Tax Court Invalidates Regulation on CPAR/BBA Partnership FPA Limitations Period and Holds Partnership Adequately Disclosed to Avoid Limitations Extension (7/3/24)

In JM Assets, LP v. Commissioner, 165 T.C. ___ No. 1 (7/2/25) (reviewed opinion with no dissents), TC here dkt #46 and GS here [to come], the Court invalidated a regulation that, if valid, would have extended the period for a final partnership adjustment under the CPAR/BBA beyond the statutory period of 330 days. The FPA is the final action imposing the imputed tax at the partnership level under CPAR/BBA.

 The Court offers the following “latest possible dates” for a valid FPA (Slip Op. 12-13):

(1) three years after the date on which the partnership return was filed, I.R.C. § 6235(a)(1)(A); (2) three years after the due date of the return, I.R.C. § 6235(a)(1)(B); (3) three years after the date on which the partnership filed an administrative adjustment request under section 6227, I.R.C. § 6235(a)(1)(C); (4) in the case of a proposed partnership adjustment under section 6231(a)(2), the date that is 330 days (plus any extension under 6225(c)(7)) after the date of such a notice, I.R.C. § 6235(a)(3); or (5) in the case of a modification request made pursuant to section 6225(c), 270 days (plus any extension under 6225(c)(7)) after the date on which everything required to be submitted to the Secretary pursuant to such section is so submitted, I.R.C. § 6235(a)(2).

JM Assets involved (5) relating to modification requests.

I don’t think there is anything surprising in that interpretation of the statutory text under Loper Bright’s de novo interpretation standard. I should note that the IRS argued unsuccessfully for delegated interpretive authority for the regulation of the type Loper Bright approved.

I think the more interesting part of JM Assets is its conclusion that the FPA period was not extended by § 6235(c)(2) which provides that for an extension for the FPA if there is a substantial omission of income as defined by § 6501(e)(1)(A). That part of opinion deals with the general tax extension in the latter section. I discuss the general tax extension in my Federal Tax Procedure (Practitioner Edition pp. 198-199; Student Edition pp. 138-139).

Section 6501(e)(1)(A),  in relevant part provides that if there is a “substantial omission of income,” the general statute of limitations is extended from the general 3-year period to 6-years. As applicable to the FPA, that would give an extended period for the FPA beyond the latest period quoted above and would validate the FPA to JM Assets. The Court reasons (Slip Op. 16-17, bold face supplied by JAT):

           The test for whether there is a substantial omission of income under section 6501(e) may be expressed as a fraction where “the numerator is the amount properly includable gross income that was omitted from a taxpayer’s return, and the denominator is ‘the amount of gross income stated in the return.’” Harlan v. Commissioner, 116 T.C. 31, 40 (2001) (quoting I.R.C. § 6501(e)(1)(A)). To evaluate whether JM Assets has a substantial omission of income, we must further define the numerator and denominator.

           An omission of income occurs when the face of the return does not provide a clue as to the existence of the omitted item, thus placing the Commissioner at a disadvantage in determining the accuracy of the return. See Colony, Inc. v. Commissioner, 357 U.S. 28, 36 (1958). The Supreme Court in Colony determined that the statutory purpose for extending the period of limitations is “to give the Commissioner additional time to review a taxpayer’s return when the taxpayer had reported no information about a given transaction.” Barkett v. Commissioner, 143 T.C. 149, 153 (2014). Under section 6501(e)(1)(B)(iii), any amount 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, is not considered omitted income. In contrast, where a taxpayer merely discloses net gain so that the Commissioner is not apprised of the nature, amount, or existence of gain, the amount is not adequately disclosed. Highwood Partners v. Commissioner, 133 T.C. 1, 21–22 (2009).

The issue turns upon whether JM Assets provided a clue as to the omitted income. What does the statutory text "clue" mean. Merriam Webster online, here, provides this definition:

something that guides through an intricate procedure or maze of difficulties specifically : a piece of evidence that leads one toward the solution of a problem.

Of course, since § 6501(e)(1)(B)(iii) has been law for a long time, it has already been interpreted in further nuanced ways that may not be consistent with a general definition of clue. When I read the discussion in JM Assets quoted above, I thought the discussion was not nuanced. I recalled Estate of Fry v. Commissioner, 88 T.C. 1020 (1987) which I discuss in my book (Practitioner Ed. p. 202-203; Student Ed. p. 142 (quoting Fry in text) as follows (some footnotes omitted and numbering changed for this post bold-face provided for this quote):

          As noted above, even if income is omitted from the calculations on the return, the omission will be disregarded if an adequate disclosure of the omitted income is provided on the return. What is adequate disclosure? The statute requires disclosure “in a manner adequate to apprise the Secretary of the nature and amount of such item.” Some have read the Supreme Court’s decision in The Colony, interpreting a pre-1954 Code version of the 6 year exception, to bless disclosure of a mere clue as a way to avoid application of the 6 year exception. The language of the 1954 Code version [and the 1986 version] (the current version), however, requires adequate notice n1 and not just a “a mere clue that might intrigue Sherlock Holmes.”n2 Indeed, the disclosure must generally appear on the face of the return or an attached statement and “be apparent * * * to the elusive ‘reasonable man.” n3.

   n1 Estate of Fry v. Commissioner, 88 T.C. 1020, 1023 (1987) (“The statement must be sufficiently detailed to alert the Commissioner and his agents as to the nature of the transaction so that the decision as to whether to select the return for audit may be a reasonably informed one.”). [JAT Note: although an older case, Estate of Fry’s quote is repeated in more recent cases (e.g., Graev v. Commissioner, 147 T.C. 16, 62-63 (2016)) and has not, so far as I am aware been questioned; caveat though, I did a quick online search but I have not done detailed research on that last statement.]
   n2 George Edward Quick Trust v. Commissioner, 54 T.C. 1336, 1347 (1970), aff'd per curiam, 444 F.2d 90 (8th Cir. 1971). In Benson v. Commissioner, 560 F.3d 1133, 1136-1137 (9th Cir. 2009), the Court rejected the argument that, since the IRS ultimately found the putatively omitted item, the IRS was not at a special disadvantage requiring a six-year period. The taxpayer’s argument was, of course, circular. If the IRS did not discover the omission, then the statute was six years but would be meaningless because the IRS did not discover the omission even in the six years. If the IRS did discover it in the six-year period, then the six-year period would not apply because the IRS discovered it.
   n3 Univ. Country Club, Inc. v. Commissioner, 64 T.C. 460, 468 (1975).

           The disclosure contemplated is one filed on or with the taxpayer’s own original return which contains the substantial omission. For this reason, the filing of an amended return will not cure the original return failure to disclose that caused the extended statute of limitations. (Students will recall that the same concept applies with respect to the filing of a nonfraudulent amended return where the original return was fraudulent; the amended return does not cure the fraud that triggers the unlimited statute of limitations.) Where, however, the taxpayer’s original return provides a reference to another return that has been filed on or before the date the taxpayer’s return is filed, the references can constitute adequate notice. For example, where a taxpayer reports on his return items from a flow-through entity such as a partnership or an S-corporation, the information on the referenced entity return filed on or before the filing of the taxpayer’s return can be considered in assessing whether the taxpayer has made adequate disclosure.

          The disclosure escape from the six-year statute of limitations is not a license for a taxpayer to omit income that is clearly taxable and attempt to provide some obtuse disclosure so as to avoid § 6501(e). Gamesmanship via an erroneous or misleading disclosure could result in criminal prosecution and/or the civil fraud penalty. Rather, it seems that such disclosure is most effectively employed where the taxpayer has some reasonable argument that the income may not be taxable and desires to achieve two goals by a reasonable disclosure -- first the avoidance of criminal and civil penalties and second the application of the normal three-year limitations period.

To be clear, however, I am not questioning the application of the standard in JM Assets. The author of the opinion is a great judge (I could not make that personal evaluation for all of the Tax Court judges). I do not claim better research or judgment that the Tax Court judge, I just think that the discussion in the opinion about adequate disclosure is not, well, as adequate (aka nuanced) as it could have been.

One other nuance in the opinion that I also think is not nuanced is the following (Slip Op. 11 n. 5) in quoting a Blue Book (Joint Committee Staff General Explanation prepared after enactment):

Although this publication is not legislative history, “like a law review article, may be relevant to the extent it is persuasive.” United States v. Woods, 571 U.S. 31, 48 (2013).

The quote from Woods is correct, but it too is not nuanced.

First, remember the Woods’ author was Justice Scalia, perhaps the most forceful voice on the Court  ever against any interpretive assistance in legislative history, including subsequent legislative history (OK, I know subsequent legislative history is an oxymoron). In any event, it was a unanimous opinion, and the quote comes in an important place (at the end). Still, I am not sure that the quote is an actual holding  rather than just a persuasive argument that the Blue Book is not more persuasive than a law review article; the quote may be just Justice Scalia’s hyperbole of the type he engaged commonly and was not important enough to the result to make his fellow Justices engage with Justice Scalia in comments to the opinion or in concurring or dissenting opinions to force nuance.

Second, I have discussed this issue in a blog: Is the JCT Blue Book More Persuasive than a Law Review Article? (Federal Tax Procedure Blog 4/27/21), here. I have also revised the working draft for the discussion in my Federal Tax Procedure (Practitioner Ed. 23-24; Student Ed. p. 15) to the following (with changes indicated in red, footnotes omitted):

          I ask readers to consider whether the two explanations of the uses of the Blue Book are consistent. Is the Blue Book written by those intimately involved in the legislative process no more persuasive than a law review article? What does it mean for the Blue Book to be persuasive? There is one analog to the Blue Book that I am familiar with. Shortly after enactment of the Administrative Procedure Act (“APA”), the Attorney General published a Manual on the Administrative Procedure Act (1947). The Supreme Court has said that the Manual is entitled to “some deference because of the role played by the Department of Justice in drafting the legislation.” If the Attorney General’s Manual interpretation of the APA is entitled to deference, then the JCT’s Blue Book which shares the key legislative process characteristic should be entitled to some consideration in the nature of deference. The deference (or some extra oomph) that may attach to the AG Manual and the Blue Book may function somewhat like Chevron deference formerly attaching to agency statutory interpretations based upon statutory ambiguity (see discussion beginning on p. 99), but the demise of Chevron deference should not affect the discussion here of deference to other statutory interpretation sources based on factors other than statutory ambiguity.

In sum, I think the Woods’ reference in the footnote was not nuanced. Perhaps that is why it is in a footnote and did not need to be nuanced. (Remember on a related theme that Justice Scalia asserted once in oral argument that he did not read footnotes in briefs. See Federal Tax Procedure (Practitioner Ed. pp. 1-2; Student Ed. 1-2).