(CN) - The government cannot get extra time to go after taxpayers who have understated their profits from a property sale by exaggerating how much they paid in the first place, the Supreme Court ruled Wednesday.
Typically the government must assess a taxpayer deficiency within three years after the return in question was filed. The time limit extends to six years when the taxpayer's gross income does not include a profit that exceeds 25 percent of what he stated.
The court looked at this issue to resolve whether the Internal Revenue Service properly made a $1.3 million adjustment in 2006 to the tax return that Home Concrete & Supply filed for 1999 fiscal year.
Two energy executives created Home Concrete in April 1999 to minimize their tax liability when selling their business interests. On Aug. 31, 1999, Home Concrete sold substantially all of its assets to a third-party purchaser for $10.6 million.
This appeared as a modest $69,000 profit on Home Concrete's 1999 tax return, however, because the company stated its inside basis as $10.5 million.
The IRS did not investigate the transactions until June 2003, and the parties did not comply with a summons until the following year. After paying $1.3 million to satisfy the 2006 adjustment, Home Concrete filed suit for reimbursement in the Eastern District of North Carolina.
A federal judge ruled for the IRS, finding that its action was timely, but the 4th Circuit disagreed on appeal and said the adjustment was barred by the three-year limitations period.
The Supreme Court affirmed Wednesday, relying on its 1958 resolution of Colony v. Commissioner.
"In Colony this court held that taxpayer misstatements, overstating the basis in property, do not fall within the scope of the statute," according to the majority opinion authored by Justice Stephen Breyer.
Tax law extends the three-year limitations period for cases where the taxpayer "omits" an amount from the reported gross income, the court emphasized.
The decision picks apart the government's weak arguments, which attributed significance to use of the word "item" instead of "amount" in a subsection of the statute.
"The word's appearance in subsection (e)(2), we concede, is new," Kennedy wrote. "But to rely in the case before us on this solitary word change in a different subsection is like hoping that a new batboy will change the outcome of the World Series."
Though the government pointed out that the Treasury Department defined misstatements as "an omission from gross income" in 2010, the justices declined to give this factor weight.
"We do not accept this argument," Breyer wrote. "In our view, Colony has already interpreted the statute, and there is no longer any different construction that is consistent with Colony and available for adoption by the agency."
The court's 2005 holding in National Cable & Telecommunications Associaion v. Brand X Internet Services sets the parameters for when the "court's prior judicial construction of a statute trumps an agency construction."
Breyer and Justice Antonin Scalia did not join in the next and final section of the opinion, which parses Brand X.
"The fatal flaw in the government's contrary argument is that it overlooks the reason why Brand X held that a 'prior judicial construction,' unless reflecting an 'unambiguous' statute, does not trump a different agency construction of that statute," according to the opinion, which was joined in full by Chief Justice John Roberts and Justices Clarence Thomas and Antonin Scalia. (Emphasis in original.)
"It may be that judges today would use other methods to determine whether Congress left a gap to fill," the opinion concludes. "But that is beside the point. The question is whether the court in Colony concluded that the statute left such a gap. And, in our view, the opinion (written by Justice Harlan for the Court) makes clear that it did not." (Parentheses in original.)
Scalia blasted the plurality for creating "confusion and uncertainty" by continually revising precedent.
"Rather than making our judicial-review jurisprudence curiouser and curiouser, the court should abandon the opinion that produces these contortions, Brand X," Scalia wrote. "I join the judgment announced by the court because it is indisputable that Colony resolved the construction of the statutory language at issue here, and that construction must therefore control."
The dissent says, however, that the government's revision of the tax code in 1954 "leaves room" for the government's case against Home Concrete.
"In the instant case the court concludes these statutory changes are 'too fragile to bear the significant argumentative weight the government seeks to place upon them,'" Justice Anthony Kennedy wrote. "But in this context, the changes are meaningful. Colony made clear that the text of the earlier version of the statute could not be described as unambiguous, although it ultimately concluded that an overstatement of basis was not an omission from gross income. The statutory revisions, which were not considered in Colony, may not compel the opposite conclusion under the new statute; but they strongly favor it. As a result, there was room for the Treasury Department to interpret the new provision in that manner."
Justices Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan joined Kennedy's dissent.
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