Editor: Michael Dell, CPA
Procedure & Administration
In Chief Counsel Advice (CCA) 201333008, the Office of Chief Counsel has advised that information in a late-filed Form 1120S, U.S. Income Tax Return for an S Corporation, “should be treated like information found in an amended return and disregarded” for purposes of determining the individual’s disclosure of income in the timely filed Form 1040, U.S. Individual Income Tax Return, even though the S corporation return is referenced in that Form 1040.
In the CCA, the taxpayer filed a Form 1040 in year 1 showing a certain amount of income from the S corporation. More than three years after the filing of the Form 1040, and after the ordinary three-year period to assess had expired, the S corporation filed a Form 1120S revealing that the taxpayer’s distributive share of S corporation income exceeded 125% of the sum reported on the taxpayer’s individual return for the tax year (Form 1040).
The Office of Chief Counsel was presented the question of whether the late-filed Form 1120S constituted a disclosure (since the S corporation income was referenced in the original Form 1040) for purposes of determining whether there was a substantial omission of income under Sec. 6501(e).
Law and Background
Sec. 6501(a) generally requires the IRS to assess any tax within three years after the return is filed. Sec. 6501(e)(1) extends the period of limitation on assessment to six years when there is a substantial omission of income equal to 25% or more of the gross income reported on the return.
The Office of Chief Counsel noted that the purpose of extending the limitation period is to “level the playing field when the taxpayer’s omission of income places the IRS at a disadvantage in discovering errors.” Under Sec. 6501(e)(1)(B)(ii), items that are adequately disclosed in the return (or attachments and schedules) are not considered omissions for purposes of determining a substantial omission.
When an individual’s return contains a reference to other documents or returns, those referenced items can serve as notice to the IRS. However, for a Form 1120S to be read as incorporated by reference in a taxpayer’s return, the Form 1120S must be in existence and in the IRS’s possession when the taxpayer’s return is filed. When a Form 1120S is not filed until after the taxpayer’s Form 1040, the late Form 1120S should be treated like information found in an amended return and disregarded for disclosure purposes under Sec. 6501(e).
In support of this position, the Office of Chief Counsel cited Insulglass Corp., 84 T.C. 203 (1985), in which the Tax Court determined that information the IRS discovered during an audit should be treated as information filed on an amended return. The Tax Court in Insulglass found support in Houston, 38 T.C. 486 (1962), which held that a taxpayer’s filing of an amended return that includes in income amounts that had been omitted from the original return does not prevent the IRS from invoking the six-year period, based upon the omission from the original return, even though the amended return disclosed the previously omitted items.
Delinquent Form Is Not a Disclosure for Sec. 6501(e) Purposes
The timing of the disclosure is paramount. Gross income is disclosed within the meaning of Sec. 6501(e)(1)(B)(ii) only if the information necessary to place the IRS on notice of the nature and amount of gross income from the item is in the possession of the IRS when the return is filed.
The Office of Chief Counsel used the procedures applicable to the filing of a Form 1120S to explain this:
The Form 1120-S is due to the IRS on the fifteenth day of the third month of the year. That is one month prior to when the individual Form 1040 is typically due. Therefore, the Form 1120-S, if filed timely, should already be within the possession of the IRS at the time the individual return is filed. Where the Form 1120-S is filed after the original individual return, the IRS is not required to consider a theoretical, non-existent Form 1120-S in conjunction with the Form 1040. In this instance, the Form 1120-S cannot be said to be incorporated into the original Form 1040 and therefore the information reported thereon was not disclosed for purposes of IRC § 6501(e)(1). Where the IRS is forced into the disadvantageous position of reviewing an [individual’s] return without the benefit of the Form 1120-S, the taxpayer loses the benefit of any protection the disclosures in that Form 1120-S may have provided.
In short, to determine whether there is a substantial understatement of gross income for the purpose of applying the six-year statute under Sec. 6501(e)(1), only the amount of S corporation income listed on the original return is considered, the Office of Chief Counsel stated. Any gross income from the S corporation not listed on the face of the Form 1040 (or in a referenced document contemporaneously in the IRS’s possession) is an omission.
One of the potential adverse consequences of filing returns late is highlighted in this CCA and, in this case, is caused by the S corporation’s return’s being filed late, not the individual’s return. Partners in partnerships and shareholders in S corporations should be aware of this possible application of the six-year statute of limitation to an individual tax return filing as a result of an audit or amended tax return filing, or as in the case in this CCA, a return the partnership or S corporation filed late.
As noted in this CCA, the IRS takes the position that information discovered or provided by the taxpayer after the return is filed (e.g., during an audit, in amended returns, or in subsequent information returns), regardless of whether such information would ordinarily be considered disclosed, is includible only if it is filed with, or prior to, the taxpayer’s return. When information disclosing income that should have been included in the taxpayer’s return is provided to the IRS after the return is filed, that information is not considered to be disclosed on the return, is omitted gross income under Sec. 6501(e), and may extend the statute of limitation for an additional three years.
Michael Dell is a partner at Ernst & Young LLP in Washington, D.C.
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