Overstatement of Basis Does Not Trigger 6-Year Audit Period

The U.S. Supreme Court has laid to rest an ongoing controversy over whether a taxpayer’s understatement of basis, which causes less gain to be reported, amounts to an omission of gross income. The reason why this is important is that omitting more than 25% of gross income means the IRS has 6 years, rather than 3 years, to audit a return.

The controversy arose with various tax shelters, called Son of Boss cases. The IRS in those cases, relying on regulations is issued in 2010, examined returns beyond the usual 3-year audit period. Some courts upheld the IRS move, while others did not. With the high court’s 5-4 decision, the matter is now settled. It had been well settled under the 1939 Tax Code that an overstatement of basis was not an understatement of income. The court said it could not now give a different interpretation to similar language in the 1986 Tax Code without a good reason; the mere IRS argument was not a good reason.