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IRS Barred by Statute of Limitations from Assessing Tax and Penalties Nine Years after Merger

(Parker Tax Publishing October 2017)

The Tax Court held that the IRS was barred by the statute of limitations from assessing tax and penalties on a corporation that was merged into a new corporation almost nine years before the notice of deficiency was issued. The Tax Court found that under Beard v. Comm'r, 82 T.C. 766 (1984), the surviving corporation's return for the year at issue qualified as a return for the merged corporation's short tax year, thus triggering the three year period of limitations for assessments. New Capital Fire, Inc. v. Comm'r, T.C. Memo. 2017-177.

In 2002, Capital Fire Insurance Co. (Old Capital) merged into New Capital Fire, Inc. (New Capital) with New Capital surviving. The merger was designed to be a tax free reorganization under Code Sec. 368(a)(1)(F). Old Capital did not file a tax return for 2002. In 2003, New Capital filed a 2002 return which included a pro forma Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return, for Old Capital's tax year 2002. The pro forma return reported Old Capital's employer identification number (EIN), as well as its income, deductions, and credits for the short tax year ending on the date of the merger. Included with the return was a statement notifying the IRS that the merger had occurred and stating that the operations of Old Capital were included in the return on Form 1120-PC. New Capital reported Old Capital's tax payments and checked the box stating that it was Old Capital's final return. The return was signed under penalties of perjury.

In 2012, the IRS issued a notice of deficiency to Old Capital in which it determined that Old Capital was required to file a return for its 2002 short tax year because the merger failed to meet the Code Sec. 368(a)(1)(F) requirements. The notice was issued nearly nine years after New Capital filed its 2002 return. In sending the notice after the statute of limitations had expired, the IRS relied on the exception to the statute of limitations on assessments in Code Sec. 6501(c)(3), which provides that a tax may be assessed at any time if the taxpayer fails to file a return. The IRS argued that there were two separate taxpayers, Old Capital and New Capital, which were each required to file returns. According to the IRS, Old Capital did not file a return for 2002, and New Capital's return did not qualify as a valid return for Old Capital's short tax year.

The Tax Court rejected the IRS's arguments and held that New Capital's 2002 return was sufficient to trigger the running of the three year statute of limitations on assessment for Old Capital's 2002 tax year. The Tax Court applied the test in Beard v. Comm'r, 82 T.C. 766 (1984), which says that a document qualifies as a return and starts the running of the limitations period if it (1) contains sufficient data to calculate the tax liability; (2) purports to be a return; (3) is an honest and reasonable attempt to comply with the tax law; and (4) is signed under penalties of perjury.

The Tax Court noted that New Capital claimed to be a continuation of Old Capital on its 2002 return. New Capital included a pro forma return for Old Capital that gave the old company's name as well as its income, deductions, and credits. Based on these facts, the Tax Court determined that New Capital's return contained sufficient information to calculate Old Capital's tax liability. The New Capital return also clearly purported to be a return of Old Capital, according to the Tax Court, because it reported Old Capital's tax payments, listed Old Capital's EIN, and the box was checked indicating that it was Old Capital's final return.

The Tax Court rejected the IRS's argument that New Capital's 2002 return was purposefully misleading and therefore failed the third prong of the Beard test. According to the Tax Court, even if the return was purposefully misleading, that alone would not render it a nullity. The Tax Court noted that New Capital's return included Old Capital's income for 2002 up to the effective date of the merger. The Tax Court also noted that the IRS had not alleged a fraudulent intent on New Capital's part to evade Old Capital's tax liability. It was the IRS's duty, in the Tax Court's view, to determine whether New Capital's return was erroneous within the three year statute of limitations period under Code Sec. 6501(a). Because the Tax Court determined that New Capital's return satisfied the Beard test, the exception for failure to file under Code Sec. 6501(c)(3) did not apply, and the assessment of the deficiency was therefore barred by the statute of limitations.

For a discussion of the statute of limitations on assessments, see Parker Tax ¶260,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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