Longer Statute of Limitations for Overstating Income Tax Basis Now in Effect

Generally, the IRS has 3 years after the later of the date a tax return is filed, or the due date of the tax return, to assess additional income tax liability.  This time limit is referred to as the “statute of limitations (SOL).”  A special 6-year SOL applies if a taxpayer omits more than 25% of gross income as measured against the amount of gross income reported on the tax return.  However, if adequate disclosure is made in the tax return for why the gross income is not being included, the 3-year SOL continues to apply.

Controversy between the IRS and taxpayers erupted when the IRS tried to apply the 6-year SOL to an understatement of tax resulting from an overstatement of income tax basis.  The IRS argued that the deductions from overstated tax basis was equivalent to understating gross income.  However, the U.S. Supreme Court ruled against the IRS in Home Concrete & Supply, LLC.  Now, the U.S. Congress has overridden the Supreme Court decision by enacting a new law as part of the temporary highway funding act signed into law on July 31, 2015.

The new law treats an overstatement of income tax basis as an omission from gross income for purposes of the 6-year SOL.  Furthermore, the new law states that the adequate disclosure rule does not apply to the overstatement of basis.  The new law is effective for tax returns filed after July 31, 2015; and also to tax returns filed on or before July 31, 2015 where the SOL rules in effect before this change had not expired as of July 31, 2015.