Free Memorandum - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS GRAPEVINE IMPORTS, LTD., a Texas Limited Partnership, and T-TECH, INC., a Texas Corporation as Tax Matters Partner, Plaintiffs, v. United States of America, Defendant. § § § § § § § § § §

Case No. 05-296T Judge Francis M. Allegra

PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)

MEADOWS, OWENS, COLLIER, REED COUSINS & BLAU, L.L.P. 901 Main Street, Suite 3700 Dallas, TX 75202 (214) 744-3700 Telephone (214) 747-3732 Facsimile

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TABLE OF CONTENTS TABLE OF AUTHORITIES .......................................................................................................... ii I. II. III. INTRODUCTION .............................................................................................................. 1 PURPOSE OF HEARING.................................................................................................. 2 THE BURDEN IS ON THE GOVERNMENT TO SHOW AN "OMISSION." ............... 4

IV. THE COURT CAN, AND SHOULD, REACH THE ULTIMATE QUESTION OF ADEQUATE DISCLOSURE IN THIS HEARING AND SHOULD HOLD THAT THERE IS NO OMISSION OF INCOME UNDER SECTION 6501(E)(1)(A). ........................... 5 A. B. There Is No Omission When The Items At Issue Are Fully Disclosed On the Relevant Returns. .............................................................................................. 6 The Transactions At Issue Were Fully and Accurately Reported On the Returns. ................................................................................................................... 7 1. 2. 3. 4. C. The Transactions at Issue............................................................................ 8 IRS Reporting Requirements for the Tax Year 1999................................ 10 Relevant Returns....................................................................................... 11 Reporting on the Returns in This Case. .................................................... 14

Colony, Inc. v. Commissioner Is Squarely On Point and Provides That an Overstatement of Basis is Not an Omission of Gross Income For Purposes of the Extended Statute. ........................................................................................ 21 1. 2. 3. Colony Has Been Followed As Precedent for Almost Fifty Years and Is Binding Upon this Court....................................................................... 23 Why Colony Is In "Harmony With the Unambiguous Language of 6501(e)(1)(A)" .......................................................................................... 25 CC&F Western Has No Relevant Holding For This Case........................ 26

D. E.

The Completeness of Plaintiffs' Reporting Defeats Application of the SixYear Statute........................................................................................................... 29 The Only Dispute As to Reporting Arises From the Government's Unwillingness to Answer the Court's Question of What Reporting Was Required. ............................................................................................................... 29

V.

CONCLUSION................................................................................................................. 30

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TABLE OF AUTHORITIES Cases U.S. Supreme Court Colony, Inc. v. Comm'r, 357 U.S. 28 (1958)..........................................................................passim United States v. Basye, 410 U.S. 441 (1973).................................................................................10 Circuit Courts Benderoff v. United States, 398 F.2d 132 (8th Cir. 1968).................................................23, 24, 25 CC&F Western Op. Ltd. v. Comm'r, 273 F.3d 402 (1st Cir. 2001).........................................27, 28 Colony Inc. v. Comm'r, 244 F.2d 75 (6th Cir. 1957).....................................................................21 Crum v. Comm'r, 635 F.2d 895 (D.C. Cir. 1980)..........................................................................11 Davis v. Hightower, 230 F.2d 549 (5th Cir. 1956)..............................................................7, 11, 25 Deakman-Wells Co. v. Comm'r, 213 F.2d 894 (3d Cir. 1954)........................................................7 Estate of Iverson v. Comm'r, 255 F.2d 1 (8th Cir. 1958)................................................................4 Estate of Klein v. Comm'r, 537 F.2d 701 (2d Cir. 1976).................................................................7 Insurance Co. of the West v. United States, 243 F.3d 1367 (Fed. Cir. 2001)................................23 Lawrence v. Comm'r, 258 F.2d 562 (9th Cir. 1958)..................................................................7, 14 McLaulin v. Comm'r, 276 F.3d 1269 (11th Cir. 2001)..................................................................10 Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968).....................................................................24 Sicari v. Comm'r, 136 F.3d 925 (2d Cir. 1998).............................................................................11 Stone Container Corp. v. United States, 229 F.3d 1345 (Fed. Cir. 2000).....................................23 Wood v. Comm'r, 245 F.2d 888 (5th Cir. 1957)..............................................................................4 District Courts Bishop v. United States, 338 F. Supp. 1336 (N.D. Miss. 1970).....................................................24 In re G-I Holdings Inc., No. 02-3082, 2006 WL 2595264 (D.N.J. Sept. 8, 2006)..................25, 28 Lazarus v. United States, 142 F. Supp. 897 (Ct. Cl. 1956)..............................................................4

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Tax Court Colony, Inc. v. Comm'r, 26 T.C. 30 (1956)...................................................................................21 Connell Bus. Co. v. Comm'r, 87 T.C.M. (CCH) 1384 (2004)...................................................4, 24 Estate of Frane v. Comm'r, 98 T.C. 341 (1992)............................................................................25 Harlan v. Comm'r, 116 T.C. 31 (2001)...........................................................................4, 5, 12, 13 Hoffman v. Comm'r, 119 T.C. 140 (2002).............................................................................4, 5, 12 Philipp Bros. Chemicals v. Comm'r, 52 T.C. 240 (1969)...............................................................4 Quick Trust v. Comm'r, 54 T.C. 1336 (1970)....................................................................11, 12, 24 Rose v. Comm'r, 24 T.C. 755 (1955).........................................................................................4, 12 University Country Club v. Comm'r, 64 T.C. 460 (1975).................................................11, 24, 25 Walker v. Comm'r, 46 T.C. 630 (1966).........................................................................4, 11, 12, 24 Statutes 26 U.S.C. § 701..............................................................................................................................10 26 U.S.C. § 705..............................................................................................................................16 26 U.S.C. § 721..............................................................................................................................16 26 U.S.C. § 752....................................................................................................................4, 11, 16 26 U.S.C. § 1361............................................................................................................................10 26 U.S.C. § 6229............................................................................................................................12 26 U.S.C. § 6501....................................................................................................................passim Treasury Regulations Treas. Reg. § 1.702-1.....................................................................................................................17 Treas. Reg. § 1.752-6.......................................................................................................2, 4, 22, 31 Treas. Reg. § 1.752-6T....................................................................................................................4 Treas. Reg. § 301.7701-3...............................................................................................................10

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Other Authorities IRS Publication 550.........................................................................................................................8 IRS Chief Counsel Advisory Memorandum 200628021...............................................................25 Sheryl Stratton, "IRS Officials Defend New Approach to Appeals and Penalties," Tax Analysts Tax Notes Today No. 2006 TNT 241-3 (Dec. 15, 2006).............................................................................................4

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS GRAPEVINE IMPORTS, LTD., a Texas Limited Partnership, and T-TECH, INC., a Texas Corporation as Tax Matters Partner, Plaintiffs, v. United States of America, Defendant. § § § § § § § § § §

Case No. 05-296T Judge Francis M. Allegra

PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A) Plaintiffs Grapevine Imports, Ltd. ("Grapevine") and T-Tech, Inc. ("T-Tech") (collectively "Plaintiffs") submit this memorandum of law regarding the applicability and interpretation of the "omission" provision of the six-year statute of limitations, 26 U.S.C. § 6501(e)(1)(A), to aid the Court in its review of the evidence to be presented at the hearing scheduled for January 18, 2007: I. INTRODUCTION The Court has asked the parties to provide expert testimony to aid the Court's understanding of the transactions challenged by the IRS in its Final Partnership Administrative Adjustment ("FPAA") and the application of the extended statute of limitations under Internal Revenue Code ("IRC") Section 6501(e)(1)(A) to this dispute. In furtherance of the Court's goal, Plaintiffs have spent the last four months working with our expert Gerald ("Jerry") Songy to prepare his report and supplemental report, crafting arguments in response to the Government's designated expert Cheryl Kiger, and taking depositions of these experts. Mr. Songy is prepared

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to testify about the Plaintiffs' reporting of these transactions on their tax returns and Plaintiffs' compliance with the IRS requirements and statutory requirements that existed in 1999. Mr. Songy's reports, deposition, and testimony will demonstrate that the Plaintiffs reported the transactions at issue in a manner adequate to apprise the IRS of Plaintiffs' tax position. As the Court has previously noted, the Government bears the burden of proof at this stage to show an "omission" of gross income. As of December 13, 2006, the Government intends to provide no expert testimony on this issue, despite being ordered to do so by the Court and despite bearing the burden of proof. Even before December 13, the Government's designated expert was unable to provide useful information to the Court regarding the six-year statute of limitations. Plaintiffs reiterate their argument that the U.S. Supreme Court's decision in Colony v. Commissioner, 357 U.S. 28 (1958) controls the outcome of this proceeding. Both Colony and the present case involve an overstatement of basis1 that is reflected on the tax return; the Supreme Court found that this was not sufficient to warrant application of the extended statute of limitations in Colony. precedent. II. PURPOSE OF HEARING In the Court's Opinion dated June 14, 2006, the Court stated its purpose for the upcoming hearing as follows: This difficulty stems, in part, from the fact that the court must comprehend not only what is present on those returns, but perhaps what should have been there and is not, both of which inquiries require the court to better understand the underlying transactions. Plaintiffs will discuss the case in detail and its ongoing value as

For purposes of these motions for summary judgment on the statute of limitations only, Plaintiffs agree that the Tigues' basis in the partnership is overstated as a result of retroactive Treasury Regulation § 1.752-6. PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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(emphasis added). Thus, this hearing serves to answer three questions for the Court: 1) how the transactions at issue were reported on the relevant returns submitted to the IRS; 2) what the IRS required at that time for reporting of these transactions; and 3) whether the taxpayers' reporting met the IRS's requirements. All of these inquiries provide the factual background for the central legal issue before the Court: was there an omission of gross income on the taxpayers' returns that would trigger application of the six-year statute of limitations under Section 6501(e)(1)(A)? The question that Plaintiffs submitted to Mr. Songy serves to answer the questions posed by the Court: "How did Grapevine Imports, Ltd. and its partners present the 1999 Transactions at issue on the relevant 1999 federal tax returns?" (Songy Report at 1). Mr. Songy relied upon the IRS's own regulations, manuals, instructions, and publications, in addition to his lengthy experience at the IRS, to answer this question. Mr. Songy gave his opinion based upon what the IRS required of taxpayers at that time, answering the Court's inquiry of "what should have been there and is not" on the returns. On the other hand, the Government's expert (now withdrawn) made clear in her deposition that she could not give an opinion on what the IRS required taxpayers to include on the returns. Rather, the Government's expert only gave her

"observations" about the returns ­ a standard not requested by this Court and not articulated in any case law as relevant for the six-year statute of limitations. Because the Government now has withdrawn its expert, Plaintiffs anticipate that the Government will merely "argue" the observations Ms. Kiger made in her report without presenting evidence as ordered by the Court. Plaintiffs submit that the evidentiary hearing will show the Court that Plaintiffs reported the transactions at issue on the relevant returns in a manner adequate to apprise the IRS of their position regarding the tax treatment of those transactions. Moreover, this reporting was in keeping with the IRS's own reporting requirements in effect at that time. In accordance with
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binding legal precedent, there is no "omission" of gross income in this case because the taxpayer has fully disclosed the transactions at issue on the relevant returns. Plaintiffs arrived at a different figure for the net gain on the sale of Grapevine than the IRS would propose due to a legitimate, reasonable difference in opinion with the IRS regarding the tax treatment of the items at issue, given the state of the law at the time of these transactions.2 As the case law makes clear, a difference in opinion alone does not create an "omission" that would trigger the six-year statute. III. THE BURDEN IS ON THE GOVERNMENT TO SHOW AN "OMISSION." In the Court's June 2006 opinion, the Court discussed the burden of proof under Section 6501(e)(1)(A) and held that the defendant (the Government) bears the burden of proof to invoke application of the six-year statute. (Rec. Doc. No. 54 at 25). Plaintiffs merely reiterate that holding and provide further case law to support that finding. It has long been recognized that the burden of proof to show an "omission" of income under Section 6501(e)(1)(A) is on the Government. See Estate of Iverson v. Comm'r, 255 F.2d 1, 5 (8th Cir. 1958); Wood v. Comm'r, 245 F.2d 888, 893 (5th Cir. 1957); Lazarus v. United States, 142 F.Supp. 897 (Ct. Cl. 1956); Hoffman v. Comm'r, 119 T.C. 140, 146 (2002); Harlan v. Comm'r, 116 T.C. 31, 39 (2001); Philipp Bros. Chemicals v. Comm'r, 52 T.C. 240, 254 (1969); Walker v. Comm'r, 46 T.C. 630, 637 (1966); Rose v. Comm'r, 24 T.C. 755, 767 (1955); Connell Bus. Co. v. Comm'r, 87 T.C.M. (CCH) 1384 (2004).

See Sheryl Stratton, "IRS Officials Defend New Approach to Appeals and Penalties," Tax Analysts Tax Notes Today No. 2006 TNT 241-3 (Dec. 15, 2006). In the article, former IRS Chief Counsel B. John Williams, Jr. discussed the enactment of Treasury Regulations §§ 1.752-6 and 1.752-6T, which purport to redefine retroactively the term "liability" under IRC § 752 to include contingent liabilities. This change is retroactive to October 1999. Mr. Williams noted that without the retroactive regulations he "could see an opinion reasonably concluding that the [Son of BOSS] transaction was more likely than not to prevail in court given the law as it existed at the time." (emphasis added). PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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Recent cases have elaborated further on how burden-shifting applies under Section 6501(e)(1)(A). Expiration of the statute of limitations is an affirmative defense, and the party who raises the defense bears the ultimate burden of proof on the issue. Hoffman, 119 T.C. at 146-47. In this case, Plaintiffs raised the defense of the statute of limitations; thus, Plaintiffs must make a prima facie showing that the usual three-year statute of limitations has expired. See Harlan, 116 T.C. at 38-39. As the Court has held, Plaintiffs have made this prima facie showing by demonstrating that the FPAA was issued beyond the three-year statute for 1999, regardless of whether the three-year period is measured from the date Grapevine filed its Form 1065 return or the date the Tigues filed their Form 1040 return. (Opinion, Rec. Doc. No. 54 at 21). See Hoffman, 119 T.C. at 146. Once the party makes a prima facie showing that the period of limitations has expired, the burden shifts to the opponent (in this case, the Government) to prove that an exception to the general limitations period applies. Harlan, 116 T.C. at 39. Thus, the Government bears the burden of proof at this point to demonstrate that the Plaintiffs have "omitted an amount of gross income which is more than 25 percent of the amount of gross income stated in the tax return." Id. The fact that the Government intends to present no expert testimony on this issue, despite the Court's instruction that it do so, in itself fails to satisfy the Government's burden of proof. IV. THE COURT CAN, AND SHOULD, REACH THE ULTIMATE QUESTION OF ADEQUATE DISCLOSURE IN THIS HEARING AND SHOULD HOLD THAT THERE IS NO OMISSION OF INCOME UNDER SECTION 6501(E)(1)(A). This hearing will clarify that there is no "omission" of income in this case. While the Court has limited this hearing to evidentiary issues surrounding the reporting of the transactions at issue on Plaintiffs' returns, Plaintiffs submit that after this hearing there will be ample evidence in the record for the Court to rule that the six-year statute under Section 6501(e)(1)(A)
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does not apply.3 As discussed below, Plaintiffs have fully disclosed the transactions at issue on their returns in keeping with IRS requirements, and that reporting was adequate to apprise the IRS of the nature and amount of the transactions under any applicable legal standard. For these reasons, there is no "omission" of income that would trigger application of the six-year statute to this case. A. There Is No Omission When The Items At Issue Are Fully Disclosed On the Relevant Returns. Section 6501(e)(1)(A) sets forth a framework whereby the IRS obtains the benefit on an additional three years to examine and adjust a taxpayer's return 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." "Gross income" is not defined in the statute except to provide a special definition for certain income from a "trade or business." 26 U.S.C. § 6501(e)(1)(A)(i). Expressed in mathematical terms, the six-year limitations period applies when: "Omitted" Amount Gross Income Stated in the Return > 0.25

But as noted by the U.S. Supreme Court in Colony Inc. v. Commissioner, the extended statute of limitations does not automatically apply to any understatement of income of 25% or more: "if the mere size of the error had been the principal concern of Congress, one might have expected to find the statute case in terms of errors in the total tax due or in total taxable net income."4 357 U.S. 28, 36 (1958). Further, Section 6501(e)(1)(A)(ii) provides for an additional step in the analysis: any amount which is disclosed "in a manner adequate to apprise the Secretary of the nature and amount" of the item is not included in the "omitted" amount for purposes of the six3

Should the Court not be convinced at this stage, Plaintiffs are fully prepared to present further evidence and expert testimony regarding the adequacy of their disclosures on the returns at issue in a future hearing. 4 The applicability of Colony to the present case is discussed in further detail in Section IV.C., infra. PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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year statute. Thus, by the terms of the statute, if an amount is adequately disclosed to the IRS, that amount is not considered an "omission" from gross income and does not trigger application of the six-year statute. In keeping with this statutory framework, federal courts have long recognized that when items are fully reported on the returns but not included in the final figure of taxable income, those items are not omissions of gross income within the meaning of the extended statute of limitations. See, e.g., Estate of Klein v. Comm'r, 537 F.2d 701, 705 (2d Cir. 1976)

("[e]ssentially, s 6501(e)(1)(A)(ii) directs that anything that is `disclosed' in the return is not `omitted' from the return"); Lawrence v. Comm'r, 258 F.2d 562, 562 (9th Cir. 1958) (holding that there is no omission under the extended statute "[w]hen a taxpayer has made a full disclosure of his `position' with respect to his gross income . . . but has not `included' the amount involved as taxable"); Davis v. Hightower, 230 F.2d 549, 553 (5th Cir. 1956) (holding that no omission occurred when the taxpayer fully disclosed his tax position but understated income because of a "difference between him and the Commissioner as to the legal construction to be applied to a disclosed transaction"); Deakman-Wells Co. v. Comm'r, 213 F.2d 894 (3d Cir. 1954) (holding that there was no omission when the item at issue was "disclosed in the return but eliminated in the computation of the final figure"). B. The Transactions At Issue Were Fully and Accurately Reported On the Returns. In the FPAA, the IRS proposes two adjustments to the partnership return of Grapevine Imports. First, the IRS contends that each partner's outside basis in the partnership should be decreased by $10,000,000.5 Second, the IRS argues that the partners' loss of $21,884 on the sale
5

The FPAA for each partner indicates a decrease in that partner's outside basis of $10,000,000, and reduction of that basis to $0. But as discussed in this section this adjustment appears to be incorrect or inexact. The short sales of U.S. Treasury Notes at issue in this case amounted to roughly $5 million for each partner, not $10 million for PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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of U.S. Treasury Notes should be eliminated. Both of these proposed adjustments surround two almost identical transactions entered into by two partners in Grapevine, Joseph and Virginia Tigue. Grapevine Imports, Limited is a Texas partnership which operated an automotive sales and service business. The partnership was formed in 1997, two years prior to the transactions at issue. Joseph and Virginia Tigue each held a 49.5% partnership interest in Grapevine. T-Tech, a Texas S-Corporation wholly owned by Joseph Tigue, held the remaining 1% interest and did not enter into the short sale transactions at issue. 1. The Transactions at Issue. On December 9, 1999, Joseph and Virginia Tigue opened two short sales of U.S. Treasury Notes. In a typical short sale transaction, the investor borrows property and sells it to a buyer. This is the "opening" of the short sale. At a later date, the investor buys substantially identical property and delivers it to the lender. This is the "closing" of the short sale. See IRS Publication 550 at 51 (1999). Each of the Tigues sold Treasury Notes with a $5 million face value, maturing November 30, 2001, for $4,989,059.50, plus interest of $8,025.96. The

combined sales price or opening proceeds was $9,978,119, with combined interest of $16,051.92. Joseph and Virginia Tigue opened these short sales through their individual Delaware single-member limited liability companies, JJT Meandering Investments, LLC and VBT Meandering Investments, LLC. As single-member LLCs, these entities are disregarded for federal income tax purposes, which will be discussed in detail later.
each partner. In addition, Grapevine Imports was an existing partnership to which the partners had made capital contributions unrelated to the short sale transactions at issue. Any proposed reduction of the partners' outside basis to $0 is unwarranted and fails to take into account the partners' substantial unrelated capital contributions to Grapevine. PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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On December 10, 1999, Joseph and Virginia Tigue transferred the proceeds from both short sale transactions and the obligations to close the short sales to Grapevine as a capital contribution. The Tigues also each contributed $25,000 margin cash to cover any fluctuations in the market prior to closing of the short sale. On December 10, 1999, Grapevine closed the short sales by buying U.S. Treasury Notes in the amount of $10,000,003. Subtracting the "opening" proceeds ($9,978,119) from the

"closing" proceeds ($10,000,003) yielded a $21,884 loss, all of which Grapevine reported on its partnership tax return. On December 31, 1999, Joseph and Virginia Tigue sold their interests in Grapevine to an unrelated third party for a total sales price of $10,916,240. Together they claimed a basis in the partnership of $10,961,317, resulting in a long-term capital loss of $45,077. T-Tech also sold its 1% partnership interest on December 31, 1999, for a total sales price of $110,265. T-Tech claimed a basis of $9,359, with a long-term capital gain of $100,906. Thus, the reporting of the short sales on the relevant returns can be broken into three elements, as explained by our expert, Jerry Songy: · Transferring the proceeds from the short sales and the obligations to close the short sales to Grapevine, and the effect on the partners' basis in the partnership of the transfer; Closing of the short sales by Grapevine, the reporting of the loss on the short sales, and the effect on the partners' basis in the partnership of the closing; Selling the partnership interests in Grapevine on December 31, 1999 and the reporting of the gain or loss on the sale by the partners, Joseph and Virginia Tigue and T-Tech.

· ·

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2. IRS Reporting Requirements for the Tax Year 1999. Mr. Songy's expert report and supplemental report discuss in detail the IRS's reporting requirements for the 1999 taxable year. There are several key principles and requirements to keep in mind in evaluating the returns in this case. First, the IRS treats partnership returns like the one filed by Grapevine and S-Corporation returns like the one filed for T-Tech as informational returns: no income reported on those returns is taxable to the partnership or SCorporation. (Songy Report at 5-6). This is because partnerships and S-Corporations are considered to be flow-through entities, meaning that all income, losses, and deductions are passed through to their owners. 26 U.S.C. §§ 701 & 1361-63; United States v. Basye, 410 U.S. 441, 448 (1973); McLaulin v. Comm'r, 276 F.3d 1269, 1271 n.4 (11th Cir. 2001). Second, limited liability companies with only one member are not taxed as entities separate from their owners pursuant to 26 CFR § 301.7701-3(b)(1)(ii). Indeed, they are

"disregarded" for federal tax purposes. 26 CFR § 301.7701-3. The income from the singlemember LLC is reported directly on the owner's tax return, in this case, the Tigues' individual Form 1040. Mr. Songy discusses the IRS reporting requirements for single-member LLCs in his supplemental report. (Songy Supplemental Report at 2-5). Third, Mr. Songy's report and supplemental report point to specific portions of IRS instructions to tax return preparers to complete the forms provided rather than attaching correspondence or separate statements to the return. (Songy Report at 6-7). As these

instructions illustrate, there was no requirement in 1999 that tax returns should include narratives

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describing transactions; in fact, narratives are discouraged under these instructions. The IRS instructions conform to case law precedent which states that narrative reporting is not required.6 Fourth, the taxpayers in this case reported their tax positions in accordance with IRS requirements, and put the IRS on notice of their tax position by filing the returns and forms at issue with the IRS. Although Plaintiffs anticipate that the IRS will argue otherwise, the IRS's computer system fallibilities, its disorganization, and its unduly complex administrative structure are irrelevant to whether the transactions were adequately disclosed to the IRS: the "taxpayer should not be penalized because the tax collector neglects to tell his right hand what his left is doing." Crum v. Comm'r, 635 F.2d 895, 900 (D.C. Cir. 1980). See also Sicari v. Comm'r, 136 F.3d 925, 929 (2d Cir. 1998) (holding that "[n]ormally, reasonable diligence will require the Service to consult its own files, at least those maintained in computer databases in the same district" and that "[i]f the Service has a computer feature that requires minimal time and effort to implement, then the Service should be required to exercise this feature") (internal citations and quotations omitted). 3. Relevant Returns. The FPAA adjusts Grapevine's partnership return Form 1065 for 1999. There is no omission of gross income on the partnership return, as Plaintiffs have previously argued. The IRS's central proposed adjustment to Grapevine's return treats the opening of the short sale as a liability under IRC § 752 and consequently adjusts the Tigues' basis in the partnership. The

See Davis v. Hightower, 230 F.2d 549, 553 (5th Cir. 1956) (holding the taxpayer's disclosure was adequate when he reported a transaction "as required by the return itself"); University Country Club v. Comm'r, 64 T.C. 460, 470 (1975) (stating that "it is difficult to see what additional entry petitioner could have made on its income tax return to apprise the Commissioner" of the disputed transaction); Quick Trust v. Comm'r, 54 T.C. 1336, 1347 (1970) (holding that adequate disclosure does not require "a detailed revelation of each and every underlying fact"); Walker v. Comm'r, 46 T.C. 630, 639 (1966) (holding that all that is required is "information disclosed in the return to permit the computation of the proper amount" of gross income). PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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IRS's proposed treatment of the short sale transaction does not have an effect upon Grapevine's gross income, as the Government's own expert acknowledged in her deposition.7 Thus, the extended six-year statute of limitations under IRC § 6229(c)(2) does not apply because there is no omission of gross income on Grapevine's Form 1065. The IRS's proposed adjustments have no income impact upon that return. However, as the Court is looking at the application of Section 6501(e)(1)(A) to this case, it is well-accepted that, in evaluating the applicability of Section 6501(e)(1)(A), a court should consider all related tax returns and forms. See, e.g., Hoffman v. Comm'r, 119 T.C. 140, 147 (2002) (applying the "well established" rule that under Section 6501 the "return" includes both the taxpayer-partner's return, the partnership return, and other related information returns); Quick Trust v. Comm'r, 54 T.C. 1336, 1346 (1970) (holding that, in proceeding to determine individual tax liability, partnership return would be considered for Section 6501 purposes); Walker v. Comm'r, 46 T.C. 630, 637-38 (1966) (holding it proper to consider partnership return and individual return for Section 6501 analysis); Rose v. Comm'r, 24 T.C. 755, 769 (1955) (holding that a return filed with the IRS of a nontaxable entity was "an adjunct to the individual returns . . . and must be considered together with such individual returns and treated as a part of them" for Section 6501 analysis). In Harlan v. Commissioner, 116 T.C. 31 (2001), the Tax Court recently discussed in detail which returns and forms should be considered by a court evaluating Section 6501(e)(1)(A). The Tax Court stated the rule as follows: In dealing with documents that were not physically attached to the taxpayer's return, we have consistently drawn a line between (1) documents that have been filed as tax returns of other taxpayers, and (2) documents that, even if filed as tax
7

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returns, were not tax returns of other taxpayers. Documents in the former category have not been taken into account . . . . 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 . . . S corporation tax returns . . . and other documents which are not tax returns of taxpayers. Id. at 53. Pursuant to this case law precedent, the Court should consider the following returns and forms as part of its Section 6501(e)(1)(A) analysis in this case: · Form 1065 Partnership Return of Grapevine Imports, Ltd. (Plaintiffs' Exhibit 66). · Form 1040 Joint Individual Return of Joseph and Virginia Tigue (Plaintiffs' Exhibit 63). · · Form 1120S S-Corporation Return of T-Tech, Inc. (Plaintiffs' Exhibit 68). Forms 1099 of JJT Meandering Investments LLC, VBT Meandering Investments LLC, and Grapevine Imports, Ltd. (regarding short sale transactions in 1999) (Plaintiffs' Exhibits 69, 70, and 71).8 · Forms SS-4 of JJT Meandering Investments LLC and VBT Meandering Investments LLC (regarding employer identification numbers of LLCs) (Plaintiffs' Exhibits 73 and 74). These returns and forms were all properly filed with the IRS and provide notice to the IRS of elements of the transactions at issue. As will be discussed, the entities and individuals filing
8

The Government's expert report revealed that the IRS likely has destroyed the Forms 1099 for the tax year 1999 related to this case because the IRS's policy is to destroy taxpayer records after six years. This would mean that the Forms 1099 were destroyed sometime in late 2005, well after the inception of this lawsuit. Both the Government's expert and Plaintiffs' expert found these forms to be material evidence, and their destruction during the pendency of this litigation has yet to be adequately explained. The exhibits submitted to the Court were found in the files of the taxpayers' CPA. Page 13

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these returns and forms are referenced in Grapevine's Form 1065 and are properly considered by the Court for purposes of the six-year statute of limitations. 4. Reporting on the Returns in This Case. Mr. Songy explains in depth in his expert report and supplemental report how the transactions were reported on the relevant returns and forms, so only a summary is provided here. Prior to the filing of any tax returns for the year 1999, Joseph and Virginia Tigue received an opinion from the law firm of Jenkens and Gilchrist regarding the legal implications and potential tax treatment of the transactions at issue (the "Jenkens opinion"). Joseph and Virginia Tigue, Grapevine, and T-Tech all relied upon the Jenkens opinion in completing the relevant returns and reporting the transactions at issue. While the IRS contends that the tax treatment of the short sales was invalid (a contention with which Plaintiffs disagree), that issue is not before the Court at this time. The question is whether the short sales were accurately reported in a manner consistent with the Plaintiffs' tax position. See, e.g., Lawrence v. Comm'r, 258 F.2d 562, 562 (9th Cir. 1958) (holding that there is no omission under the extended statute "[w]hen a taxpayer has made a full disclosure of his `position' with respect to his gross income . . . but has not `included' the amount involved as taxable"). As Mr. Songy's reports demonstrate, Plaintiffs' reporting was consistent with the legal opinion they received and complied with IRS reporting requirements. a) Reporting Consistent With the Jenkens Opinion. Plaintiffs reported these transactions consistent with the Jenkens Opinion in the following ways: 1. Joseph and Virginia Tigue reported the income and dividends received from the short sales directly on their Form 1040 individual tax returns
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because their single-member LLCs were disregarded for income tax purposes. (Songy Supplemental Report at 10-12). The Forms SS-4 filed by the Tigues with the IRS informed the IRS of the LLCs' disregarded status. (Songy Report at 8-9; Songy Supplemental Report at 2-5).

(Plaintiffs' Exhibits 73 and 74). 2. Joseph and Virginia Tigue and Grapevine did not consider the opening of the short sales of U.S. Treasury Notes to be a taxable transaction, as advised by the Jenkens opinion. Consistent with that opinion, Joseph and Virginia Tigue did not report the opening of the short sales on their individual tax return. Indeed, there is no reporting requirement on

taxpayers for the opening of a short sale transaction, so the Tigues' reporting was consistent with IRS requirements. Nonetheless, the IRS was advised of the opening of the short sales via the Forms 1099 filed on behalf of the taxpayers with the IRS. (Songy Report at 9-10; Songy Supplemental Report at 5-7). (Plaintiffs' Exhibits 69, 70 and 71). 3. Consistent with the Jenkens opinion, Grapevine's filing of a partnership tax return indicated the partnership's belief that it should be classified as a partnership for income tax purposes. (Songy Report at 10). (Plaintiffs' Exhibit 66). 4. The Jenkens opinion advised that the contributions of cash and the obligations to close the short sales to Grapevine were not taxable transactions. Accordingly, Joseph and Virginia Tigue did not treat the contributions as taxable.
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requirements. (Songy Report at 11). This reporting is also required by 26 U.S.C. § 721 (nonrecognition of gain or loss on contribution to partnership). 5. Jenkens advised Joseph and Virginia Tigue that the obligations to close the short sales should not be considered liabilities under IRC Section 752. As Mr. Songy explains, reporting of this position was not required. (Songy Report at 11). Even if the short sales had been treated as a Section 752 liability, this would have affected the Form 1065, Schedule M-2, and would have no overall impact on the partnership's income. (Songy Report at 11.) 6. Consistent with the Jenkens opinion, Joseph and Virginia Tigue increased their basis in their partnership interests by the amount of the cash contributed without offsetting that amount by the obligations to close the short sales. As Mr. Songy's report demonstrates, this reporting aligns with the Jenkens opinion and IRS requirements. (Songy Report at 11). 7. Jenkens advised Joseph and Virginia Tigue that Grapevine's closing of the short sale obligations was not a deemed distribution to the partners under IRC Section 705(a)(2)(B); thus, Jenkens advised that the Tigues would recognize no income from the closing of the short sale transactions. Accordingly, the Tigues did not reduce their basis in the partnership upon the closing of the short sales. (Songy Report at 11-12). 8. The Jenkens opinion further advised Joseph and Virginia Tigue that the step transaction doctrine, sham transaction doctrine, and Treasury
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Regulation 1.702-1 all would not apply to the transactions at issue. This advice had no effect upon the tax reporting by Plaintiffs, except that Grapevine's filing of a partnership tax return indicated the Plaintiffs' belief that it should not be disregarded for income tax purposes. (Songy Report at 12). b) Tracing the Short Sales Transactions Through the Returns. The partnership return Form 1065 reports key elements of the short sales at issue. (Plaintiffs' Exhibit 66). Schedule M-2, Analysis of Partner's Capital Accounts, reports the total capital contributed by the partners of Grapevine during the year 1999 as $12,151,221. (Plaintiffs' Exhibit 66 at 4). This amount includes Joseph and Virginia Tigue's contributions of the proceeds from the opening of the short sales totaling $9,978,119, the interest on the short sales of $16,052, and $50,000 in margin cash contained in the brokerage accounts. Thus, $10,044,172 of the capital contributions listed in Schedule M-2 relates to the short sale transactions. (Songy Report at 14-15). Joseph and Virginia Tigue's contributions of the short sale proceeds are also reflected on the Form 1065 on their individual Schedules K-1 at Line J(b). (Songy Report at 15). (Plaintiffs' Exhibit 66 at 10 & 12). In addition, Forms 1099 were filed with the IRS by the brokerage firm BT Alex Brown regarding the short sales. (Plaintiffs' Exhibits 69, 70, & 71). Each Form 1099 for Joseph and Virginia Tigue shows clearly a "short sale" of United States Treasury Notes in the amount of $4,989,059.50, and shows the dates of the short sales. (Songy Supplemental Report at 5-7). (Plaintiffs' Exhibits 69 & 70). Combined, these short sale proceeds total $9,978,119. This figure is reported on Grapevine's Form 1065, attached schedule, as the "sale" price of U.S. Treasury Notes. (Plaintiffs' Exhibit 66 at 7). The Form 1099 also shows interest and dividend
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income related to the short sales. (Songy Supplemental Report at 5-7). (Plaintiffs' Exhibits 69 & 70). Joseph and Virginia Tigue reported this interest and dividend income on Schedule B of their Form 1040 tax return. (Songy Supplemental Report at 11-12). (Plaintiffs' Exhibit 63 at 4). The reporting of the interest and dividend income from the short sales at the individual level on the Tigues' Form 1040 shows that Joseph and Virginia Tigue opened the short sales. The reporting of the purchase and sale price on Grapevine's Form 1065, attached schedule, shows that Grapevine closed the short sales. From the reporting of the figures shown on the Forms 1099, one can readily determine that the short sale was opened at the individual level and closed at the partnership level. The partnership Form 1065 reports the opening and the closing of the short sales. Schedule K, Line 4(d), shows a short-term capital loss of $21,884, and references an attached schedule. (Plaintiffs' Exhibit 66 at 3). The attached schedule reflects a "purchase" of U.S. Treasury Notes in the amount of $10,000,003 and a "sale" of the notes in the amount of $9,978,119, with an overall loss of $21,884, which corresponds to the figure reported on Schedule K, Line 4(d). (Plaintiffs' Exhibit 66 at 7). The $9,978,119 "sale" price is the

combined total of the short sale proceeds as reported on the Forms 1099. Each of the partners' Schedules K-1, Line 4(d), reflected their proportionate share of the $21,884 loss. (Songy Report at 16-17). (Plaintiffs' Exhibit 66 at 8, 10 & 12). T-Tech, a 1% partner of Grapevine, was required to report a proportionate share of the partnership's loss on the closing of the short sale on the corporation's tax return. The tax return of T-Tech, Form 1120S, reflected this loss at Schedule K, Line 4(d). (Plaintiffs' Exhibit 68 at 2). This loss was also reflected in an attached schedule which listed Grapevine by name and taxpayer identification number. (Plaintiffs' Exhibit 68 at 6). The loss was also reflected on the
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Form 1120S, Schedule K-1, allocating the entire loss taken by T-Tech to its 100% owner, Joseph Tigue. (Songy Report at 18). (Plaintiffs' Exhibit 68 at 5). Similarly, Joseph and Virginia Tigue as 49.5% partners were required to report their proportionate shares of the partnership's loss on the closing of the short sale on their individual tax return. Form 1040 Schedule D filed by the Tigues reported the loss and referenced an attached schedule. (Plaintiffs' Exhibit 63 at 5). The attached schedule listed the appropriate amount of loss as well as Grapevine's name and taxpayer identification number. (Songy Report at 19). (Plaintiffs' Exhibit 63 at 9). c) Tracing the Sale of the Partnership Through the Returns. Key elements of the sale of the partnership also are clearly reflected on the relevant returns. On Grapevine's Form 1065, Schedule L, the balance sheet per books is "zeroed out" at the end of the year. (Plaintiffs' Exhibit 66 at 4). Similarly, the Form 1065, Schedule M-2 also shows a zero balance in the partners' capital accounts at the end of the year. (Plaintiffs' Exhibit 66 at 4). The Form 1065, Schedules K-1, Lines D and I(1) reflect that each partner had a 0% partnership interest at the end of the year, and that this was the final K-1 for each partner. (Songy Report at 20-22). (Plaintiffs' Exhibit 66 at 8, 10 & 12). The corporate return Form 1120S for T-Tech, Inc. also showed that the corporation sold its partnership interest in Grapevine at Schedule K, Line 4(e) and an attached schedule that lists Grapevine by name and taxpayer identification number. (Songy Report at 23). (Plaintiffs' Exhibit 68 at 2 & 6). Joseph and Virginia Tigue's individual return Form 1040 shows the sale of their partnership interests at Schedule D, Part II. (Plaintiffs' Exhibit 63 at 5). The partnership is listed by name, "Grapevine Imports, Ltd." The sales price of $10,916,240 and basis of $10,961,317
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are clearly reflected in the proper spaces on the return. The loss of $45,077 is also listed. The loss that Joseph Tigue incurred on the sale of the partnership through his wholly-owned corporation T-Tech, Inc. is also reflected in an attached schedule. (Plaintiffs' Exhibit 63 at 9). The schedule lists T-Tech by name and taxpayer identification number, and lists the appropriate amount of loss as carried over from the S-Corporation and partnership returns. The capital loss from the sale of the partnership was then applied toward the Tigues' capital gains from other sources to arrive at a total long term capital gain of $119,816, reflected at Schedule D, Part II, Line 16. (Songy Report at 24). (Plaintiffs' Exhibit 63 at 5). d) Plaintiffs' Reporting on the Relevant Returns. The transactions at issue in the FPAA involve three elements: 1) the opening of the short sales by Joseph and Virginia Tigue through their single-member LLCs; 2) the contribution of the short sale proceeds and obligations to close the short sales to the partnership, Grapevine, and the effect of that contribution on the Tigues' partnership basis; and 3) the sale of the Tigues' 100% partnership interests at the end of the taxable year and the reporting of that sale. As Jerry Songy's report and supplemental report demonstrate, these three elements are revealed in multiple places on the relevant returns. The IRS was notified of all of these elements through the returns and forms filed with the IRS by the Plaintiffs. Together, these forms and returns inform the IRS about the transaction in sufficient detail to put a reasonable revenue agent on notice that there is something that he or she should look at further, as the Government's expert conceded in her deposition (before she was withdrawn).9

9

Kiger Deposition at 177 lines 2-9. Page 20

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C. Colony, Inc. v. Commissioner Is Squarely On Point and Provides That an Overstatement of Basis is Not an Omission of Gross Income For Purposes of the Extended Statute. The parties have briefed the Court extensively on the applicability of Colony to these proceedings, so Plaintiffs will only provide a summary here. On its facts, Colony presented a full reporting of gross receipts coupled with an improperly calculated, overstated basis in residential lots, resulting in an understated gain on their sale. Colony, Inc. v. Commissioner, 26 T.C. 30, 31 (1956), aff'd 244 F.2d 75 (6th Cir. 1957), rev'd, 357 U.S. 28 (1958). Before the Supreme Court, the IRS argued that the use of the term "amount" in the extended statute of limitations suggests "a concentration on the quantitative aspect of the error--that is, whether or not gross income was understated by as much as 25%." Colony, 357 U.S. at 32. Thus, the IRS argued that the statute applied to any understatement of income of 25% or more. The Supreme Court remarked that "this view is somewhat reinforced if, in reading the [statutory language], one touches slightly on the word `omits' and bears down hard on the words `gross income[.]'" Id. In contrast, the taxpayer argued that the IRS's reading failed to take full account of the word "omits," when Congress could have chosen other words such as "reduces" or "understates." Id. Under the word's ordinary meaning, "omits" means "to leave out or

unmentioned; not to insert, include, or name[.]" Id. Thus, the taxpayer contended that Section 275(c) applied only in situations in which specific receipts or accrual of income items are left out of the computation of gross income. Id. at 33. The Supreme Court noted that the statutory language was ambiguous but in the legislative history found "persuasive evidence that Congress was addressing itself to the specific situation where a taxpayer actually omitted some income receipt or accrual in his computation of
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gross income, and not more generally to errors in that computation arising from other causes." Id. The Supreme Court determined that: [I]n enacting § 275(c) Congress manifested no broader purpose than to give the Commissioner an additional two years to investigate tax returns in cases where, because of a taxpayer's omission to report some taxable item, the Commissioner is at a special disadvantage in detecting errors. In such instances the return on its face provides no clue to the existence of the omitted item. On the other hand, when, as here, the understatement of a tax arises from an error in reporting an item disclosed on the face of the return the Commissioner is at no such disadvantage. Id. (emphasis added). Therefore, the Supreme Court held that the IRS's assessment against the taxpayer was barred by the general three-year statute of limitations because the taxpayer's total gross receipts and overstated basis were disclosed on the return. Id. at 30 & 37. Significantly, in reaching its decision, the Supreme Court noted that its conclusion was "in harmony with the unambiguous language of [Section] 6501(e)(1)(A)[.]" Id. Much like Colony, the present case involves a full reporting of gross receipts coupled with an allegedly improperly calculated, overstated basis10 in an asset, resulting in an understated gain on its sale. In this case, the amount of the taxpayers' claimed basis was reported on both the partnership return and the individual tax return. In fact, the Plaintiffs disclosed far more about the transaction at issue than did the taxpayers in Colony, as shown in the demonstrative exhibit attached as Exhibit 75. If the taxpayers' spare reporting of a single line-item showing a large basis was sufficient to avoid the extended statute of limitations in Colony, Plaintiffs' reporting in this case as discussed above more than meets the "adequate disclosure" or "clue" standard, and the six-year statute of limitations should not apply.

10

For purposes of these motions for summary judgment on the statute of limitations only, Plaintiffs agree that the Tigues' basis in the partnership is overstated as a result of retroactive Treasury Regulation § 1.752-6. Page 22

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1. Colony Has Been Followed As Precedent for Almost Fifty Years and Is Binding Upon this Court. The Supreme Court precedent of Colony is binding in this proceeding. The Court of Claims is obligated to follow Supreme Court precedent, even if that precedent has been eroded or is arguably incorrect. Insurance Co. of the West v. United States, 243 F.3d 1367, 1372 & 1372 n.2 (Fed. Cir. 2001) (holding that "[t]his court is obligated to follow the Supreme Court's interpretation [of its prior case law], even though that interpretation may be dicta" and noting that the Supreme Court opinion at may have been factually incorrect); Stone Container Corp. v. United States, 229 F.3d 1345, 1350 (Fed. Cir. 2000) (holding that "[a]s a subordinate federal court, we do not share the Supreme Court's latitude in disregarding the language in its own prior opinions . . . . once the Supreme Court has spoken, it is the duty of other courts to respect that understanding of the governing rule of law") (internal citations omitted). Plaintiffs contend that Colony has established a significant precedent that has been recognized for almost fifty years by the federal courts. a) Colony as Precedent. In the years after Colony, many courts referred to the Supreme Court's interpretation of the extended statute of limitations as the "clue" test, relying upon the Supreme Court's language that "the return on its face provides no clue to the existence of the omitted item." See, e.g., Benderoff v. United States, 398 F.2d 132, 136 (8th Cir. 1968) ("the proper test appears to be whether the return provides a clue as to the omitted item"). Contrary to the IRS's recent position that Colony should be disregarded, there is a clear line of authority spanning the forty-eight years since Colony applying the "clue" test as an interpretative measure for Section 6501(e)(1)(A)(ii)'s safe harbor provision. Under Section 6501(e)(1)(A)(ii), the extended statute of limitations does

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not apply when a taxpayer discloses the omitted item in the return in a manner "adequate to apprise the Secretary of the nature and amount of such item." The "clue" test provides the courts with a guide of what is adequate disclosure under the statute sufficient to avoid the extended statute. The most obvious application of Colony's "clue" test has been to cases where a taxpayer completely leaves out an item of income and makes no reference to related returns.11 In those cases, there is no "clue" on the return about the omitted item, and the extended statute of limitations applies. However, the "clue" test has been equally and consistently applied to cases in which a taxpayer reports an item in some fashion on the return but improperly accounts for the item in determining its tax liability.12 In summary, the "clue" test focuses on the taxpayer's reporting of the item at issue in the return in determining the following two elements: 1) whether the taxpayer's position is reported in keeping with IRS requirements even though it is at odds with the IRS's position regarding tax treatment;13 and 2) whether the taxpayer has given enough information to trigger follow-up by a reasonable revenue agent.14
See, e.g., Phinney v. Chambers, 392 F.2d 680, 683-84 (5th Cir. 1968) (citing Colony and finding omission when taxpayer made no reference at all to payments received on an installment note); Bishop v. United States, 338 F.Supp. 1336, 1349-53 (N.D. Miss. 1970) (citing the clue test and finding omission when no reference made in returns to gifts received from an estate); Connell Bus. Co. v. Comm'r, 87 T.C.M. (CCH) 1384 (2004) (citing the clue test and finding an omission when taxpayer made no reference at all to trust from which it received income and no report of said income). 12 See, e.g., Benderoff v. United States, 398 F.2d 132, 135-38 (8th Cir. 1968) (finding no omission when dividends from S-Corp were reported on the return but listed as nontaxable); University Country Club v. Comm'r, 64 T.C. 460, 468-72 (1975) (finding no omission when taxpayer listed capital surplus account in detail and characterized the amounts as capital stock rather than income); Quick Trust v. Comm'r, 54 T.C. 1336, 1346 (1970) (finding no omission when taxpayer reported inflated basis in partnership because taxpayer referred to partnership in its return); Walker v. Comm'r, 46 T.C. 630, 639-40 (1966) (finding no omission when taxpayer reported full amount of installment sale to be taken as income in the future that should have been taken as present income). 13 See, e.g., Davis v. Hightower, 230 F.2d 549 (5th Cir. 1956) ("the full and complete statement by the taxpayer of every gross item of income and gain received by him as required by the return itself" defeats the application of the extended statute of limitations). PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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2. Why Colony Is In "Harmony With the Unambiguous Language of 6501(e)(1)(A)" The Supreme Court concluded the Colony opinion by stating that its holding was "in harmony with the unambiguous language of 6501(e)(1)(A)." 357 U.S. at 37. The IRS has espoused one theory as to why the Colony's holding complies with the current statute, that is, because the facts of the case fall within Section 6501(e)(1)(A)(i)'s "gross receipts" test.15 The IRS argues that the Colony taxpayer's satisfaction of the "gross receipts" test limits the Colony's application to cases involving "gross receipts" or involving inventory. As discussed in prior briefs, this argument has several flaws, not the least of which is that Congress' enactment of 6501(e)(1)(A) in 1954 could not have been an effort to overrule Colony, an opinion issued in 1958. However, the Supreme Court's statement that its holding is "in harmony with the unambiguous language of 6501(e)(1)(A)" should be read much more broadly than the IRS contends: the statement applies to the entire 6501(e)(1)(A). The Colony opinion also concerned itself with the taxpayer's disclosure on the returns, in addition to the issue of gross receipts. See

Benderoff, 398 F.2d at 137 (the "clue" must allow the "Commissioner to observe, heed, and investigate" the item); Estate of Frane v. Comm'r, 98 T.C. 341, 355 (1992) rev'd in part on other grounds, 998 F.2d 567 (8th Cir. 1993) (the "clue" must be "sufficiently detailed ... so that a decision as to whether to select the return for audit may be a reasonably informed one") (internal citations omitted). There has been significant debate in the recent, unreported G-I Holdings case about whether the standard under Section 6501(e)(1)(A)(ii) is that of a "reasonable man" or a "reasonable revenue agent." In re G-I Holdings Inc., No. 02-3082, 2006 WL 2595264 at *6 n.3, slip op. at 10 n.3 (D.N.J. Sept. 8, 2006). While the G-I Holdings court refused to decide the issue, this appears to be a distinction without a difference. The statute itself clearly indicates that the information in the return must be "adequate to apprise the Secretary" (emphasis added), a standard which by its terms incorporates the skill and knowledge of a typical IRS examiner. The IRS has made much of language in a 1975 Tax Court case, University Country Club v. Commissioner, which states that the standard is that of a "reasonable man." 64 T.C. 460, 471 (1975). However, the court in that case was merely distinguishing between a subjective standard, which the IRS wanted, and objective standard, which the court found was correct. Id. Moreover, the context of the Tax Court's statements indicates that there was no question that the objective standard of Section 6501(e)(1)(A)(ii) took into account the knowledge of the IRS: the court variously refers to the standard as "adequate to so apprise the Commissioner" and "adequate ... for the Commissioner to observe[.]" Id. at 469-70. 15 Plaintiffs refer to the IRS' interpretation of the "gross receipts" test as expressed in their Brief Supporting Partial Motion for Summary Judgment (Rec. Doc. No. 38), and in Chief Counsel Advisory Memorandum 200628021. PLAINTIFFS' MEMORANDUM OF LAW IN ADVANCE OF EVIDENTIARY HEARING ON APPLICABILITY OF 26 U.S.C. § 6501(e)(1)(A)
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357 U.S. at 33-35 (discussing legislative history surrounding taxpayers' disclosures on tax returns) and 36 (holding that extended statute of limitations did not apply to "an error in reporting an item disclosed on the face of the return"). The Supreme Court held in Colony that the t