Free Memorandum - District Court of Federal Claims - federal

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 1 of 44

______________________________________________________________________________ ______________________________________________________________________________

IN THE UNITED STATES COURT OF FEDERAL CLAIMS GRAPEVINE IMPORTS, LTD., and T-TECH, INC., as Tax Matters Partner Plaintiffs, v. UNITED STATES OF AMERICA, Defendant. ' ' ' ' ' ' ' ' ' '

NO. 05-296T (Judge Allegra)

UNITED STATES' BRIEF IN SUPPORT OF THE APPLICATION OF THE SIX-YEAR STATUTE OF LIMITATIONS Respectfully Submitted, GROVER HARTT, III Attorney of Record Tax Division U.S. Department of Justice 717 N. Hardwood, Suite 400 Dallas, Texas 75201 (214) 880-9721 (Main) (214) 880-9741 (Fax) EILEEN J. O'CONNOR Assistant Attorney General DAVID D. GUSTAFSON Chief, Court of Fed. Claims Section CHRISTOPHER R. EGAN Of Counsel

______________________________________________________________________________ ______________________________________________________________________________

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 2 of 44

TABLE OF CONTENTS QUESTIONS PRESENTED ........................................................................................................ 1 STATEMENT OF FACTS........................................................................................................... 2 A. Joseph And Virginia Tigue Attempted To Offset $10 Million of Gain By Using A Son of BOSS Tax Shelter To Manufacture $10 Million Of Basis................................................. 2 B. The Tigues' Form 1040 Reports a $45,077 Loss From Their Sale of Grapevine Imports, and Grapevine Imports' Form 1065 Reports a Simple Purchase and Sale of Treasury Securities.................................................................................................................. 6

ARGUMENTS AND AUTHORITIES...................................................................................... 11 I. THE TIGUES' OMISSION OF ALMOST $10 MILLION OF GROSS INCOME QUALIFIES AS SUBSTANTIAL ......................................................................................... 12 A. 1. 2. The Tigues' Omission Meets Section 6501(e)'s Substantial Threshold....................... 12 Mr. and Mrs. Tigue's 1999 Form 1040 Omitted $9,978,119 of "Gross Income" .... 13 Mr. and Mrs. Tigue's 1999 Form 1040 Stated Only $469,158 of "Gross Income" . 15

3. Mr. and Mrs. Tigue's Omission Greatly Exceeds Section 6501's 25 Percent Threshold .......................................................................................................................... 17 B. The Supreme Court's Holding in Colony, Inc. v. Commissioner Does Not Conflict With the Analysis or Result in This Case ............................................................................. 17 1. Mr. and Mrs. Tigue's Income is Personal Gain, But The Colony, Inc.'s Income Was Trade and Business Income Received From the Sale of Goods........................................ 18 2. The Statute Governing Mr. and Mrs. Tigues' Assessment is 26 U.S.C. § 6501, but the Statute Governing The Colony, Inc. was Section 6501's Predecessor in the Internal Revenue Code of 1939, 26 U.S.C. § 275........................................................................... 19 C. The 1997 Amendment to Section 6501(a) Prospectively Supersedes Prior Contrary Interpretations of Section 6501(e) ........................................................................................ 22 1. Section 6501's Plain Language Limits Reported Income to Income Reported on Mr. and Mrs. Tigue's Individual Form 1040 ........................................................................... 25 a. The Language Itself .............................................................................................. 25

ii

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 3 of 44

b. c.

The Specific Context In Which the Language Is Used......................................... 27 The Broader Context of the Statute as a Whole.................................................... 28

2. Case Law and Other Authority That Interprets Section 6501(e) for Pre-1997 Tax Years Does Not Apply to Mr. and Mrs. Tigue's 1999 Tax Return. ................................. 29 3. Nothing in the Legislative History of the 1997 Amendment to Section 6501(a) Suggests that Congress Sought to Define the Term "Return" Differently for Purposes of Section 6501(e) than the Broad Definition Provided in Section 6501(a). ........................ 30 II. THE TIGUES DID NOT ADEQUATELY DISCLOSE THEIR OMITTED INCOME.................................................................................................................................. 32 A. Section 6501(e) Requires Courts to Evaluate the Adequacy of Return Disclosures, Not the Effectiveness the Taxpayer's Efforts at Concealment. ................................................... 33 B. The Tigues' Disclosures Were Inadequate and Misleading ......................................... 35

CONCLUSION ........................................................................................................................... 37

TABLE OF AUTHORITIES Cases AD Global Fund, LLC v. United States, 67 Fed. Cl. 657 (2005).................................................. 28 Adickes v. S. H. Kress & Co., 398 U.S. 144, 157 (1970).............................................................. 15 Badaracco v. Commissioner, 464 U.S. 386 (1984) ...................................................................... 28 BedRoc Ltd., L.L.C. v. United States, 541 U.S. 176 (2004).......................................................... 25 Blum v. Stevenson, 465 U.S. 886 (1984)....................................................................................... 25 BP America Production Co., v. Burton, No. 05-669, 2006 WL 3542766 (Dec. 11, 2006) .......... 28 Bufferd v. Commissioner, 506 U.S. 523 (1993)...................................................................... 26, 31 CC & F Western Operations, L.P. v. Commissioner, 273 F.3d 402 (1st Cir. 2001) .. 13, 27, 33, 34 Colm Producer, Inc. v. United States, No. 3:03-CV-3402-N, 2006 WL 3228527 (N.D. Tex. Oct. 16, 2006) ......................................................................................................................... 6, 15, 38 Conn. Nat'l Bank v. Gerrnain, 503 U.S. 249 (1992) ................................................................... 25 Cruz v. Commissioner, No. 15081-89, 1990 WL 178938, 60 T.C.M. (CCH) 1280 (Nov. 20, 1990) ................................................................................................................................... 24, 29 E. I. Du Pont De Nemours & Co. v. Davis, 264 U.S. 456 (1924)................................................. 28 E.I. Du Pont De Nemours & Co. v. Davis .................................................................................... 28 Federal Nat. Mortg. Ass'n v. United States, No. 06-5055, 2006 WL 3257875 (Fed. Cir. Nov. 13, 2006) ......................................................................................................................................... 28 Grapevine Imports, Ltd. v. United States, 71 Fed. Cl. 324 (Fed. Cl. 2006) ..................... 25, 27, 32 Gustafson v. Alloyd Co., 513 U.S. 561 (1995).............................................................................. 31 Gutierrez v. Ada, 528 U.S. 250 (2000) ......................................................................................... 31

iii

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 4 of 44

Harlan v. Commissioner, 116 T.C. 31 (2001) .................................................................. 23, 24, 29 Hoffman v. Commissioner, 119 T.C. 140 (2002).................................................................... 24, 29 In re G-I Holdings, Civ. No. 02-3082, 2006 WL 2595264 (D.N.J. Sept. 8, 2006) .... 15, 34, 35, 36 Insulglass Corp. v. Comm'r, 84 T.C. 203 (1985).............................................................. 13, 14, 27 Jarecki v. G.D. Searle & Co., 367 U.S. 303 (1961) ..................................................................... 31 Klein v. Commissioner, 537 F.2d 701 (2d Cir. 1976) ................................................. 23, 24, 29, 30 Klien v. Commissioner, 683 T.C. 585 (1975) ............................................................................... 23 Norfolk Dredging Co. Inc. v. United States, 375 F.3d 1106 (Fed. Cir. 2004) .............................. 25 Park `N Fly, Inc. v. Dollar Park & Fly, Inc., 469 U.S. 189 (1985).............................................. 25 Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968) ......................................................... 21, 22 34 Quick's Trust v. Commissioner, 54 T.C. 1336 (1970) .................................................................. 33 Rhone Poulenc Surfactants and Specialties, L.P. v. Commissioner, 114 T.C. 533 (2000) .... 33, 34 Robinson v. Shell Oil Co., 519 U.S. 337 (1997) ........................................................................... 25 Schneider v. Commissioner, 1985 Tax Ct. Memo LEXIS 488, at *9-11.................... 13, 14, 16, 27 Statutes 26 U.S.C § 61......................................................................................................................... passim 26 U.S.C. § 150............................................................................................................................. 32 26 U.S.C. § 275....................................................................................................................... 19, 20 26 U.S.C. § 275(c) ........................................................................................................................ 19 26 U.S.C. § 318............................................................................................................................. 32 26 U.S.C. § 3322........................................................................................................................... 32 26 U.S.C. § 368(a) ........................................................................................................................ 32 26 U.S.C. § 59(e)(2)...................................................................................................................... 32 26 U.S.C. § 61(a) .......................................................................................................................... 13 26 U.S.C. § 6229........................................................................................................................... 28 26 U.S.C. § 6229(c) ...................................................................................................................... 12 26 U.S.C. § 6501(a) ............................................................................................................... passim 26 U.S.C. § 6501(e) ...................................................................................................................... 17 26 U.S.C. § 6501(e)(1)(A) .......................................................................................... 12, 16, 27, 29 26 U.S.C. § 6501(e)(1)(A)(i) ................................................................................................. passim 26 U.S.C. § 6501(e)(1)(A)(ii) ..................................................................................... 19, 21, 33, 37 26 U.S.C. § 6511........................................................................................................................... 26 26 U.S.C. § 6513........................................................................................................................... 26 26 U.S.C. § 665(a) ........................................................................................................................ 32 26 U.S.C. § 6664(c)(3)(A) ............................................................................................................ 32 26 U.S.C. § 701............................................................................................................................. 16 26 U.S.C. § 702(a). ................................................................................................................. 16, 27 26 U.S.C. § 722............................................................................................................................... 5 26 U.S.C. § 733(1) .......................................................................................................................... 5 26 U.S.C. § 752(a) .......................................................................................................................... 5 26 U.S.C. § 752(b) .......................................................................................................................... 5 26 U.S.C. § 7701(a)(1).................................................................................................................. 16 26 U.S.C. § 7701(a)(13)................................................................................................................ 16 26 U.S.C. § 702(c) ........................................................................................................................ 29 Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1284(a), 111 Stat. 788, 1038 (1997) ......... 23

iv

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 5 of 44

Other Authorities H.R. Conf. Rep. 105-220, 1997 WL 451277 (1997) .................................................................... 31 H.R. Rep. 105-148, 1997 WL 353016 (1997) .............................................................................. 31 IRS Chief Counsel Notice 2003-020, IRS CCN CC-2003-020, available at 2003 WL 24016805 (June 25, 2003)............................................................................................................................ 2 SIR ARTHUR CONAN DOYLE, THE ADVENTURE OF THE EMPTY HOUSE, available at http://sherlockholmes.classic-literature.co.uk/the-adventure-of-the-empty-house/ebook-page-13.asp. . 11, 39 Terry Box, Grapevine Dealership Sold to V.T., DALLAS MORNING NEWS, Dec. 2, 1999, at 2D.... 5 Regulations 25 Fed. Reg. 11,867 (Nov. 26, 1960)............................................................................................ 23 Treas. Reg. § 1.61-6(a) ................................................................................................................. 13 Treas. Reg. § 1.702-1(c)(2)..................................................................................................... 23, 24

v

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 6 of 44

IN THE UNITED STATES COURT OF FEDERAL CLAIMS GRAPEVINE IMPORTS, LTD., and T-TECH, INC., as Tax Matters Partner Plaintiffs, v. UNITED STATES OF AMERICA, Defendant. ' ' ' ' ' ' ' ' ' '

NO. 05-296T (Judge Allegra)

UNITED STATES' BRIEF IN SUPPORT OF THE APPLICATION OF THE SIX-YEAR STATUTE OF LIMITATIONS This brief will establish that the Notice of Final Partnership Administrative Adjustment ("FPAA") issued to Grapevine Imports, Ltd. was timely. As explained below, the 1999 tax year of Joseph and Virginia Tigue ­ the actual taxpayers in this case -- is subject to a six-year assessment limitations period because they omitted almost $10 million of gross income from their 1999 Form 1040. Although this omission directly resulted from Mr. and Mrs. Tigue's execution of a Son of BOSS tax shelter transaction, Mr. and Mrs. Tigue's tax returns give no clue that the shelter transaction ever occurred. At best, their reporting was sloppy, incomplete, and misleading. At worst, it was designed to deceive. Either way, Mr. and Mrs. Tigue failed to honor their self-reporting responsibility. This failure made it much more difficult for the IRS identify and ferret out their tax shelter transaction.

QUESTIONS PRESENTED 1. Whether Mr. and Mrs. Tigue omitted "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" when they filed their 1999 Form 1040?

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 7 of 44

a. How much "properly includible" gross income did Mr. and Mrs. Tigue omit from their 1999 Form 1040? b. How much gross income did Mr. and Mrs. Tigue state in their 1999 Form 1040? 2. Whether any omitted income was "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." a. Under what standard does the Court evaluate the adequacy of disclosures? b. Was any omitted income otherwise adequately disclosed on Mr. and Mrs. Tigue's return or a statement attached to their return?

STATEMENT OF FACTS Facing a $10 million capital gain from the anticipated sale of their auto dealership, Grapevine Imports, Ltd., Joseph and Virginia Tigue attempted to eliminate that gain by using a Son of BOSS tax shelter to manufacture $10 million of basis. Instead of disclosing that shelter transaction on their tax return, Mr. and Mrs. Tigue's reporting makes it appear that the shelter never existed.

A. Joseph And Virginia Tigue Attempted To Offset $10 Million of Gain By Using A Son of BOSS Tax Shelter To Manufacture $10 Million Of Basis In December 1999, Mr. and Mrs. Tigue used one partnership, one corporation, and two newly created limited liability companies to improperly create $9,978,119 of basis in two days. The Tigues' basis-generating transaction is commonly referred to as a Son of BOSS tax shelter. 1 The relationship between Mr. and Mrs. Tigue's entities is shown in the following chart:

1

See IRS Chief Counsel Notice 2003-020, IRS CCN CC-2003-020, available at 2003 WL 24016805 (June 25, 2003), for a general description of Son of BOSS tax shelters.

2

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 8 of 44

Grapevine Imports, Ltd.

T-Tech, Inc. (1%)

JJT Meandering Investments, LLC (49.5%)

VBT Meandering Investments, LLC (49.5%)

Joseph J. Tigue

Joseph J. Tigue

Virginia B. Tigue

According to Plaintiff Grapevine Imports' complaint challenging the FPAA, Jenkens & Gilchrist's opinion letters, 2 and DB Alex Brown's (the broker from whom the Tigues borrowed the treasury securities involved in the short sale) account documents, the Tigues' Son of BOSS transaction consisted of the following purported steps: 3 · Step One ­ Short Sale Opened On December 9, 1999, Mr. and Mrs. Tigue caused their recently created and whollyowned Limited Liability Companies, JJT (Joseph J. Tigue) Meandering Investments and VBT (Virginia B. Tigue) Meandering Investments, 4 to borrow treasury securities worth $9,978,119 from broker DB Alex Brown. 5 They immediately sold those securities for $9,978,119 in cash. 6

2 3

Gov. Ex. 6 (Jenkens Opinion) at 00000012. The United States asserts the following facts for summary judgment purposes only. The United States may argue during the trial of this case's merits that the transactions described in this brief should be re-characterized or set aside and ignored. 4 Mr. and Mrs. Tigue appear to ignore these LLCs for tax reporting purposes. See Grapevine 1999 Form 1065, Sch. K-1s (listing Joseph and Virginia Tigue as direct partners). 5 Comp., par. 24-25; Gov. Ex. 9 (JJT Open Confirmation); Gov. Ex. 10 (VBT Open Confirmation). Total proceeds documented in exhibits 9 and 10 is calculated as (4,989,062 (principal) ­ 3.00 (handling fee)) + (4,989,062 (principal) ­ 3.00 (handling fee)) = $9,978,119. 6 Id.

3

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 9 of 44

·

Step Two ­ Proceeds and Obligation to Close Contributed to Grapevine One day later, on December 10th, the Tigues caused JJT and VBT to contribute the sale proceeds and the obligation to "close the short-sale" (i.e., the obligation to return the borrowed treasury securities to DB Alex Brown, the short-sale lender) to Grapevine Imports, Ltd. in return for a combined 99% LP interest in Grapevine. 7

·

Step Three ­ Short Sale Closed Grapevine then, on the same day, immediately satisfied the short-sale obligation by purchasing treasury securities for $10,000,003 and repaying those notes to the short-sale lender, DB Alex Brown. 8

These steps resulted in a net economic loss of $21,884. 9 The following chart summarizes these steps:

Dec. 9th $9,978,119 of Treas. Securities Transferred

DB Alex Brown

Dec. 10th $10,000,003 of Treas. Securities Transferred

Dec. 9th JJT and VBT Sell Treas. Securities for $9,978,119

JJT VBT

Grapevine Imports

Dec. 10th GV Purchases Treas. Securities for $10,000,003

Dec. 10th $9,978,119 of Proceeds and Close Obligation Transferred

7 8

Compl., par. 27-28; Gov. Ex. 11 (JJT Transfer Request); Gov. Ex. 12 (VBT Transfer Request). Compl., par 29-30; Gov. Ex. 8 (Close Confirmation). $10,000,003 is calculated by adding the $3.00 handling charge to the $10,000,000 principal amount. See id. 9 $10,000,003 (close) less $9,978,119 (open) = $21,884.

4

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 10 of 44

Why would Mr. and Mrs. Tigue engage in such a circular transaction that took place in a mere two days and produced a $21,884 loss? Basis. Before the transaction, Mr. and Mrs. Tigue had agreed to sell Grapevine Imports--a news article announced the sale on December 2, 1999. 10 Because their tax basis in the partnership was very low, 11 they undoubtedly knew that the Grapevine sale would trigger an almost $10 million gain. Their Son of BOSS transaction attempted to avoid that substantial capital gain by manufacturing $9,978,119 of basis in two days (the actual elapsed time was probably closer to 24 hours). The creation of that basis revolves around Mr. and Mrs. Tigues' treatment of the obligation to close the short sale that they, through their LLCs, contributed to Grapevine Imports. The Tigues assert that the obligation to close the short sale was not a liability, but it was. When a partner contributes an asset and a liability to a partnership, the partner's basis in the partnership is usually increased by the partner's carryover basis in the asset, 12 decreased by the liability assumption, 13 and increased by the partner's share of the liability assumed. 14 When the partnership later satisfies the liability, the partner's basis is decreased by the partner's share of the liability that is satisfied. 15 Thus, if the obligation to close the short sale was a liability, the basis adjustments from the proceeds and obligation contribution would have essentially offset each other. But if the obligation to close the short sale was not a liability, the proceeds contribution would have greatly increased JJT and VBT's basis in the partnership, and the obligation to close the short sale would not have offset it. The following chart demonstrates the

10 11

Terry Box, Grapevine Dealership Sold to V.T., DALLAS MORNING NEWS, Dec. 2, 1999, at 2D. See K-1 beginning capital balances in Gov. Ex. 5 (Grapevine 1999 Form 1065). 12 26 U.S.C. § 722 (partner's basis in partnership equals value of contributed proceeds plus partner's adjusted basis in contributed property). 13 26 U.S.C. §§ 752(b) (partnership's assumption of partner's debt treated like money distribution), 733(1) (money distribution decreases partner's basis in partnership). 14 26 U.S.C. § 752(a). 15 26 U.S.C. § 752(b).

5

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 11 of 44

results of these two positions. 16 Grapevine asserts that the short-sale contributions increased JJT & VBT's combined basis in Grapevine by $9,978,119, but the IRS asserts that the short-sale contributions decreased JJT & VBT's basis by $21,884: 17

Basis of JJT & VBT's Interest in Grapevine Imports
Comparison of Short-Sale Obligation Treatments Obligation as Liability $9,978,119.00 ($10,000,003) $10,000,003 ($10,000,003) (21,884.00) Obligation as Non-Liability $9,978,119.00 9,978,119.00

Transaction Contribution of Sales Proceeds Partnership's Assumption of Short-Sale Obligation Partners' Share of Assumed Short-Sale Obligation Partnership's Close of Short Sale Total Basis Adjustment

B. The Tigues' Form 1040 Reports a $45,077 Loss From Their Sale of Grapevine Imports, and Grapevine Imports' Form 1065 Reports a Simple Purchase and Sale of Treasury Securities Having attempted to create almost $10 million of additional new basis, Mr. and Mrs. Tigue purportedly consummated the sale of their interest in Grapevine Imports on December 31, 1999. 18 They received $10,916,240 of sale proceeds, yet they contend they recognized a $45,077 loss from the sale. As explained above, Mr. and Mrs. Tigue used the $9,978,119 of basis created by the Son of BOSS transaction to eliminate their capital gain. The Tigues reported the Grapevine loss on their Form 1040's Sch. D: 19

16

In a case involving a Son of BOSS shelter quite similar to Mr. and Mrs. Tigue's, a federal district court in Texas recently held that an obligation to close a short sale is treated as a liability when it is transferred to a partnership along with the short-sale proceeds. Colm Producer, Inc. v. United States, No. 3:03-CV-3402-N, 2006 WL 3228527 (N.D. Tex. Oct. 16, 2006). 17 For simplicity, it is assumed that JJT & VBT's share of the partnership close obligation would be 100%. 18 A news article announcing Grapevine's sale indicates that the sale may have closed before December 31st. Box, supra note 10. 19 Gov. Ex. 1 (1999 Tigue Form 1040) at DOJ-000585.

6

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 12 of 44

Although the Sch. D explicitly lists "Mo., day, yr." in the date acquired and date sold columns, Mr. and Mrs. Tigue provided only the years in those columns. If they had provided the month and year, one might have noticed that the sale occurred late in the year after a series of treasury security transactions. The rest of Mr. and Mrs. Tigue's 1999 Form 1040 reports $469,158 of positive income:

Stated Income on Tigue 1040 (Gov. Ex. 1) Income Amount Location Interest $27,275 DOJ-000584 (Sch. B) Dividends $40,915 DOJ-000584 (Sch. B) Short-Term Capital Gain $0 DOJ-000589 (Sch. 1) Long-Term Capital Gain $164,953 DOJ-000589 (Sch. 1) Partnership Non-Passive $112,431 DOJ-000589 (Sch. 1) Partnership Passive $11,688 DOJ-000589 (Sch. 1) Other Income $111,896 DOJ-000590 (Sch. 2) Total Stated Income $469,158

Note that the above amounts do not include loss amounts reported on the return. As explained in more detail below, gross income under 26 U.S.C § 61 does not include loss amounts. Like the Tigues' 1999 From 1040, Grapevine Import's 1999 Form 1065 provides incomplete and misleading information about its 1999 activities. Even though it never sold any treasury securities and only closed the short sale that had been opened by the LLCs, Grapevine reported a transaction that looks like the partnership first purchased and then sold "treasury notes." 20

20

Gov. Ex. 5 (1999 Grapevine Form 1065) at DOJ-000161.

7

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 13 of 44

Line 4(d) of the Form 1065's Sch. K instructs taxpayers to "attach Schedule D" for short-term capital gains and losses, but Grapevine did not file a Schedule D. 21 Instead, it provided the above information on its own statement that lumps together other income, other deductions, and "SCHEDULE K ­ SHORT-TERM LOSSES." Schedule D lists "Mo., day, yr." in its dateacquired and date-sold columns, 22 but Grapevine's statement provides only the month and year. If Grapevine had provided the days purchased and sold, one might have noticed that the purchase and sold dates were reversed. Unlike a simple purchase and sale, JJT and VBT sold the securities first. Grapevine then closed the short sale by purchasing securities. 23 The Sch. M-2 and K-1s in Grapevine's 1999 Form 1065 report various lumped-together capital contributions and distributions that are not limited to the Son of BOSS transaction. The Sch. M-2 reports $12,151,221 of contributions and $10,197,429 of distributions: 24

The K-1s report each partner's share of those contributions and distributions. 25 Finally, Grapevine alleges that JJT and VBT opened the treasury short-sale and contributed the obligation to close that short-sale to Grapevine Imports in return for a combined
21 22

Id. at DOJ-000157. See 1999 Schedule D (Form 1065), available at http://www.irs.gov/formspubs/article/0,,id=141434,00.html. 23 See shelter-steps above. 24 Gov. Ex. 5 (1999 Grapevine Form 1065) at DOJ-000158. 25 Gov. Ex. 5 (1999 Grapevine Form 1065) at DOJ-000162, DOJ-000164, DOJ-000166.

8

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 14 of 44

99 percent partnership interest, 26 but Grapevine's K-1s list Grapevine's partners as T-Tech, Inc., Joseph J. Tigue, and Virginia B. Tigue: 27

The names and EINs for JJT Meandering Investments, LLC and VBT Meandering Investments, LLC do not appear anywhere on Grapevine's Form 1065. Of course, the two newly created LLCs are disregarded entities in any case.

26 27

Complaint at ¶ 24-25, 27-28. Gov. Ex. 5 (1999 Grapevine Form 1065) at DOJ-000162, DOJ-000164, DOJ-000166.

9

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 15 of 44

The following chart summarizes how each step of Mr. and Mrs. Tigue's tax shelter was disclosed, or more importantly, not disclosed:
Date Steps Reporting

12/9/1999 12/9/1999

JJT borrows treasury securities worth $4,989,059.50. VBT borrows treasury securities worth $4,989,059.50.

Not Disclosed on Form 1040 or 1065 Not Disclosed on Form 1040 or 1065 Grapevine reports treasury notes "SOLD 12/99" for $9,978,119. (Gov. Ex. 5, Sch. K Attachment, at DOJ000161) Grapevine reports treasury notes "SOLD 12/99" for $9,978,119. (Gov. Ex. 5, Sch. K Attachment, at DOJ000161) Grapevine reports aggregate 1999 capital contributions of $12,151,221 on its Schedule M-2 and a $6,065,405 capital contribution on Joseph Tigue's K-1. (Gov. Ex. 5, at DOJ-000158, DOJ-000164) Not Disclosed on Form 1040 or 1065 Not Disclosed on Form 1040 or 1065 Grapevine reports aggregate 1999 capital contributions of $12,151,221 on its Schedule M-2 and a $6,065,406 capital contribution on Virginia Tigue's K-1. (Gov. Ex. 5, DOJ-000158, DOJ-000166) Not Disclosed on Form 1040 or 1065 Not Disclosed on Form 1040 or 1065 Grapevine reports a $21,884 short term loss on treasury notes "PURCHASED 12/99" for $10,000,003 and "SOLD 12/99" for $9,978,119. (Gov. Ex. 5, Sch. K Attachment, at DOJ-000161)

12/9/1999

JJT sells treasury securities for $4,989,059.50.

12/9/1999

VBT sells treasury securities for $4,989,059.50.

12/10/1999 12/10/1999 12/10/1999

JJT contributes the $4,989,059.50 of proceeds, and the obligation to return the borrowed treasury securities to Grapevine Imports in return for 49.5% LP interest. Grapevine assumes JJT's obligation to return the borrowed treasury securities. Grapevine treats JJT's obligation to return borrowed securities as non-liability.

12/10/1999 12/10/1999 12/10/1999

VBT contributes the $4,989,059.50 of proceeds, and the obligation to return the borrowed treasury securities to Grapevine Imports in return for 49.5% LP interest. Grapevine assumes VBT's obligation to return the borrowed treasury securities. Grapevine Imports treats VBT's obligation to return borrowed securities as non-liability.

12/10/1999

12/10/1999

12/10/1999

Grapevine purchases treasury notes for $10,000,003. Grapevine satisfies JJT's loan obligation by transferring the purchased treasury notes to the lender. Grapevine satisfies VBT's loan obligation by transferring the purchased treasury notes to the lender.

Not Disclosed on Form 1040 or 1065

Not Disclosed on Form 1040 or 1065 Joseph and Virginia Tigue recognize a $45,077 longterm capital loss on their joint 1999 Form 1040 based upon proceeds of $10,916,240, basis of 10,961,317, and sold date of 1999 (Gov. Ex. 1 at DOJ-000585) Joseph and Virginia Tigue recognize a $45,077 longterm capital loss on their joint 1999 Form 1040 based upon proceeds of $10,916,240, basis of 10,961,317, and sold date of 1999 (Gov. Ex. 1 at DOJ-000585)

12/31/1999

JJT sells its interest in Grapevine Imports, Ltd. for $5,458,120.

12/31/1999

VBT sells its interest in Grapevine Imports, Ltd. for $5,458,120.

10

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 16 of 44

ARGUMENTS AND AUTHORITIES "Ah! my dear Watson, there we come into those realms of conjecture where the most logical mind may be at fault." 28

Sherlock Holmes was a master of intelligent conjecture. When presented with missing or misleading information, he could call upon his super-human intuition to infer unstated facts and uncover attempted deception. Fortunately for the Treasury and taxpayers in general, our nation's self-reporting tax system does not expect or require IRS employees to engage in the same kind of conjecture--at least not within three years. Generally, 26 U.S.C. § 6501(a) gives the IRS three years to assess a tax deficiency. Section 6501(e) extends that assessment period to six years, however, where a taxpayer makes a substantial omission from gross income. Failing to give the IRS this additional time would turn the nation's self-reporting tax system on its head. Instead of largely relying upon taxpayers' reporting to initially identify errors, the IRS would have to question the nature and amount of every return's reporting. Such a system would compel the IRS to audit every tax return filed by every taxpayer. The federal budget could not bear such a system's cost, and America's taxpayers would resent its intrusiveness. This case is a striking example of why the six-year period is warranted. Through their various entities, Joseph and Virginia Tigue used an illogical transaction and a hollow legal interpretation to eliminate almost $10 million of income. As explained in the next sections of this brief, the dearth of information provided by Mr. and Mrs. Tigue's return did not "adequate[ly]...apprise the Secretary of the nature and amount" of this $10 million omission. 29

28

SIR ARTHUR CONAN DOYLE, THE ADVENTURE OF THE EMPTY HOUSE, available at http://sherlock-holmes.classicliterature.co.uk/the-adventure-of-the-empty-house/ebook-page-13.asp. Holmes goes on to provide a hypothesis explaining Colonel Moran's motive for murder. When asked to evaluate Holmes's theory, Watson exclaims, "I have no doubt that you have hit upon the truth." Id. 29 26 U.S.C. § 6501(e)(1)(A)(ii).

11

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 17 of 44

Although the omission's nature hinged upon an obligation to close a treasury short sale, Mr. and Mrs. Tigue's reporting failed to give even a hint that the obligation ever existed. In fact, their reporting made it appear that the obligation never existed. The burden to establish that the taxpayer omitted 25 percent or more of their gross income is upon the United States. We shall now do so.

I. THE TIGUES' OMISSION OF ALMOST $10 MILLION OF GROSS INCOME QUALIFIES AS SUBSTANTIAL Mr. and Mrs. Tigue omitted $9,978,119 of income from a return that reports a net loss of $973,087. The following analysis explains why that omission is substantial, entitling the United States to the six-year statute of limitations under 26 U.S.C. § 6501(e).30

A. The Tigues' Omission Meets Section 6501(e)'s Substantial Threshold Section 6501(e)(1)(A) of the Internal Revenue Code provides: (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-(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. 26 U.S.C. § 6501(e)(1)(A). 31 Section 6501(e) establishes an omission calculation that includes two numbers: omitted gross income and stated gross income. These two numbers are inserted into a fraction--omitted
30

Because it applies only to partnership income, 26 U.S.C. § 6229(c)'s substantial omission provision obviously does not apply to this case. The income at issue in this case is individual income from the sale of a partnership. 31 The legislative history relevant to the enactment of this provision is not especially illuminating.

12

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 18 of 44

gross income is the numerator and stated gross income is the denominator. If the resulting fraction exceeds 25 percent, then the omission qualifies as "substantial" and section 6501(e) replaces the taxpayer's general three-year assessment limitation period with a six-year period. As explained below, Mr. and Mrs. Tigue's omission easily qualifies as substantial.

1. Mr. and Mrs. Tigue's 1999 Form 1040 Omitted $9,978,119 of "Gross Income"

When determining how much "gross income" was omitted, one must first determine the definition of "gross income." Courts generally look for that definition in 26 U.S.C. § 61. Section 61 provides the general definition of "gross income" for all Internal Revenue Code provisions. 32 Section 6501(e) provides an exception from section 61's definition for sales of goods or services by a trade or business, but section 61's general definition applies to all other taxpayers ­ including individual taxpayers like the Tigues. 33 Thus, when defining "gross income" for 6501(e) purposes, courts start with section 61. Under section 61, gain from the sale of real or personal property is included in gross income, not proceeds. Section 61(a) defines "gross income" as "all income from whatever source derived." To illustrate this definition, section 61 provides a non-exclusive list of items that qualify as gross income. Included in that list are "[g]ains derived from dealings in property."(emphasis added) Treas. Reg. § 1.61-6(a) further defines these property gains as "the excess of the amount realized over the unrecovered cost or other basis for the property sold or

32

See, e.g., Insulglass Corp. v. Comm'r, 84 T.C. 203, 210 (1985); Schneider v. Commissioner, 1985 Tax Ct. Memo LEXIS 488, at *9-11 ("'gross income' has a well established meaning in the revenue laws, denoting statutory gross income as defined by section 61."). 33 26 U.S.C. § 6501(e)(1)(A)(i); Insulglass, 84 T.C. at 210; Schneider, 1985 Tax Ct. Memo LEXIS 488, at *9. See also, CC & F Western Operations, L.P. v. Commissioner, 273 F.3d 402, 406 n.2 (1st Cir. 2001) (at least doubtful that gross receipts test applies to activities other than the sale of goods and services).

13

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 19 of 44

exchanged." In other words, gross income from property sales equals proceeds minus basis, not proceeds alone. 34 In this case, Mr. and Mrs. Tigue omitted at least $9,978,119 of gross income. Their Form 1040 reports a $45,077 loss from their sale of Grapevine Imports, 35 but they should have recognized a $9,933,042 gain. As explained above, the Tigues used a Son of BOSS tax shelter transaction to inflate their basis in Grapevine by $9,978,119. This inflated basis eliminated all of their gain from the Grapevine sale and generated the $45,077 loss, which Mr. and Mrs. Tigue used to offset other gains. 36 All of that inflated basis is eliminated, however, by the FPAA issued to Grapevine. 37 The FPAA invalidates the Son of BOSS transaction and reduces the partners' outside basis in Grapevine by eliminating the artificial basis attributable to the short sale transaction. The report provided by Grapevine's expert, Gerald Songy, appears to assert that Mr. and Mrs. Tigue omitted no income. Mr. Songy bases this conclusion on his assumption that Jenkens and Gilchrist correctly concluded that Mr. and Mrs. Tigue's Son of BOSS transaction was valid. 38 The pervasive phrase "Consistent with the Jenkens Opinions" appears eight times throughout Mr. Songy's report. Based on that assumption, Mr. Songy concludes that "the 1999 Transactions at issue were fully reported on the appropriate 1999 tax returns." 39 Obviously, Mr. Songy's analysis begs the question.

34

Insulglass, 84 T.C. at 210; Schneider, 1985 Tax Ct. Memo LEXIS 488, at *10 ("The statute and underlying regulations are clear in requiring that a gain on the sale of property be included in gross income...Nowhere in the definition of gross income under section 61 is there authority to indicate that capital losses or the gross proceeds in a capital loss situation are to be included in the computation of gross income."). 35 Gov. Ex. 1 (1999 Tigue Form 1040) at DOJ-000585. 36 Id. (showing other long-term gains reduced by loss from sale of Grapevine). 37 See FPAA attached to Grapevine Compl. 38 Songy Report at 25. 39 Songy Report at 25.

14

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 20 of 44

If the conclusion in the Jenkens opinion letter were somehow held to be correct, then the Son of BOSS transaction passes muster, and the Tigues win not just the 1999 year on limitations but also the entire case on the merits. Of course, Jenkens is wrong, and the Tigues lose. 40 At this stage of the proceedings, when considering whether to grant Grapevine's motion for summary judgment, the Court must resolve all genuine factual disputes in favor of the United States and determine whether the United States has a valid legal defense to Grapevine's complaint. 41 In particular, the Court must assume that the Tigues' Son of BOSS shelter failed to create the inflated basis they needed to avoid the capital gain from their sale of Grapevine to determine whether the limitations period for assessing tax attributable to the shelter is still open. Once it is assumed that the Tigues' shelter transaction is invalid, the foundation upon which Mr. Songy predicated all of his conclusions evaporates.

2. Mr. and Mrs. Tigue's 1999 Form 1040 Stated Only $469,158 of "Gross Income"

Determining the amount of Mr. and Mrs. Tigue's stated gross income requires the Court to answer two questions: (1) where must gross income be stated; and (2) what qualifies as stated gross income. Section 6501's plain language answers the first question. Section 6501(e) refers to "gross income stated in the return." Section 6501(a) defines the "return" as follows:
For purposes of this chapter, the term "return" means the return required to be filed by the taxpayer (and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit). 42

Here, Mr. and Mrs. Tigue are the taxpayers, and the return required to be filed is their Form 1040. While Grapevine's partnership return, Form 1065, relates to the Tigues' Form 1040,
40 41

See Colm Producer, Inc. v. United States, No. 3:03-CV-3402-N, 2006 WL 3228527 (N.D. Tex. Oct. 16, 2006). See, e.g., Adickes v. S. H. Kress & Co., 398 U.S. 144, 157 (1970) (summary judgment materials "must be viewed in the light most favorable to the opposing party."); In re G-I Holdings, Civ. No. 02-3082, 2006 WL 2595264, at *3 (D.N.J. Sept. 8, 2006) (court deciding 6501(e) issue held that "it must construe all facts and inferences in the light most favorable to the nonmoving party."). 42 26 U.S.C. § 6501(a) (emphasis added).

15

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 21 of 44

Section 6501(a) expressly provides that Grapevine's Form 1065 is not a "return" in which gross income is stated for purposes of section 6501(e). To explain, section 6501(a) refers to "the return required to be filed by the taxpayer." Grapevine is not a "taxpayer" because partnerships are not subject to income taxation. 43 Moreover, section 6501(a) excludes "a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit." Grapevine is a "person" under the Code. 44 As partners in Grapevine, the Tigues receive items of income, gain, loss, deduction or credit from Grapevine pursuant to 26 U.S.C. § 702(a). Section 6501(a) thus excludes Grapevine's Form 1065 from consideration as a "return" for purposes of § 6501(e)(1)(A). Therefore, Mr. and Mrs. Tigue's stated gross income may only be found on their Form 1040. The answer to the second question lies in 26 U.S.C. § 61. Within its general definition of gross income, section 61 includes items like gains, interest, and dividends, but it does not include loss amounts. As the Tax Court stated in Schneider v. Commissioner, "[n]owhere in the definition of gross income under section 61 is there authority to indicate that capital losses or the gross proceeds in a capital loss situation are to be included in the computation of gross income." 45 For section 6501(e)'s purposes, therefore, stated losses are not included in stated income. Applying the above two principles to Mr. and Mrs. Tigue results in $469,158 of "stated" income:

43

26 U.S.C. § 701; see also 26 U.S.C. § 7701(a)(13) ("The term `taxpayer' means any person subject to any internal revenue tax."). 44 26 U.S.C. § 7701(a)(1) ("The term `person' shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.") (emphasis added). 45 Schneider, 1985 Tax Ct. Memo LEXIS 488, at *10-11.

16

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 22 of 44

Stated Income on Tigue 1040 (Gov. Ex. 1) Income Amount Location Interest $27,275 DOJ-000584 (Sch. B) Dividends $40,915 DOJ-000584 (Sch. B) Short-Term Capital Gain $0 DOJ-000589 (Sch. 1) Long-Term Capital Gain $164,953 DOJ-000589 (Sch. 1) Partnership Non-Passive $112,431 DOJ-000589 (Sch. 1) Partnership Passive $11,688 DOJ-000589 (Sch. 1) Other Income $111,896 DOJ-000590 (Sch. 2) Total Stated Income $469,158

3. Mr. and Mrs. Tigue's Omission Greatly Exceeds Section 6501's 25 Percent Threshold

The last step in section 6501(e)'s substantial-omission determination is calculating the omission fraction: omitted income/stated income. If the fraction calculates a percentage higher than 25 percent, the omission is substantial, and section 6501(e)'s six-year assessment limitations period applies. Mr. and Mrs. Tigue's fraction greatly exceeds 25 percent: $9,978,119/$469,158 = 2,127%. Consequently, section 6501(e)'s six-year limitations period applies to Mr. and Mrs. Tigue's 1999 tax year, the FPAA in issue was timely, and partial summary judgment on the limitations issue should be granted in the United States' favor.

B. The Supreme Court's Holding in Colony, Inc. v. Commissioner Does Not Conflict With the Analysis or Result in This Case A careful analysis of the facts and law reviewed in Colony, Inc. v. Commissioner 46 shows that the Supreme Court's holding in that case does not conflict with the United States' analysis in this case. Mr. and Mrs. Tigue's omission theory relies on Colony, but two of Colony's characteristics distinguish it from Mr. and Mrs. Tigue's case: (1) the income evaluated; and (2) the statute applied.
46

Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).

17

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 23 of 44

1. Mr. and Mrs. Tigue's Income is Personal Gain, But The Colony, Inc.'s Income Was Trade and Business Income Received From the Sale of Goods

In Colony, The Colony, Inc. was a real estate company in the business of selling residential lots. 47 The IRS determined that Colony had substantially omitted gross income in 1946 and 1947 because it had understated its net gain from the sale of a group real estate lots. 48 Colony had reported all sales proceeds, but the IRS asserted that it had overstated its cost basis by including unallowed development expenses. 49 This overstatement, the IRS argued, improperly decreased Colony's gain. Colony argued that it had not omitted any gross income because its gross income from the sale of real estate lots equaled sales proceeds, not net gain. 50 The Supreme Court agreed, and held that Colony had not omitted its gross income. The facts in Colony include two critical and decisive differences from the facts of this case. First, unlike the present case, Colony involved no partnership or other pass-through entity. Second, Colony, Inc. was a corporation in the business of selling real estate lots. Unlike Mr. and Mrs. Tigue's personal income from the sale of their partnership, Colony's income from the sale of real estate lots was business income received from the sale of goods or services. This distinction is important because section 6501(e) treats the two kinds of income differently. For trade and business income like Colony's, section 6501(e)(1)(A)(i) defines "gross income" as "the total of the amounts received or accrued from the sale of goods or services...prior to diminution by the cost of such sales or services." In other words, gross income from a trade or business's sale of goods and services is gross receipts rather than net income. As discussed above, however, gross income on an individual's return is calculated in accordance with the general definition of gross income in 26 U.S.C. § 61. The Tigues' gross income had to include the net
47 48

Colony, Inc. v. Commissioner, 26 T.C. 30, 31 (1965). Colony, 357 U.S. at 30. 49 Id. at 32. 50 Id. at 33.

18

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 24 of 44

gain from their sale of Grapevine. Thus, while Colony omitted no gross income from its return, Mr. and Mrs. Tigue clearly did.

2. The Statute Governing Mr. and Mrs. Tigues' Assessment is 26 U.S.C. § 6501, but the Statute Governing The Colony, Inc. was Section 6501's Predecessor in the Internal Revenue Code of 1939, 26 U.S.C. § 275

Another critical difference between Colony's and the Tigue's case is the code section at issue. In this case, the Court is applying section 6501, but in Colony, the Supreme Court interpreted section 6501's predecessor 26 U.S.C. § 275 (1939). The flush language in section 275(c)'s omission provision is almost identical to section 6501(e): If the taxpayer 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 within 5 years after the return was filed. 51 But Section 275(c) did not contain section 6501(e)'s gross income definition in section 6501(e)(1)(A)(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; or section 6501(e)'s adequate disclosure provision in section 6501(e)(1)(A)(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 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.

51

26 U.S.C. § 275(c) (1939).

19

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 25 of 44

The absence of those two provisions from section 275 is important for two reasons: (1) the current statute clarifies the definition of gross income, which the Supreme Court was considering in Colony, and (2) it provides a statutory remedy that the Supreme Court provided judicially. First, section 275 did not define "gross income," but section 6501(e) does. Section 6501(e)(1)(A)(i) states that "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...prior to diminution by the cost of such sales or services." Thus, section 6501 applies Colony's gross receipts test only to certain trade and business income. This limited application reflects that Congress did not intend the gross receipts test to apply to other types of income like Mr. and Mrs. Tigue's personal gain. Otherwise, Congress would not have needed to carve out an exception for trade and business income and the subsection added in 1954 is surplusage. As explained above, courts look to 26 U.S.C. § 61 to calculate income like Mr. and Mrs. Tigue's. Second, section 6501's disclosure safe harbor eliminates the Supreme Court's primary justification for its interpretation of gross income under the old law. The Court stressed that the IRS should not receive an extended assessment period if an omission does not put the IRS "at a special disadvantage in detecting errors." 52 The Court assumed that an omission of net income caused by inflated basis would never put the IRS at a special disadvantage, so it concluded that gross income must be defined as gross receipts. Even though gain income was omitted from Colony's return, the Supreme Court determined that there was no omission for section 275's purposes because the IRS was not placed at a "special disadvantage." In effect, the Supreme Court conflated the definition of omission with adequate disclosure principles.

52

Colony, 357 U.S. at 36.

20

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 26 of 44

Congress's enactment of section 6501(e)'s adequate disclosure provision eliminated the need to conflate omission principles with adequate disclosure principles. Section 6501(e)(1)(A)(ii) provides that, even if a taxpayer omits income from the return's gross income calculation, the six-year limitation period will not apply to taxpayers that otherwise disclose the omitted income "in a manner adequate to apprise the Secretary of the nature and amount of such item." Section 6501(e) now establishes a two-step process: (1) determine whether a substantial omission occurred; (2) determine whether that omission was otherwise adequately disclosed. The Fifth Circuit recognized this two-step mandate in Phinney v. Chambers. 53 In that case, the taxpayer and her husband held an installment note that they had received in exchange for stock they held as community property. When the husband died, the executor of his estate took possession of the entire note under a state law provision that allowed community debts to be paid out of community property. While in the estate's possession, the note was paid in full. In accordance with its interpretation of the installment recognition method, the estate prepared a trust tax return showing the taxpayer's community share of the note payment as proceeds received from the sale of stock. The trust return did not report a gain, however, because it reported a basis in the stock equal to the proceeds. Part of this basis apparently originated from a basis step-up that the taxpayer claimed upon her husband's death. The IRS subsequently denied this basis step-up and issued a deficiency notice over three years after the taxpayer's trust and individual returns were filed. The IRS asserted that section 6501(e)'s six-year assessment period applied because the taxpayer had substantially omitted her income. The taxpayer, on the other hand, asserted that no omission occurred.

53

Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968).

21

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 27 of 44

As Grapevine argues in this case, the taxpayer in Phinney relied upon Colony, Inc. v.
Commissioner to argue that no "omission" of income can occur where a taxpayer reports the

correct amount of proceeds. 54 Since her trust return had reported the correct amount of note proceeds, she argued that section 6501(e)'s six-year assessment period did not apply. The Fifth Circuit disagreed concluding that "the enactment of [section 6501(e)'s adequate disclosure exemption] makes it apparent that the six year statute is intended to apply where there is either a complete omission of an item or income" or a misstatement "of the nature of an item of income." 55 The Fifth Circuit went on to determine that the taxpayer's disclosure of proceeds did not qualify for section 6501(e)'s adequate disclosure exemption. 56
Phinney's analysis of section 6501(e)'s first step applies to Mr. and Mrs. Tigue. That

omission analysis establishes that Mr. and Mrs. Tigue omitted $9,978,119 from a return stating only $469,158 of income. The next step, determining whether the omitted income is otherwise adequately disclosed, is discussed below in Part II.

C. The 1997 Amendment to Section 6501(a) Prospectively Supersedes Prior Contrary Interpretations of Section 6501(e) As previously noted, the last sentence of section 6501(a) provides that "[f]or purposes of this chapter [i.e., Chapter 66 of the Code], the term `return' means the return required to be filed

54 55

Id. at 683. Id. at 685. 56 Id. at 684-685. A statement in Phinney may lead one to conclude that the Fifth Circuit conflated section 6501(e)'s omission and adequate disclosure principles, but a close inspection shows that it did not. The Fifth Circuit states that "if an item of income is shown on the face of the return or an attached statement that is not shown in a manner sufficient to enable the secretary by reasonable inspection of the return to detect the errors then it is the omission of `an amount' properly includable in the return." Id. at 685 (emphasis added). Read in isolation, it appears that the Fifth Circuit is using adequate disclosure principles--"shown in a manner sufficient to enable the secretary...to detect errors"--to determine whether an omission occurred. A close inspection shows, however, that the Fifth Circuit was actually referring to adequate disclosure principles. Immediately after the above quote, the Fifth Circuit states, "It seems here that there can be no substantial argument that the disclosure made by the bank's return was `adequate to apprise the Secretary or his delegate of the nature and amount of such item.'" Id. (emphasis added).

22

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 28 of 44

by the taxpayer (and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit)." 26 U.S.C. § 6501(a). Congress added this sentence to section 6501(a) in the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1284(a), 111 Stat. 788, 1038 (1997). This amendment is effective for tax years beginning after August 5, 1997. Pub. L. No. 105-34, § 1284(b), 111 Stat. 1038 (1997). Thus amended, section 6501(a) applies to the Mr. and Mrs. Tigue's 1999 tax year. After the Court issued its opinion on June 12, 2006, and in preparation for the hearing on the applicability of the six-year statute, the United States discovered authorities predating the 1997 amendment to section 6501(a) that may appear to contradict the result we advocate here, including a regulation that, prior to this filing, neither party had brought to the Court's attention: Treas. Reg. § 1.702-1(c)(2). If section 6501(a) had not been amended, this regulation would undercut the United States' calculation of Mr. and Mrs. Tigue's omission. Section 6501(a) was amended, however, in 1997, over 35 years after the regulation was promulgated.57 Thus, the statute's plain language governs the issue here. We mention this regulation only for the sake of completeness, and to discharge our duty of candor to the court. The following analysis explains the genesis of the 1997 amendment. Prior to 1997, there was a debate about the definition, under 26 U.S.C. § 6501(e), of "gross income stated in the return." When applying section 6501(e) to taxpayer-partners, some argued that income stated in "the return" included income stated in both the taxpayer's return and a proportionate share of the gross receipts stated in the partnership's return. 58 Others argued that income stated in "the return" included only income stated in the taxpayer's return, i.e.,
57 58

See 25 Fed. Reg. 11,867 (Nov. 26, 1960). See Klein v. Commissioner, 537 F.2d 701 (2d Cir. 1976) (discussing "return" issue as part of innocent spouse determination); Harlan v. Commissioner, 116 T.C. 31, 53-55 (2001); Klien v. Commissioner, 683 T.C. 585, 589590 (1975) (IRS arguing that section 6501(e)'s plain language refers only to income reported on the taxpayer's return)..

23

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 29 of 44

partnership income is accounted for through flow-through items reported on the taxpayer's return. 59 Treas. Reg. § 1.702-1(c)(2) and four cases reviewing pre-1997 tax years attempted to resolve that debate by concluding, on the basis of the regulation, that a partner's stated gross income includes income stated in both the taxpayer's return and the partner's share of gross receipts (not gross income) stated on the partnership's return. 60 This debate affects the calculation of Mr. and Mrs. Tigue's omission because their partnership, Grapevine Imports, stated over $85 million of trade and business gross receipts on its 1999 Form 1065. 61 Every bit of that $85 million was offset by cost of goods sold and other expenses, resulting in a net loss for the partnership, 62 but under the regulation's pre-1997 interpretation, Mr. and Mrs. Tigue would receive credit for "stating" those trade and business
receipts. In other words, that $85 million of gross receipts would be inserted into the

denominator of Mr. and Mrs. Tigue's omission fraction. Under that approach, Mr. and Mrs. Tigue's omission would fall short of section 6501(e)'s 25 percent threshold. The 1997 amendment to section 6501(a) changes that outcome. It resolved the previous debate over what was meant by "return" by explicitly defining "the return" as only the partner's return. For post1997 tax years, section 6501's plain language defines "the return" as only the taxpayer's return. Mr. and Mrs. Tigue's individual share of Grapevine's income (the $1,034,736 ordinary loss) is accounted for through the flow-through items reported on their Form 1040, not through preexpense trade and business receipts reported on Grapevine's Form 1065.

59 60

Id. See Hoffman v. Commissioner, 119 T.C. 140 (2002); Harlan v. Commissioner, 116 T.C. 31 (2001), acq. 2002-7 I.R.B. 496, 2002 WL 1814914; Cruz v. Commissioner, No. 15081-89, 1990 WL 178938, 60 T.C.M. (CCH) 1280 (Nov. 20, 1990); Treas. Reg. § 1.702-1(c)(2) (partnerships). See also Klein v. Commissioner, 537 F.2d 701 (2d Cir. 1976) (discussing "return" issue as part of an innocent spouse determination). 61 Gov. Ex. 5 (Grapevine 1999 Form 1065) at line 1c. 62 Gov. Ex. 5 (Grapevine 1999 Form 1065) at line 22 (showing a $1,034,736 ordinary loss from trade and business activities).

24

Case 1:05-cv-00296-FMA

Document 66

Filed 12/20/2006

Page 30 of 44

1. Section 6501's Plain Language Limits Reported Income to Income Reported on Mr. and Mrs. Tigue's Individual Form 1040

When a statute's text is plain and unambiguous, the Supreme Court has repeatedly held that statutory construction begins and ends with that text. 63 Courts should resort to legislative history, administrative interpretations, and other extrinsic tools only if a statute's text is ambiguous. 64 When interpreting that statutory text, the Supreme Court held in Robinson v. Shell
Oil Co. that courts should consider three factors: (1) "the language itself"; (2) "the specific

context in which that language is used"; and (3) "the broader context of the statute as a whole." 65 All three of these factors mandate the conclusion that a partner's reported income under section 6501(e) includes amounts reported on the individual return only; gross receipts reported on a partnership return are not included. a. The Language Itself As discussed above, for tax years beginning after August 5, 1997 ­ including the Tigues' 1999 tax year ­ section 6501(a)'s language instructs that reported income under section 6501(e) is found only on "the return required to be filed by the taxpayer" ­ the partner's return ­ "and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit," including the partnership's return. (emphasis added). The term "return" appears throughout section 6501 and other limitations statutes within Chapter 66 of

63

E.g., BedRoc Ltd., L.L.C. v. United States, 541 U.S. 176, 183 (2004); Park `N Fly, Inc. v. Dollar Park & Fly, Inc., 469 U.S. 189, 194 (1985); Grapevine Imports, Ltd. v. United States, 71 Fed. Cl. 324, 328-329 (Fed. Cl. 2006). 64 E.g., Blum v. Stevenson, 465 U.S. 886, 896 (1984) ("Where...resolution of a question of federal law turns on a statute and the intention of Congress, we look first to the statutory language and then to the legislative history if the statutory language is unclear."); Norfolk Dredging Co. Inc. v. United States, 375 F.3d 1106, 1110 (Fed. Cir. 2004); Grapevine, 71 Fed. Cl. at 336 ("the fact that Congress might have acted with greater clarity or foresight does not give courts a carte blanche to redraft statutes in an effort to achieve that which Congress is perceived to have failed to do"). See also Conn. Nat'l Bank v. Gerrnain, 503 U.S. 249, 253-54 (1992) ("courts must presume that a legislature says in a statute what it means and means in a statute what it says."). 65 Robinson v. Shell Oil Co., 519 U.S. 337, 341 (1997).

25

Case 1:05-cv-00296-FMA

Document 6