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Taxpayer's Statute of Limitations Isn't Extended by Third Party's "Intent to Evade Tax".

(Parker Tax Publishing September 3, 2015)

The suspension of the three-year statute of limitations in Code Sec. 6501(c)(1) is only triggered by the intent of the taxpayer to evade tax and not the intent of a third party who is remotely connected with the relevant tax return. BASR Partnership v. U.S., 2015 PTC 263 (Fed. Cir. 2015).


In 1999, the members of the Pettinati family were about to realize a large capital gain from the sale of their printing business. Before they consummated the sale, Erwin Mayer, a lawyer in the Chicago office of the now defunct law firm of Jenkens & Gilchrist, contacted the family and proposed a tax advantaged investment opportunity. This opportunity involved numerous transactions which ended with all the stock in the printing business being owned by a family partnership, BASR. The Pettinatis could then sell the printing business by directing BASR to sell its shares to the buyer. In addition to recommending the transactions, three attorneys at Jenkens & Gilchrist signed a tax opinion document attesting to the legitimacy of the transactions. Mayer characterized the transactions as a "tax advantaged investment opportunity." Finally, the Pettinatis received guidance on reporting these transactions on their 1999 tax returns in a manner that was consistent with the opinion letters.

The Pettinatis hired Malone & Bailey PLLC to prepare their tax returns. While Malone & Bailey had a long-standing relationship with the Pettinatis, it had no prior connection with Jenkens & Gilchrist. Malone considered the legal opinions provided to the Pettinati family when preparing the BASR and Pettinati tax returns. Ultimately, by creating the BASR partnership, the Pettinatis greatly reduced the tax liability arising from the sale of their printing business.

In 2010, the IRS issued a final partnership administrative adjustment (FPAA) to BASR for the tax returns that reflected the sale of the printing business. In the FPAA, the IRS explained that BASR lacked economic substance because its principal purpose was to reduce substantially the present value of its purported partners' aggregate federal tax liability. The IRS adjusted the tax effect of the printing business sale accordingly, significantly increasing the Pettinatis' tax liability for the 1999 tax returns. BASR filed an action in the Court of Federal Claims (Claims Court), arguing that the adjustments and increased tax liability in the FPAA were untimely under the three-year statute of limitations in Code Sec. 6229(a) and Code Sec. 6501(a).

Arguments before the Court of Federal Claims

As a general rule, Code Sec. 6501(a) provides that the IRS must assess additional taxes and penalties with respect to a taxpayer's tax return within three years after the return was filed. Code Sec. 6229(a) provides a similar rule with respect to assessing tax attributable to any partnership item. However, there are certain exceptions that may extend or suspend the three-year limitations period. Code Sec. 6501(c)(1) provides that, in the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed at any time. Similarly, in Code Sec. 6229(c)(1), the statute remains open in the case of a partner who signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item.

Before the Claims Court, the IRS acknowledged the general limitations periods, but asserted that the limitations period remained open under Code Sec. 6501(c)(1) and Code Sec. 6229(c)(1) because the case involved a false or fraudulent return with the intent to evade tax. The IRS conceded that the Pettinatis themselves lacked the intent to evade tax and did not allege that the return preparers acted with intent to evade taxes or to have the Pettinatis evade taxes. The IRS asserted only that Mayer acted with the intent to evade tax when he conceived of and marketed the tax-advantaged investment structure. Contrary to the opinion letters supplied to the Pettinatis by Jenkins & Gilchrist, the IRS argued, Mayer knew these transactions were fraudulently designed to generate large noneconomic tax losses for wealthy taxpayers.

In reply, BASR argued that the three-year statute of limitations is suspended only when the taxpayer intended to evade tax and, therefore, Mayer's admitted fraud was insufficient and too remote to extend the statute with respect to the Pettinatis. Ultimately, the Claims Court agreed with BASR and the IRS appealed to the Federal Circuit.

Federal Circuit's Analysis

In its appeal, the IRS relied on the Tax Court's decision in Allen v. Comm'r, 128 T.C. 37 (2007) and the Second Circuit's decision in City Wide Transit, Inc. v. Comm'r, 2013 PTC 27 (2d Cir. 2013). In Allen, the court concluded that a tax preparer could supply the necessary intent to evade tax. In City Wide Transit, the court held that an accountant that filed fraudulent tax returns on behalf of a company, in order to embezzle money that the company otherwise owed the IRS, intentionally evaded that company's taxes, with the effect that the statute of limitations was indefinitely extended for the company. The IRS also stressed the Supreme Court's recognition, in Badaracco v. Comm'r, 464 U.S. 386 (1984), that "statutes of limitation sought to be applied to bar rights of the Government, must receive a strict construction in favor of the Government."

The Federal Circuit was asked to determine whether Code Sec. 6501(c)(1)'s suspension of the three-year statute of limitations is only triggered by the intent of the taxpayer, as urged by BASR, or whether, as the IRS maintained, the requisite intent can be that of a third-party who is more remotely connected with the relevant tax return.

The Federal Circuit affirmed the Claims Court and held that Code Sec. 6501(c)(1) suspends the three-year limitations period only when the IRS establishes that the taxpayer, and not a third party, acted with the intent to evade tax.

The court noted that Code Sec. 6501(c)(1) is not the only Code provision that deals with the consequences of intentional tax evasion. A survey by the court of Code sections dealing fraud-related provisions revealed, the court said, that those provisions contemplate fraud by the taxpayer, as opposed to by a person who merely contributed, albeit in a fraudulent way, to the filing of an inaccurate tax return.

Additionally, the court found the IRS's reliance on the cases cited to be misplaced. The Federal Circuit did not find the reasoning of the Tax Court in Allen to be persuasive, noting that the Tax Court conducted only a limited analysis of the text of Code Sec. 6501(c)(1). In City Wide, the court observed, the Second Circuit confronted only the issue of whether the person who prepared the tax returns acted with the intent to evade taxes. Contrary to the IRS's assertions, the court said, City Wide did not actually address the question of whether the tax preparer's intent was sufficient to trigger Code Sec. 6501(c)(1) and thus was not relevant to the instant inquiry. Finally, the court said that it did not read the Supreme Court's statement in Badaracco as requiring it to adopt the IRS's interpretation of the statute of limitations. In contrast to the present case, the court observed, there was no indication in Badaracco that the Court's interpretation was inconsistent or incoherent in the greater statutory scheme.

For a discussion of when the statute of limitations may be extended, see Parker Tax ¶260,130. (Staff Editor Parker Tax Publishing)

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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