On June 30, 2021, the Tax Court issued a Memorandum Opinion in the case of Pragias v. Commissioner (T.C. Memo. 2021-82). The primary issue presented in Pragias v. Commissioner was whether the six-year statute of limitations under IRC § 6501(e) (substantial omission of items) applied.

The Substantial Omission Extension under IRC § 6501(e) in Pragias v. Commissioner

IRC § 6501(a) generally requires that the IRS assess tax within three years after the taxpayer files his return. However, IRC § 6501(e), as relevant to this case and as in effect at the relevant time, extends this period to six years for returns that satisfy a two-part test. See Quick Tr. v. Commissioner, 54 T.C. 1336, 1346 (1970), aff’d per curiam, 444 F.2d 90 (8th Cir. 1971).

First, the extended limitations period applies only if “the taxpayer omits from gross income an amount properly includible therein” and that amount “is in excess of 25% of the amount of gross income stated in the return.” IRC § 6501(e)(1)(A).

Second, the omitted amount must not be adequately disclosed: “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.” IRC § 6501(e)(1)(B)(ii).

So, What is an Omission of Income?

The petitioners argue that whether a return “omits” an amount of gross income within the meaning of IRC § 6501(e)(1)(A) is a facts-and-circumstances inquiry. Citing this Court’s recent decision in Beverly Clark Collection, LLC v. Commissioner, T.C. Memo. 2019-150, petitioners assert that they did not “omit” their distributive share of the partnership’s capital gain, irrespective of the adequate disclosure test discussed infra, because their gross income calculation understates the partnership’s item rather than leaving it out entirely.

The Tax Court rejected this argument on the basis of Estate of Fry v. Commissioner, 88 T.C. 1020, 1020 n.3, 1021-1022 (1987), wherein the return undervalued a parcel of land received in exchange for stock by more than 25% of reported gross income. In Estate of Fry, the Tax Court applied the six-year limitations period, even though the taxpayer understated the sale proceeds rather than omitting the transaction altogether, because the return did not adequately disclose the item by the terms of IRC § 6501(e). Id. at 1022-1023; see also Quick Tr., 54 T.C. at 1346 (after agreeing with the IRS that the return understated gross income, the Court determined in one sentence that the understatement exceeded 25% of reported gross income and moved immediately to the adequate disclosure analysis).

What is Adequate Disclosure?

Adequate disclosure is a question of fact, and the taxpayer bears the burden of proving that the return adequately disclosed the nature and amount of the determined omitted income. Highwood Partners v. Commissioner, 133 T.C. 1, 21 (2009). In a quintessential case of adequate disclosure, the taxpayer errs in computing gross income but fully discloses the amounts underlying the error elsewhere in the return. See Benson v. Commissioner, 560 F.3d 1133, 1136 (9th Cir. 2009), aff’g T.C. Memo. 2006-55; see also Walker v. Commissioner, 46 T.C. 630, 640 (1966) (finding that adequate disclosure exists “where a taxpayer arrives at an incorrect computation of tax only by reason of a difference between him and the respondent as to the legal construction to be applied to a disclosed transaction” (citing Davis v. Hightower, 230 F.2d 549 (5th Cir. 1956))).

For example, in Univ. Country Club, Inc. v. Commissioner, 64 T.C. 460, 468-470 (1975), the Tax Court held that a return adequately disclosed an item omitted from gross income where the taxpayer reported the full amount of receipts, but it mischaracterized them as nontaxable capital contributions. In keeping with the Supreme Court’s admonition that the Code limits the extended limitations period to returns that provide “no clue to the existence of the omitted item,”[1] the taxpayer does not necessarily have to disclose the exact amount of the omitted income to avoid the six-year limitations period. See Quick Tr., 54 T.C. at 1347. The Tax Court has found adequate disclosure of a partner’s distributive share of partnership income where information on the partnership return suggested the distributive share was understated, even though the IRS could not have discerned the amount of the understatement from the face of the return. Id.

The petitioners’ failure to identify the source of their capital gain on Schedule E, and the partnership’s failure to file a return with the requisite Schedules K-1, could have attracted IRS attention. But unlike the partnership return in Quick Tr., the petitioners’ return provided no clue that their distributive share of partnership income was greater than reported on the face of the return itself. Cf. CNT Inv’rs, LLC v. Commissioner, 144 T.C. 161, 218 (2015) (applying the six-year limitations period in similar circumstances).

Holding

The six-year limitations period applies because the Tax Court assumed for purposes of the petitioners’ motion for summary judgment that the petitioners understated their distributive share of the partnership’s capital gain by more than 25% of the gross income stated on the return, as the IRS alleges, and the return does not adequately disclose the omitted amount by the terms of IRC § 6501(e)(1)(B)(ii).

(T.C. Memo. 2021-82) Pragias v. Commissioner

[1] See United States v. Home Concrete & Supply, LLC (Home Concrete), 566 U.S. 478, 482-83 (2012) (quoting Colony, Inc. v. Commissioner, 357 U.S. 28, 36 (1958)).

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