Court Cracks Down on Couple’s Tax Maneuver

(CN) - The 7th Circuit revived an Internal Revenue Service claim against a couple who failed to report more than $12 million in investment profits and essentially told the IRS it was "out of luck" under the statute of limitations.

While the IRS gets a wider berth to investigate omissions from tax returns, Kenneth and Susan Beard had argued that the transaction by which they concealed profits was an overstatement, not an omission.

The tax court had agreed and granted summary judgment to the Beards, finding that the IRS could not institute the claim without the extended six-year statute.

But the Chicago-based federal appeals panel said Wednesday that the maneuver the Beards used to hide the income is tantamount to an abusive tax shelter, giving the IRS the benefit of extended time.

In 1999, the Beards employed a Son-of-BOSS (Bond and Option Sales Strategy) transaction to artificially increase their tax basis in a partnership interest through a short sale transaction before selling that interest. A year later, the IRS said it would no longer honor such transactions. Short sales allow investors to borrow shares with the obligation to repurchase them in the future, at which point they may have decreased in value.

By using the Son-of-BOSS maneuver, the Beards limited the value of their partnership interest without reducing their tax basis in the partnership. This is advantageous for the taxpayer because the capital gains tax on this type of transaction is calculated by subtracting the outside basis from the amount recognized in the sale of the ownership rights. A higher outside basis means lower capital gains tax and more money in the taxpayer's pocket.

The IRS did not detect the Beards had used Son-of-BOSS to misstate their true capital gains until nearly six years had passed. By arguing for the regular statute of limitations, the Beards, in essence, told the IRS it "was out of luck as the notice of deficiency came too late," according to the 7th Circuit ruling.

While the tax court based its award of summary judgment on a 1958 precedent that turns on a clause in the 1939 code, the three-judge appeals panel found that the code had changed in 1954.

The court's opinion states that the 1954 update clarifies the tax code.

"Reading [the updated section] as a gestalt, the meaning is clear, and an inflation of basis should be considered an omission from gross income such that it triggers the extended six-year statute of limitations," Judge Terence Evans wrote for the court.

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