Tax News

CCH (cch.taxgroup.com) reports:

  In a tax shelter case stemming from a John Doe summons issued to a law firm in 2003, the six-year statute of limitations for substantial omissions from gross income under Code Sec. 6501(e) was applied to a partnership return. The partners in the partnership had increased their basis in the partnership with premiums paid on a long position in a foreign currency option without reducing their basis for premiums received from a related and partially offsetting short foreign currency option.

  This increased basis was then transferred to stock distributed to the partners under the carry-over basis rules of Code Sec. 732(b). The high-basis stock was then sold for a large capital loss.

  In attacking the transaction, the IRS applied the extended six-year statute of limitations by virtue of the partners' incorrect accounting for the offsetting foreign currency positions. The foreign currency options were subject to Code Sec. 988 because they were denominated in Japanese yen, a nonfunctional currency. Under Reg. §1.988-1(e), each transaction subject to Code Sec. 988 must be reported and accounted for separately.

  The taxpayers violated this rule by netting the amounts paid and received on the two contracts. The taxpayer's argument that the two contracts were a single transactions due to similar terms was rejected as the long and short options were priced separately and payment on the contracts was determined separately. Failure to report gain and loss on the individual transactions resulted in a substantial omission of gross income and, thus, Code Sec. 6501(e) was applicable.

  However, the IRS motion for summary judgment that the foreign options, and the overall transaction, were shams was denied as it contradicted the Service's argument that the options were subject to Code Sec. 988. Nonetheless, the court refused to state that the a 6-year period of limitations would not apply if the IRS's sham theory were eventually upheld, only that it was not deciding that question in the context of a motion for summary judgment.

  Furthermore, the IRS position in the final partnership administrative adjustment (FPAA) that the foreign currency transactions should be disregarded did not preclude application of the extended statute of limitations even though disregarded transactions cannot create omitted income. The failure to raise the issue of omitted income under Code Sec. 988 on the FPAA did not prevent the court from addressing the issue. In addition, the IRS's alternative argument - that the two options should be combined as one transaction, thus limiting the increase to the partners' basis to the net amount of the two options - was not a concession on the part of IRS that no income was omitted.

  Finally, the partners' reporting of the net loss from the offsetting foreign options on their individual returns was not adequate disclosure for purposes of avoiding the finding of omitted income under
Code Sec. 6501(e)(1)(A)(ii).

Highwood Partners, 133 TC No. 1, Dec. 57,904

Other References:

 
Code Sec. 988

  CCH Reference - 2009FED ¶28,907.021

  CCH Reference - 2009FED ¶28,907.022

  CCH Reference - 2009FED ¶28,907.026

 
Code Sec. 6501

  CCH Reference - 2009FED ¶38,971.55

  CCH Reference - 2009FED ¶38,971.76

  Tax Research Consultant

  CCH Reference - TRC PART: 60,352.10
CCH Reference -
TRC INTL: 3,462
CCH Reference - TRC INTLOUT: 21,100