis with
matters that are not in dispute between the parties, in order
better to understand the context in which the disputed matters
operate.
III. Evolution of the Statute
Section 250(d) of the Revenue Act of 1918 (Pub. L. 65-254,
40 Stat. 1057, 1083) provided a general 5-year statute of
limitations, but no limit in the case of fraud.
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Section 250(d) of the Revenue Act of 1921 (Pub. L. 67-98, 42
Stat. 227, 265) reduced the general period of limitations to 4
years.
The Revenue Act of 1924 (Pub. L. 68-176, 43 Stat. 253, 299)
kept the 4-year general statute of limitations, as section
277(a)(1); it provided that there was no limit in the case of
fraud or failure to file a tax return, as section 278(a).
Section 277(a)(1) of the Revenue Act of 1926 (Pub. L. 69-20,
44 Stat. 9, 58, 59) reduced the general period of limitations to
3 years; the 1926 Act left unchanged the fraud and failure-to-
file rule.
Section 275(a) of the Revenue Act of 1928 (Pub. L. 70-562,
45 Stat. 791, 856, 857) reduced the general statute of
limitations to 2 years; section 276(a) of the 1928 Act left
unchanged the fraud and failure-to-file rule. Both of these
rules remained unchanged by the Revenue Act of 1932. Pub. L. 72-
154, 47 Stat. 169, 237, 238.
In what became the Revenue Act of 1934 (Pub. L. 73-216, 48
Stat. 680), the House Bill provided (1) that the general statute
of limitations be lengthened to 3 years and (2) that the fraud
and failure-to-file rule be expanded to apply also to substantial
understatements of gross income. The Ways and Means Committee
report (H. Rept. 73-704, pp. 34, 35 (1934), 1939-1 C.B. (Part 2)
554, 580) explains these changes as follows:
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Section 275. Period for assessment and collection. The
present law limits the time for assessments to 2 years from
the date the return is filed. Experience has shown that
this period is too short in a substantial number of large
cases, resulting oftentimes in hastily prepared
determinations with the result that additional burdens are
thrown upon taxpayers in getting ill-advised assessments
removed. In other cases, revenue is lost by reason of the
fact that sufficient time is not allowed for disclosure of
all the facts. Subsection (a), therefore, increases the
period of 2 years to 3 years.
* * * * * * *
Section 276(a). No return or false return. The present
law permits the Government to assess the tax without regard
to the statute of limitations in case of failure to file a
return or in case of a fraudulent return. The change in
this section continues this policy, but enlarges the scope
of this provision to include cases wherein the taxpayer
understates gross income on his return by an amount which is
in excess of 25 percent of the gross income stated in the
return. It is not believed that taxpayers who are so
negligent as to leave out of their returns items of such
magnitude should be accorded the privilege of pleading the
bar of the statute.
The House passed the following statutory language:
SEC. 276. SAME--EXCEPTIONS.
(a) No Return or False Return.--If the taxpayer fails
to file a return, or files a false or fraudulent return with
intent to evade tax, or 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,
the tax may be assessed, or a proceeding in court for the
collection of such tax may be begun without assessment, at
any time. [Emphasis added.]
In the Senate, the Finance Committee changed the approach,
explaining in the report as follows (S. Rept. 73-558, pp. 43-44
(1934), 1939-1 C.B. (Part 2) 586, 619-620):
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Section 275. Period for assessment and collection
The present law limits the time for assessments to 2
years from the date the return is filed. Experience has
shown that this period is too short in a substantial number
of large cases resulting oftentimes in hastily prepared
determinations, with the result that additional burdens are
thrown upon taxpayers in contesting ill-advised assessments.
In other cases, revenue is lost by reason of the fact that
sufficient time is not allowed for disclosure of all the
facts. Subsection (a), therefore, increases the period of 2
years to 3 years.
* * * * * * *
The present law permits the Government to assess the
tax without regard to the statute of limitations in case of
failure to file a return or in case of a fraudulent return.
The House bill continues this policy, but enlarges the scope
of this provision to include cases wherein the taxpayer
understates gross income on his return by an amount which is
in excess of 25 percent of the gross income stated in the
return. Your committee is in general accord with the policy
expressed in this section of the House bill. However, it is
believed that in the case of a taxpayer who makes an honest
mistake, it would be unfair to keep the statute open
indefinitely. For instance, a case might arise where a
taxpayer failed to report a dividend because he was
erroneously advised by the officers of the corporation that
it was paid out of capital or he might report as income for
one year an item of income which properly belonged in
another year. Accordingly, your committee has provided for
a 5-year statute in such cases. This amendment also
necessitates a change in section 276(a) of the bill.
Section 276(a). False return or no return
This section is explained in connection with the change
in section 275.
Although the Finance Committee’s rationale was different
from that of the Ways and Means Committee, the Finance
Committee’s statutory language describing the omission that would
trigger a 5-year limitation period (sec. 275(c)) was the same as
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the language that the Ways and Means Committee used to trigger a
broadening of the fraud exception (sec. 276(a) of the House
bill).
In conference, the House receded and the Senate amendments
were agreed to. See H. Rept. (Conference Report) 73-1385, at 25
(1934), 1939-1 C.B. (Part 2) 627, 634. None of the referenced
committee reports explains the intended meaning of the phrase
“the amount of gross income stated in the return”. Also, we have
not found in the hearings or the floor debates any discussion of
the meaning of that phrase. See Estate of Klein v. Commissioner,
63 T.C. 585, 594 (1975), affd. 537 F.2d 701 (2d Cir. 1976).
The language of section 275(c) continued unchanged in the
later revenue acts and through the Internal Revenue Code of 1939.
Section 275(c), I.R.C. 1939, became section 6501(e)(1)(A),
I.R.C. 1954, with three modifications, as follows:
(1) the 5-year limitations period of former law was
changed to 6 years;
(2) “gross income” from a trade or business was
redefined for these purposes to not include the subtraction
for cost of sales or services; and
(3) for purposes of the numerator of the fraction,
adequate disclosure of an item will preclude that item being
treated as omitted.
The Ways and Means Committee report for H.R. 8300, which
became the Internal Revenue Code of 1954 (H. Rept. 83-1337,
p. 107 (1954)), describes these changes as follows:
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(2) The period of limitation for assessment is made 6
years instead of 5 in the case of the omission of 25 percent
of gross income, and a similar rule is applied in the bill
to the estate and gift taxes. However, under the bill this
longer period is not to apply if disclosure of the nature
and amount of omitted items is made on or with the tax
return.
The report goes on to state as follows (id. at A414):
Several changes from existing law have been made in
subsection (e) of this section. In paragraph (1), which
relates to income tax, the existing 5-year rule in the case
of an omission of 25 percent of gross income has been
extended to 6 years. The term gross income as used in this
paragraph has been redefined to mean the total receipts from
the sale of goods or services prior to diminution by the
cost of such sales or services. A further change from
existing law is the provision which states that any amount
as to which adequate information is given on the return will
not be taken into account in determining whether there has
been an omission of 25 percent.
The Finance Committee report is almost identical to the Ways
and Means Committee report. See S. Rept. 83-1622, pp. 143-144,
584 (1954).
In addition, in section 702(c) (no corresponding provision
in prior law) the Congress provided as follows:
SEC. 702. INCOME AND CREDITS OF PARTNER.
* * * * * * *
(c) Gross Income of a Partner.--In any case where it is
necessary to determine the gross income of a partner for
purposes of this title [i.e., title 26, the Internal Revenue
Code], such amount shall include his distributive share of
the gross income of the partnership.
This provision is explained as follows in the Ways and Means
Committee report, H. Rept. 83-1337, supra at 65-66:
- 22 -
A. General rules (secs. 701-707)
(1) Income of partners.--Under your committee’s bill,
as under present law, partners will be liable individually
for income tax on their distributive shares of partnership
income. The bill provides that the partnership will act as
a mere conduit as to income and loss items, transferring
such items directly to the individual partners.
The items required to be segregated will retain their
original character in the hands of the partner as though
they were realized directly by him from the same source from
which realized by the partnership and in the same manner.
After excluding the items required to be separately treated,
the remaining income or loss, which corresponds to the
ordinary income or loss of the partnership under present
law, is attributed to the partners.
The computation of partnership income is generally on
the same basis as existing law. The partnership is allowed
the usual business deductions, but is denied the deductions
peculiar to individuals.
The bill provides that all elections with respect to
income derived from a partnership (other than the election
to claim a credit for foreign taxes) are to be made at the
partnership level and not by the individual partners. This
rule recognizes the partnership as an entity for purposes of
income reporting. It avoids the confusion which would occur
if each partner were to determine partnership income
separately for his own purposes.
(2) Distributive shares.--The taxation of partnership
income or other items directly to the partners requires a
determination of each partner’s share of such items. In
general, such shares will be determined in accordance with
the partnership agreement as under existing practice.
The report goes on to state as follows, id. at A221, A222:
Section 702. Income and credits of partner
This provision represents no change in current law and
practice. It incorporates provisions of sections 182,
183(c), 184, 186, and 189 of present law.
* * * * * * *
- 23 -
Subsection (c) makes clear that, whenever the gross
income of a partner is to be determined, such amount shall
include his distributive share of the partnership gross
income. For example, a partner is required to include his
distributive share of partnership gross income in
determining his individual gross income for the purposes of
determining the necessity of filing a return, the
application of the provision permitting the spreading of
income for services rendered over a 3-year period, the
amount of gross income received from possessions of the
United States, and whether the extended period of limitation
provided in the case of 25-percent omission from gross
income is applicable. [Emphasis added.]
The Finance Committee report, S. Rept. 83-1622, supra at 378, is
almost identical, and does not even note that the Finance
Committee proposed to amend section 702(c) by applying it to
determinations “for purposes of this title” (i.e., the entire
Internal Revenue Code), while the House would have applied
section 702(c) to determinations “for purposes of this chapter”
(i.e., chapter 1, relating to income taxes). The statute of
limitations is in chapter 66, not chapter 1. The Senate version
was enacted. See H. Rept. (Conf. Rept.) 83-2543, at 14 (1954),
relating to Senate Amendment 177.
In 1956, the Treasury Department promulgated regulations
(T.D. 6175, 1956-1 C.B. 211, 214-216) dealing with the extended
limitations period, as follows:
Sec. 1.702-1. Income and credits of partner.--
* * * * * * *
(c) Gross income of a partner.--
* * * * * * *
- 24 -
(2) In determining the applicability of the 6-year
period of limitation on assessment and collection
provided in section 6501(e) (relating to omissions of
more than 25 percent of gross income), a partner’s
gross income includes his distributive share of
partnership gross income (as described in section
6501(e)(1)(A)(i)). In this respect, the amount of
partnership gross income from which was derived the
partner’s distributive share of any item of partnership
income, gain, loss, deduction, or credit (as included
or disclosed in the partner’s return) is considered as
an amount of gross income stated in the partner’s
return for the purposes of section 6501(e). For
example, A, who is entitled to one-fourth of the
profits of the ABCD partnership, which has $10,000
gross income and $2,000 taxable income, reports only
$300 as his distributive share of partnership profits.
A should have shown $500 as his distributive share of
profits, which amount was derived from $2,500 of
partnership gross income. However, since A included
only $300 on his return without explaining in the
return the difference of $200, he is regarded as having
stated in his return only $1,500 ($300/$500 of $2,500)
as gross income from the partnership.
In providing for an extended limitations period, the
Congress did not indicate why gross income, rather than adjusted
gross income or any other concept, was chosen as the touchstone
for the extended statute of limitations,9 nor did the Congress
provide a clue as to what is meant by “the return” for purposes
of determining the amount of the denominator in the 25-percent
calculation. Compare Colony, Inc. v. Commissioner, 357 U.S. 28(1958), in which the Supreme Court relied on legislative history
to decide what is meant by “omits from gross income” for purposes
9
Note that a taxpayer’s omission of gross income does not
necessarily result in an adjustment to the taxpayer’s taxable
income. See Colony, Inc. v. Commissioner, 357 U.S. 28, 36
(1958); Colestock v. Commissioner, 102 T.C. 380 (1994).
- 25 -
of determining the amount of the numerator in the 25-percent
calculation. Neither side cites Colony, Inc., and neither side
points to any aspect of the legislative history that may shed
light on the meaning that the Congress intended to give to the
statutory term “the return.”
IV. Evolution of the Caselaw
In Masterson v. Commissioner, 1 T.C. 315 (1942), revd. on
another issue 141 F.2d 391 (5th Cir. 1944), the taxpayer had
filed two 1935 income tax returns on the same day, one for
herself and the other signed by her “individually, and as
independent executrix of the Estate of” her late husband. See
id. at 322-323. Each of these tax returns referred to the other.
See id. at 323. The Commissioner determined that the taxpayer
should have reported on her individual tax return the corrected
net income of the estate. See id. at 323. The notice of
deficiency was issued more than 3 years, but less than 5 years,
after the due date of the taxpayer’s tax return. We held that
the two tax returns would not be treated together as “the return”
within the meaning of section 275(c) of the Revenue Act of 1934.
See id. at 324. We said that the statute would not be construed
to permit such combining because (1) the tax returns were of
different taxpayers and (2) the estate’s income tax return was of
a different type of taxpayer and it might be that the “facts
necessary to a correct determination of the tax due would not
- 26 -
appear from two returns of the type before us here”. See id.
The Circuit Court of Appeals reversed because the panel’s
majority concluded that the Commissioner’s adjustment was
incorrect; the Circuit Court of Appeals did not indicate any
disagreement with our statute of limitations analysis.
In Ratto v. Commissioner, 20 T.C. 785 (1953), the taxpayer
and her husband were California residents, operated a liquor
business owned by them in community, and filed separate 1946 tax
returns. See id. at 786. The taxpayer’s husband reported the
liquor business operations on his Schedule C, on which he showed
“gross profit” of $30,462.96 and “net profit” of $10,029.19. He
then “computed his income tax on one-half of this amount [the net
profit] with the explanation ‘½ Community Income Reported By
Wife,’ and which he listed as a deduction.” Id. The taxpayer
reported on her Schedule E $5,014.60 as “½ community income.”
See id. at 786. Apparently, she did not show on her tax return
any other information about the liquor business. The
Commissioner determined that the taxpayer omitted $10,216.88
gross profits from the liquor business,10 together with about
$3,600 of other small items. See id. at 787. The notice of
deficiency was sent more than 3 years, but less than 5 years,
after the taxpayer filed her 1946 tax return. We held that the
10
One-half of $30,462.96, less the $5,014.60 that was
reported.
- 27 -
taxpayer’s husband’s tax return was separate from the taxpayer’s
tax return. We concluded as follows (id. at 789-790):
This Court and the circuit courts of appeals have
specifically held that for the purposes of applying section
275(c) of the Internal Revenue Code, consideration may only
be given to the return of the particular taxpayer and that
the return of another taxpayer may not be considered.
* * * * * * *
Petitioner’s complaint that “it does not seem equitable
to deny a taxpayer the benefit of the statute of limitations
merely because of a failure to duplicate the purely
mechanical computation of gross sales less cost of sales to
show the gross income amount which has already been fairly
reported” is also without merit. Section 275(c) is not
limited to situations involving bad faith. * * *
The gross income stated in petitioner’s income tax
return is therefore limited to the $5,014.60 shown therein
and does not include any amounts stated in her husband’s
return.
In Switzer v. Commissioner, 20 T.C. 759 (1953), the
taxpayer-husbands (H’s) were partners whose partnership interests
constituted community property under California law. Each H and
each of the taxpayer-wives (W’s) filed separate timely tax
returns for 1944 and 1945. The partnership filed timely
information returns for these years. The notices of deficiency
were sent to the H’s and W’s more than 3 years, but not more than
5 years, after the respective tax returns were filed. See id. at
761. The taxpayers argued that the partnership’s information
returns should be treated as being part of the taxpayers’
individual tax returns, to the extent of their partnership
interests, in the same manner as a Schedule C is treated as being
- 28 -
part of an individual Form 1040 for a sole proprietor. See id.
at 767. We rejected their arguments, relied on Masterson v.
Commissioner, supra, and held that the denominator of the section
275(c) fraction is to be determined by what is stated on the
taxpayer’s tax returns without regard to the partnership’s
information returns. See Switzer v. Commissioner, 20 T.C. at
768. However, our determination was remanded by the Court of
Appeals for the Ninth Circuit on September 17, 1954, with
directions (in accordance with the stipulation of the parties in
Switzer) to vacate our decisions and enter decisions for the
taxpayers. See Rose v. Commissioner, 24 T.C. 755, 768 (1955);
Rev. Rul. 55-415, 1955-1 C.B. 412, 413.11
11
Rev. Rul. 55-415, 1955-1 C.B. 412, although issued after
the enactment of the Internal Revenue Code of 1954, is the
Commissioner’s interpretation of section 275(c) of the Internal
Revenue Code of 1939. The ruling states, in pertinent part, as
follows (1955-1 C.B. at 413):
It is well recognized that gross income, as earned, belongs
to some taxable entity, and that a partnership is not a
taxable entity. It logically follows that the partners
should be considered as the owners of partnership gross
income.
* * * * * * *
* * * it is held that for the purpose of section 275(c)
of the Code “gross income” of a member of a partnership
includes his proportionate share of the gross income of the
partnership. See Harry Landau et al. v. Commissioner, 21
T.C. 414 [1953]. Any partner’s share of the gross income
reported in the partnership information return should be
considered as having been returned by the taxpayer as such
information return is a return by or on behalf of each
(continued...)
- 29 -
In Rose v. Commissioner, supra, the taxpayer-husband (H)
owned and operated a retail store as a sole proprietorship in
Ventura, California, and another retail store as a partnership
with his brother in Santa Barbara, California. See id. at 757.
H’s interests in the Ventura store and the Santa Barbara
partnership constituted community property. See id. at 758-759,
768. H and W filed separate tax returns for 1943. See id. at
757. The Santa Barbara partnership filed a partnership
information return for 1943. See id. at 758, 768. The Ventura
store filed a partnership information return for 1943, at the
suggestion of a revenue agent, in order to facilitate the
reporting of H’s and W’s community income derived from that
store. See id. at 758-759, 769. If H and W were treated as
having stated in their tax returns their shares of the gross
income of the Ventura store, then the denominators of their
section 275(c) fractions were more than four times the gross
income that the Commissioner determined H and W omitted, the
regular 3-year statute of limitations applied, and the notices of
deficiency for 1943 were untimely. See Rose v. Commissioner, 24
T.C. at 760, 766-770. We analyzed the situation as follows (id.
at 768-769):
11
(...continued)
partner.
- 30 -
The Ventura store was not operated by a partnership.
It was community property of the petitioners and the income
therefrom was community income. Each of the petitioners,
therefore, should have reported one-half of the gross income
from the business. Leslie A. Sutor, 17 T.C. 64, 67. The
respondent urges that they did not do so in their individual
returns, and that their failure to do so is an omission from
gross income by each of them. But we think it is
unrealistic to say that the petitioners did not report the
gross income of the Ventura store (with the exception of the
$17,946.97 which each of them omitted). They did so on Form
1065, a “partnership return.” Although there was no
partnership between them in the business of this store, Form
1065 returns were filed for the years 1938 to 1948,
inclusive, at the suggestion of a revenue agent to
facilitate the reporting of the community income of the
store. The so-called partnership return filed for 1943
reported the gross income of the Ventura store in which
petitioners each had an equal interest. It was not the
return of another taxable entity. Cf. Corrigan v.
Commissioner, 155 F.2d 164, 166 (C.A. 6); Elvina Ratto, 20
T.C. 785, 789. It showed income of the community, a
nontaxable entity. In the circumstances we think that the
so-called partnership return filed for the Ventura store was
merely an adjunct to the individual returns of Jack and Mae
Rose and must be considered together with such individual
returns and treated as part of them. This case is thus
distinguished from the Switzer case where the return in
question was a proper partnership return, whereas here it
was nothing unless it was an adjunct to the individual
returns. But if the Commissioner is now and henceforth to
concede, contrary to our decision in the Switzer case, that
a valid partnership return may be read with the return of an
individual partner to arrive at the total gross income
stated in the partner’s return, then, a fortiori, the Form
1065 return in this case which was filed merely to
facilitate the reporting of community income of the
petitioners, similar returns having been accepted for a
number of years for that purpose by the Commissioner, would
have to be read together with the individual returns of the
partners to ascertain how much gross income was reported by
each of them. Cf. Germantown Trust Co. v. Commissioner, 309
U.S. 304; Atlas Oil & Refining Corporation, 22 T.C. 552,
557. We hold, therefore, that one-half of the gross income
appearing on the Ventura store “partnership” return must be
imputed to the individual return filed by each petitioner in
determining the total gross income stated therein for the
purposes of section 275(c). [Emphasis added.]
- 31 -
In Roschuni v. Commissioner, 44 T.C. 80 (1965), the
taxpayer-wife owned an S corporation, which filed an information
return for 1958, a year for which the Commissioner determined a
deficiency against the taxpayers. The notice of deficiency was
issued more than 3 years, but less than 6 years, after
petitioners filed their 1958 tax return. We quoted extensively
from our opinion in Rose v. Commissioner, supra, concluded that
the S corporation was not a taxable entity, and stated that the
principle of Rose v. Commissioner applied. See Roschuni v.
Commissioner, 44 T.C. at 85-86. We described this principle as
requiring the information return of the nontaxable entity to be
treated as an adjunct of the taxpayers’ tax return. See id. at
85-86. We also held that the taxpayers’ reference, in their 1958
tax return, to the S corporation’s 1958 information return and
the disputed transaction, was sufficient to satisfy the
requirements of section 6501(e)(1)(A)(ii), and so any omitted
gross income from that transaction was not to be taken into
account. See id. at 85-86.
In Davenport v. Commissioner, 48 T.C. 921 (1967), the
taxpayers’ 1958, 1959, and 1960 tax returns reported losses from
a specified partnership. See id. at 924-925. The taxpayer-wife
contended that assessment of any deficiencies for these 3 years
was barred by the statute of limitations; the Commissioner
contended that the 6-year limitations period applied. See id. at
- 32 -
927-928. We held that the Commissioner failed to carry the
burden of proving an omission of more than 25 percent of the
gross incomes stated in the taxpayers’ tax returns, as follows
(id. at 928, 929):
To satisfy his burden in proving the omission,
respondent must show the amount of gross income stated in
the return and the amount of income properly includable
therein which has been omitted. Elizabeth Bardwell, 38 T.C.
84 (1962), affd. 318 F.2d 786 (C.A. 10, 1963), and Lois
Seltzer, 21 T.C. 398 (1953). In the instant case respondent
has not shown the amount of gross income stated in the
return. On each of the returns for the years 1958 through
1960 there is reported on Schedule H a net loss figure for
certain partnership income. Respondent has not shown
whether a partnership return was filed for those years and
if so the gross income reported thereon. Under section
6501(e)(1)(A) the term “gross income from a trade or
business” means the amount received or accrued from the
sales of goods or services undiminished by the cost of such
goods or services. Since there is no evidence indicating
the manner in which petitioner arrived at the loss figure
for income from the partnership, there is nothing in the
record to show petitioner’s gross income from the
partnership. Respondent’s Rev. Rul. 55-415, 1955-1 C.B.
412, following his ruling in I.T. 3981, 1949-2 C.B. 78, as
to a partner’s gross income for the purpose of section 251
of the Internal Revenue Code of 1939, provides, and this
Court has recognized, that a partnership return is to be
considered together with an individual return in determining
the total gross income stated in the individual return for
the purpose of determining whether the 6-year statute of
limitations is applicable. Jack Rose, 24 T.C. 755, 768-769
(1955). See also Elliott J. Roschuni, 44 T.C. 80 (1965),
and Genevieve B. Walker, 46 T.C 630, 637-738 (1966).
[Emphasis added.]
We therefore conclude that respondent has failed to
establish that petitioner and Richard omitted from any one
of their joint Federal income tax returns for the years
1958, 1959, and 1960 an amount of gross income properly
includable therein in excess of 25 percent of the amount of
gross income stated in such return and therefore respondent
has failed to show that the 6-year statute is applicable.
- 33 -
* * * * * * *
We, therefore, sustain respondent’s determination as
modified by the stipulation of the parties filed in this
case for the years 1961, 1962, and 1963 but hold that the
assessment or collection of any deficiency against
petitioner is barred by the statute of limitations for the
years 1958, 1959, and 1960.
In Estate of Klein v. Commissioner, 63 T.C. 585 (1975),
affd. 537 F.2d 701 (2d Cir. 1976), we were called upon to
determine the meaning of “the amount of gross income stated in
the return”, within the meaning of section 6013(e)(1)(A),
relating to relief from joint liability, as that provision
applied to 1955. See 63 T.C. at 589. Relying in part on section
6013(e)(2)(B), we held that the quoted phrase in section
6013(e)(1)(A) must be given the same meaning that it has in
section 6501(e)(1)(A), and that under the latter provision--
the only way “the amount of gross income stated in the
return” can be determined, where a partner of a partnership
which has filed a return is concerned, is to consider the
partnership return together with the individual return in
determining “the total gross income stated in the return” of
the individual partner. Genevieve B. Walker, 46 T.C. 630(1966). See Nadine I. Davenport, 48 T.C. 921, 928 (1967);
accord, Elliott J. Roschuni, 44 T.C. 80 (1965), and Jack
Rose, 24 T.C. 755 (1955). Cf. sec. 702(c); sec. 1.702-
1(c)(2), Income Tax Regs. [Estate of Klein v. Commissioner,
63 T.C. at 590-591.]
As a result, we held, for the Commissioner, that--
the partnership return, must be read as an adjunct with the
individual partner’s return in determining the total gross
income stated in the individual’s return. Indeed, that
determination with respect to partnerships arose from the
gloss upon the section by the decided cases, compare L.
Glenn Switzer, 20 T.C. 759 (1953), with Genevieve B. Walker,
- 34 -
supra, and Nadine I. Davenport, supra; cf. Elliott J.
Roschuni, supra; Jack Rose, supra.9 [Emphasis added.]
______________
9
See also Harry Landau, 21 T.C. 414 (1953); Norman Rodman, T.C.
Memo. 1973-277; and Vernie S. Belcher, T.C. Memo. 1958-180, where it is
pointed out that a “partner’s share of the gross income on the
partnership returns must be imputed to the individual return.” And that
if the partnership return is not in evidence it is impossible to know
the “gross income stated in the return.” The 6-year limitation does not
apply if disclosure “is made on or with the tax return.” (Emphasis
supplied.) H. Rept. No. 1337, 83d Cong., 2d Sess., p. 107 (1954); S.
Rept. No. 1622, 83d Cong., 2d Sess., pp. 143-144 (1954).
[Id. at 592.]
Taking into account the taxpayers’ share of the gross income
shown on their partnership’s information return as having been
shown on the taxpayers’ tax return, we held that the gross income
omitted from the taxpayers’ tax return was less than 25 percent
of the gross income stated on the taxpayers’ tax return. See
Estate of Klein v. Commissioner, 63 T.C. at 588. We concluded
from this that the taxpayer-wife failed to qualify for relief
from joint liability under the law then in effect. See id. at
589. Although we ruled for the Commissioner based on the
language of sections 6013 and 6501, we commented as follows on
the Commissioner’s argument under section 702(c) (Estate of Klein
v. Commissioner, 63 T.C. at 591 & n.6):
As we read the first sentence [of the Finance Committee
report on the 1970 enactment of sec. 6013(e)] we think “the
income reported” by a partner includes his share of the
gross income, as defined in section 6501(e)(1)(A)(i), of the
partnership. Rev. Rul. 55-415, 1955-1 C.B. 412; I.T. 3981,
1949-2 C.B. 78.6
_____________
6
Respondent cites sec. 702(c) and sec. 1.702-1(c)(2), Income Tax
Regs., in support of this position. We note in passing our belief that
- 35 -
the example given in sec. 1.702(c)(2), Income Tax Regs., conflicts with
sec. 6501(e)(1)(A)(i) and (ii) because under the latter section “gross
income” is specially defined and if a partnership return is filed the
entire amount of such “gross income” allocable to a partner is deemed
reported on the return. We do not think the gross income referred to in
sec. 702(c) is the equivalent of the “gross income” defined under sec.
6501(e)(1)(A).
In affirming our determination and agreeing with our
analysis, the Court of Appeals took the occasion to state
agreement with our comment on section 702(c), as follows (537
F.2d at 705 n.9):
We further note that we share the tax court’s opinion that
the example in Treas. Reg. § 1.702-1(c) appears to conflict
with § 6501(e)(1)(A)(ii)’s method for determining the amount
“omitted” from gross income when a partnership return has
been filed.
We conclude that one pattern that emerges from our prior
opinions dealing with the denominator in the 25-percent
calculation, is relevant to the limited matter now before us. In
dealing with documents that were not physically attached to the
taxpayer’s tax return, we have consistently12 drawn a line
between (1) documents that have been filed as tax returns of
12
In Switzer v. Commissioner, 20 T.C. 759, 767-768 (1953),
we pointed to computational anomalies that might result from
applying this approach to partnerships, and there declined to so
apply this approach. However, on appeal the Commissioner joined
the taxpayers to persuade the Court of Appeals to order us to
vacate our decisions and enter decisions for the taxpayers.
After we complied with the Court of Appeals’ order in the Switzer
dockets, we recognized that the Commissioner had, in effect,
conceded error in Switzer’s statute of limitations rulings and
meant to apply that concession generally. See Rose v.
Commissioner, 24 T.C. 755, 768-769 (1955). In Rose, we merely
distinguished Switzer but did not formally overrule it. See 24
T.C. at 769. However, since that time, we have not followed
Switzer on this point. In the instant cases, neither side cites
Switzer. Clearly, Switzer has been sapped of its vitality.
- 36 -
other taxpayers, and (2) documents that, even if filed as tax
returns, were not tax returns of other taxpayers. Documents in
the former category have not been taken into account in
determining the amount of gross income “stated in the return”,
see, e.g., Masterson v. Commissioner, supra; Ratto v.
Commissioner, supra.
On the other hand, the second category--documents that were
not filed as tax returns of other taxpayers--have been treated as
adjuncts to and part of the taxpayers’ tax returns for purposes
of determining “the amount of gross income stated in the return”.
This approach has been applied to partnership tax returns (see,
e.g., Davenport v. Commissioner, supra), S corporation tax
returns (see, e.g., Roschuni v. Commissioner, supra), and other
documents which are not tax returns of taxpayers, see, e.g., Rose
v. Commissioner, supra.
V. Analysis
Section 6501(e) and its predecessors require omitted gross
income to be compared to gross income stated in the return. In
Green v. Commissioner, 7 T.C. 263, 277 (1946), affd. 168 F.2d 994(6th Cir. 1948), we concluded that “‘Gross income’ has a well
established meaning in the revenue laws, denoting statutory gross
income as defined by section 22 [of the Revenue Act of 1938,
predecessor of present sec. 61].” In enacting the Internal
Revenue Code of 1954, the Congress added clause (i) to section
- 37 -
6501(e)(1)(A) to modify the definition of gross income in the
case of trades or businesses. Except for that modification, “the
general definition of gross income found in the Code applies.”
Northern Ind. Pub. Serv. Co. & Subs. v. Commissioner, 101 T.C.
294, 299 n.7 (1993).
However, taxpayers’ tax returns ordinarily do not provide
any place for stating gross income.13 See, e.g., Estate of Klein
v. Commissioner, 537 F.2d at 704; Davis v. Hightower, 230 F.2d
549, 552, 553 (5th Cir. 1956). We have held that “total income”,
as used in the Form 1040 is not the equivalent of “gross income”
for purposes of the extended statute of limitations. See Green
v. Commissioner, 7 T.C. at 276-277. As a result, we have dealt
with the taxpayers’ tax returns by determining whether one or
another item was properly an item of gross income within the
appropriate contemporary statutory definition of gross income.
As noted, supra, when the taxpayers’ tax returns stated
taxable income from partnerships or S corporations, we declared
that the information returns of these pass-through entities would
be treated as adjuncts to, and part of, the taxpayers’ tax
returns. See, e.g., Davenport v. Commissioner, supra
13
See supra our findings with regard to the Harlans’ 1985
tax return. Note that the parties have stipulated that the
Harlans’ gross income stated on their tax return ($1,410,077) is
almost $200,000 more than the amount that the Harlans’ tax return
labeled as gross income ($1,216,099), even without taking account
of flow of gross income from the 2d-tier partnerships.
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(partnership), Roschuni v. Commissioner, supra (S corp.).
Indeed, the Court of Appeals for the Second Circuit described the
process thusly in Estate of Klein v. Commissioner, 537 F.2d at
704:
Schedule H [more recently, Schedule E] of Form 1040,
labelled “Income from Partnerships, Estates, Trusts, and
Other Sources,” provides only one line for reporting
partnership income together with the name and address of the
partnership from which that income was derived. Schedule H
speaks in terms of “[t]otal income (or loss),” the reference
to losses obviously suggesting only a net (adjusted gross)
rather than a gross income figure. Given that limitation
upon the scope of the Form 1040, it is clear that the return
neither intends nor purports to show a taxpayer’s gross
income when that taxpayer has partnership income. Indeed,
gross income is not “stated in the return” in the case of
such a taxpayer unless one looks at the partnership return
as being a part of the personal income tax return. * * *
When we take the partnership’s information return into
consideration as part of the partner’s tax return, we find the
same limitations in the former document that the Court of Appeals
described in Estate of Klein v. Commissioner, supra, as to the
latter document. That is, the 1985 partnership information
returns for Pacific and Carlyle (Ridge’s 1st-tier partnerships)
and for Mission Resources (Theodore’s 1st-tier partnership) do
not provide for a showing of “gross income”. There is a line for
“total income (loss) (combine lines 3 through 10)”, (Form 1065,
1st p., l.11), but it is evident that several of the components
of total income are themselves net amounts. In those instances,
recourse must be had to other forms, schedules, statements, and
other documents attached to the 1st-tier partnership’s
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information return in order to determine the amount of gross
income stated on the partnership’s information return, which in
turn is necessary in order to determine the amount of the
taxpayer partner’s gross income stated in the taxpayer’s tax
return. There does not appear to be any dispute that these other
forms, schedules, statements, and other documents of the 1st-tier
partnership’s information return are treated collectively as
adjuncts to, and part of, the taxpayer partner’s tax return for
purposes of determining the amount of gross income stated on the
taxpayer partner’s tax return, even though they are not attached
to the taxpayer partner’s tax return.
If the 1st-tier partnership’s information return discloses
net income or loss from a 2d-tier partnership, then the same
analysis requires us to consider the 2d-tier partnership’s
information return as merely another document that is an adjunct
to, and part of, the taxpayer partner’s tax return. That is, to
paraphrase the Court of Appeals for the Second Circuit (see
Estate of Klein v. Commissioner, 537 F.2d at 704), gross income
is not “stated in the return” of a taxpayer partner who reports
net partnership income from a 1st-tier partnership which in turn
reports net partnership income from a 2d-tier partnership unless
one looks at the 1st-tier partnership’s information return
together with all its adjuncts--among them being the 2d-tier
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partnership’s information return--as being part of the taxpayer
partner’s tax return.
Thus, we conclude that petitioners are correct in their
contention that 2d-tier partnerships’ information returns are to
be taken into account in determining, for purposes of section
6501(e)(1)(A), the amount of gross income stated in the
taxpayer’s tax return.
VI. Other Considerations
Both sides rely on section 702(c) and section 1.702-1(c)(2),
Income Tax Regs. Respondent asserts that “The plain language of
the Code and the regulations requires” consideration of only the
1st-tier partnerships’ information returns. Petitioners assert
that “Therefore, under this explicit statutory rule [sec.
702(c)], * * * respondent must necessarily” take account of the
2d-tier partnerships’ gross income. The short answer is that the
texts of both section 702(c) and section 1.702-1(c)(2), Income
Tax Regs., are silent on the matter of 2d-tier partnerships. The
little legislative history we have found regarding section 702(c)
also is silent on this matter. We have not found any indication
that the Congress was aware of the question when it considered
and crafted section 702(c), or that the Treasury Department was
aware of the question when it issued the regulation. Indeed, it
may be argued that the statutory language (“determine the gross
income of a partner”) may apply to the numerator of the 25-
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percent fraction of section 6501(e)(1)(A) (“omits from gross
income an amount properly includible therein”) but not to the
denominator--“amount of gross income stated in the return”
(emphasis added). See also the comments of this Court and the
Court of Appeals of the Second Circuit in Estate of Klein v.
Commissioner, 63 T.C. at 591 n.6, affd. 537 F.2d at 705 n.9,
pointing out that “gross income” within the meaning of section
702(c) differs from “gross income” within the meaning of section
6501(e)(1)(A). Thus, notwithstanding both sides’ reliance, we
conclude that neither section 702(c) nor section 1.702-1(c)(2),
Income Tax Regs., leads us to a resolution of the 2d-tier
partnership matter, especially in the context of the denominator
of the 25-percent fraction.
Respondent contends as follows:
The partnership return (Form 1065) itself further
supports looking only to the direct partnership return to
determine gross income for section 6501(e) purposes. The
total gross income of the partnership is the sum of the
amounts on lines 1 through 7 with the exception of the
I.R.C. § 6501(e)(1)(A)(i) exclusion for cost of goods sold.
* * *
These contentions do not support respondent’s position. The
sum of the items on lines 1 through 7 frequently is not “The
total gross income of the [1st-tier] partnership.” Firstly, an
element of gross income may appear on another line, after line 7.
Secondly, several of the items on lines 1 through 7 are net
amounts, and the underlying gross income may have to be
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determined by inspection of other parts of the partnership
information return, Form 1065. This may be illustrated in the
instant cases by comparing lines 1 through 11 of the stipulated
1985 Pacific partnership information return with the parties’
stipulation as to Pacific’s gross income.
Table 1
Pacific’s Partnership
Information Return Pacific’s Stipulated
(Form 1065, 1st. page)1 Gross Income2
4. Ordinary income (loss) -7,705 Rental income (gross) $13,708
from other partnerships Rental income (gross) 11,730
and fiduciaries See STMT#2 Rental income (gross) 17,048
Rental income (gross) 9,024
6a. Gross rents $63,723 -275,383 Rental income (gross) 12,213
6b. Minus rental expenses Total rental income 63,723
$ STMT ATTACHED Form 4797, line 19 703,950
6c. Rental income (loss) Form 4797, line 1d 246,000
Total 1,013,673
9. Net gain (loss)(Form 4797, 34,935
line 17)
11. TOTAL income (loss) -248,153
(combine lines 3 through 10)
1
Lines 1,2,3,5,7,8, and 10 do not have any entries.
2
The stipulation specifically excludes any gross income
from Pacific’s 2d-tier partnership.
As is apparent, more than 90 percent of Pacific’s stipulated
gross income shown on its partnership information return is
related to line 9, and not lines 1 through 7. Further, line 9
does not tell the whole story--it shows only $34,935 net income
from Form 4797, but the parties’ stipulation shows a total of
$949,950 gross income from Form 4797. Thus, contrary to the
implications of respondent’s contentions, respondent’s actions in
the stipulations show that it is necessary to examine more than
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lines 1 through 7 of Pacific’s Form 1065 in order to determine
Pacific’s gross income. When we do that, we find that on line 4
of Pacific’s Form 1065 we are told to “See STMT #2”.
That statement is as follows:
STATEMENT # 2 - INC OTH PARTNERSHIPS
TEROS-PER K-1 -6,633
XX-XXXXXXX
INTEREST-33%
SECTION 743 (B) ADJ -1,072
TOTAL STATEMENT # 2 - TO FORM 1065, LINE 4 -7,705
The record does not include information about the gross income
stated in the information return of Pacific’s 2d-tier
partnership.
We conclude that (1) respondent’s contentions are contrary
to the parties’ stipulations and (2) the parties’ stipulations
are consistent with the Court’s analysis. That is, (a) the 1st-
tier partnership’s information return is treated as an adjunct
to, and a part of, the taxpayer’s tax return, (b) the 2d-tier
partnership’s information return is treated as an adjunct to, and
a part of, the 1st-tier partnership’s tax return, and (c) in
determining the amount of gross income stated in the taxpayer’s
tax return, neither the Court nor the parties are limited to what
is stated on the first page of the tax return.
Respondent’s brief closes as follows:
Finally, respondent’s interpretation of Section 6501(e)
yields a sensible, administrable result. Looking through to
the lower tiers might require an audit of each of those
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partnerships. This would impose an excessive administrative
burden both on the Service and on taxpayers.
Petitioners respond as follows:
Respondent claims that following statutory mandate of
Code section 702(c) would cause an “excessive administrative
burden” on the IRS and taxpayers. Incredibly, respondent
states that adopting a “look-through” rule to lower-tier
partnerships “might require an audit of each of those
partnerships.” In this case, respondent was able to make
computations of gross income of the Upper-Tier Partnerships
without an audit. There is no reason to suggest an audit of
the Lower-Tier Partnerships would be required.
The record in the instant cases thus far does not disclose
either the magnitude of the problem respondent warns against or
the extent of respondent’s activities with regard to the gross
income stated in the 1st-tier partnerships’ information returns.
We note that the parties’ stipulations deal with the components
of the gross incomes stated on the partnership information
returns of 16 entities, and there are only three 2d-tier
partnerships involved in the instant cases. Thus, whatever the
level of effort that respondent expended, it does not appear that
including the 2d-tier partnerships would cause that level to be
substantially increased in the instant cases.
In addition, the Supreme Court’s opinion in Colony, Inc. v.
Commissioner, 357 U.S. at 36-37, suggests that respondent is not
obligated to audit or otherwise examine beyond what is disclosed
on the tax return, for purposes of applying the amount of the
denominator in the 25-percent fraction. Clearly, it is now
accepted that respondent must deal with the 1st-tier
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partnerships’ information returns. This was established before
1958, when the Supreme Court ruled in Colony, Inc. We have no
reason to believe that the standards for respondent’s work on the
1st-tier partnerships’ information returns were intended to be
any different from those applicable to the taxpayers’ tax
returns. Given that these obligations exist as to the 1st-tier
partnerships’ information returns, we do not see any principled
basis for concluding that the 2d-tier partnerships’ information
returns require so heightened a level of examination or audit,
that our analysis of the law ought to be affected by that
heightened level. Respondent’s brief, almost afterthought,
speculation is far short of a cogent argument that principled
distinction can be drawn between 1st-tier partnerships’
information returns and all 2d-tier partnerships’ information
returns.
We do not change our analysis on account of respondent’s
warning.
Our holding in this opinion will be incorporated into the
decision to be entered in these cases when all the other issues
are resolved.14
14
The parties’ stipulations and stipulated exhibits are not
treated as exhausting the record as to the subject matter of the
instant opinion. In further proceedings, the parties will be
free to provide such additional evidence on this subject matter
as is not inconsistent with our holdings and is otherwise
admissible. See also Reis v. Commissioner, 142 F.2d 900, 902,
903 (6th Cir. 1944), affg. 1 T.C. 9 (1942), as modified by a
Memorandum Opinion of this Court dated June 4, 1943.