                        T.C. Memo. 2009-184



                      UNITED STATES TAX COURT



          KENNETH H. AND SUSAN W. BEARD, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13372-06.              Filed August 11, 2009.



     Robert E. McKenzie and Adam S. Fayne, for petitioners.

     Thomas D. Yang, for respondent.



                        MEMORANDUM OPINION


     HAINES, Judge:   In a notice of deficiency sent April 13,

2006, respondent determined that petitioner Kenneth Beard (Mr.

Beard) had overstated his basis in two S corporations sold during

the taxable year 1999, thus causing an understatement of gross

income by more than 25 percent of the amount stated in
                                - 2 -

petitioners’ return.1   The issue for decision is whether, under

those circumstances, petitioners omitted income, giving rise to

an extended 6-year period of limitations.    This issue has been

presented by petitioners’ motion for summary judgment under Rule

121 and respondent’s notice of objection, and supplemental briefs

from both parties.

                             Background

     For purposes of the pending motion, the following facts have

been assumed.   At the time they filed their petition, petitioners

resided in Illinois.    Mr. Beard was a majority shareholder in two

S corporations, MMCD, Inc. (MMCD), and MMSD, Inc. (MMSD).    Mr.

Beard had a 76-percent stock ownership interest in each entity.

     On August 24, 1999, petitioners entered into short sales

whereby they borrowed U.S. Treasury notes from a third party and

sold them for cash to another third party.    These sales generated

$12,160,000 in cash.

     On August 25, 1999, petitioners used this cash to buy more

Treasury notes in two transactions of $5,700,000 and $6,460,000.

On the same day petitioners transferred to MMCD and MMSD the

purchased Treasury notes of $5,700,000 and $6,460,000,

respectively, together with the short positions (the obligation



     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
                               - 3 -

following the short sale to replace the borrowed securities).     On

the same day MMCD and MMSD sold their Treasury notes and closed

the short positions on the Treasury notes for $7,500,000 and

$8,500,000, respectively.

     On August 29, 1999, Mr. Beard sold his entire interest in

MMCD and in MMSD to Unicom, an unrelated third-party purchaser,

for $6,574,939 and $7,638,211, respectively.

     On April 11, 2000, petitioners jointly filed their 1999

Federal income tax return.   On their Schedule D, Capital Gains

and Losses, petitioners claimed a cost basis of $6,161,351 in

MMCD and $7,638,463 in MMSD and net gains from the sales of the

shares of $413,588 and $992,748, respectively.   Petitioners also

reported gross proceeds from the sale of Treasury notes of

$12,125,340, a cost basis of $12,160,000, and a resulting net

loss of $34,660.   There is no indication on Schedule M-2,

Analysis of Accumulated Adjustments Account, Other Adjustments

Account, and Shareholders’ Undistributed Taxable Income

Previously Taxed, of the 1999 income tax return of either MMCD or

MMSD that the S corporations had assumed the liability to cover

the short position in Treasury notes.

     On April 13, 2006, respondent issued a notice of deficiency

reducing petitioners’ bases in the MMCD and MMSC stock by
                               - 4 -

$5,700,000 and $6,460,000, respectively.2   The result was a

$12,160,000 increase in the capital gain from the sale.

Respondent contends that the bases in the MMCD and MMSC stock

were inflated because they were not reduced by the liability to

close the short position.

     On July 11, 2006, petitioners filed a timely petition with

this Court.   On September 11, 2007, petitioners filed a motion

for summary judgment on the ground that the notice of deficiency

was issued after the period of limitations had expired.

Petitioners contend that overstatement of basis is not an

omission from gross income for purposes of the extended period of

limitations under section 6501(e)(1)(A).

     On February 19, 2008, respondent filed his notice of

objection to petitioners’ motion, agreeing that the material

facts necessary to determine whether petitioners actions

constitute an omission from gross income are not in dispute.

Respondent contends, however, that there is a genuine issue of

fact as to whether the notice of deficiency was timely issued

under section 6501(e).




     2
      Respondent also disallowed $155,858 of petitioners’
itemized deductions.
                                - 5 -

                              Discussion

     Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.     Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988).     The Court may grant

summary judgment when there is no genuine issue of material fact

and a decision may be rendered as a matter of law.    Rule 121(b);

Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd.

17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner, 90 T.C. 753,

754 (1988).   The moving party bears the burden of proving that

there is no genuine issue of material fact.     Dahlstrom v.

Commissioner, 85 T.C. 812, 821 (1985); Naftel v. Commissioner, 85

T.C. 527, 529 (1985).   The Court will view any factual material

and inferences in the light most favorable to the nonmoving

party.   Dahlstrom v. Commissioner, supra at 821; Naftel v.

Commissioner, supra at 529.

     Under the general rule set forth in section 6501(a), the

Internal Revenue Service is required to assess the tax (or send a

notice of deficiency) within 3 years after a Federal income tax

return is filed.   Section 6501(e)(1)(A) extends the limitations

period to 6 years “If the taxpayer omits from gross income an

amount properly includible therein which is in excess of 25

percent of the amount of gross income stated in the return”.

     Section 6501(e)(1)(A) was first enacted as section 275(c) of

the Revenue Act of 1934 (1934 Revenue Act), Ch. 277, 48 Stat.
                                   - 6 -

745.       See Badaracco v. Commissioner, 464 U.S. 386, 392 (1984).

In 1954 Congress made several changes to this provision.        See H.

Rept. 1337, 83d Cong., 2d Sess. A414 (1954); S. Rept. 1622, 83d

Cong., 2d Sess. 584-585 (1954).      Section 6501(e)(1)(A)(i)

provides an exception to the general definition of gross income,

stating that

       In the case of a trade or business, the term ‘gross
       income’ means the total of the amounts received or
       accrued from the sale of goods or services * * * prior
       to the diminution by the cost of such sales or
       services.

Also, section 6501(e)(1)(A)(ii) provides a “safe harbor” for a

taxpayer who otherwise has made a substantial omission, stating

that

       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.

       Respondent argues that the overstatement of basis in a

context outside of the sale of goods or services should constitute

an omission from gross income and thus trigger the 6-year

limitations period under section 6501(e)(1)(A).3


       3
      Respondent also argues, alternatively, that petitioners’
transfer of Treasury notes to the S corporations should be recast
as bona fide and that petitioners’ two S corporations omitted
income from their returns by failing to report the close of their
short positions. See sec. 1.1233-1(a)(1), Income Tax Regs. In a
short sale, the timing of gain or loss recognition remains open
                                                     (continued...)
                                - 7 -

     In Colony, Inc. v. Commissioner, 357 U.S. 28, 33, 37 (1958),

the Supreme Court, interpreting section 275(c) of the 1934 Revenue

Act, the predecessor of section 6501(e), held that the extended

period of limitations applies to situations where specific income

receipts have been “left out” in the computation of gross income

and not when an understatement of gross income resulted from an

overstatement of basis.   The facts of Colony dealt with a taxpayer

who developed and sold lots in a subdivision.   Id. at 30-31.

     In Bakersfield Energy Partners, LP v. Commissioner, 128 T.C.

207 (2007), affd. 568 F.3d 767 (9th Cir. 2009), a partnership

(Bakersfield) which owned oil and gas property used the Internal

Revenue Code’s partnership termination and transfer provisions to

increase its basis in that property before selling it to a third

party in 1998.4   The Commissioner issued a notice of final


     3
      (...continued)
until the seller closes the sale by replacing the borrowed
property. Hendricks v. Commissioner, 51 T.C. 235, 241 (1968),
affd. 423 F.2d 485 (4th Cir. 1970). Respondent contends that, if
petitioners’ bases in the S corporations were increased by their
transfer of Treasury notes to MMCD and MMSD, the S corporations
should have recognized gain of $12,160,000 when they closed the
short sale obligation. Respondent’s reasoning is flawed,
however, as his analysis does not take into account the transfer
of petitioners’ short sale obligation to MMCD and MMSD, which
lowered petitioners’ bases in both S corporations by the same
amount their bases were raised through the transfer of the
Treasury notes. See Rev. Rul. 95-45, 1995-1 C.B. 53.
Ultimately, respondent’s alternative argument results in the same
overstatement of basis issue present in the notice of deficiency.
     4
      Specifically, four of the seven partners in Bakersfield
took the following steps to increase Bakersfield’s zero basis in
                                                     (continued...)
                              - 8 -

partnership administrative adjustment (FPAA) almost 6 years after

Bakersfield filed its return for 1998, and Bakersfield contended

that the FPAA was untimely under Colony.     Because Bakersfield did

not omit any income receipt or accrual in its computation of gross

income, we held that the Supreme Court’s decision in Colony

applied and Bakersfield’s overstatement of basis did not trigger

the extended limitations period.     Bakersfield Energy Partners, LP

v. Commissioner, supra at 215-216.    As part of our holding, we

stated that neither “the language or the rationale of Colony, Inc.

can be limited to the sale of goods or services by a trade or

business.”   Id. at 215.

     Respondent contends that Bakersfield was wrongly decided and

that Colony should be limited to cases where the taxpayer is




     4
      (...continued)
its oil and gas property: (1) The four partners formed a new
partnership, Bakersfield Resources, L.L.C. (Resources); (2) the
four partners sold their partnership interests in Bakersfield to
Resources for $19,924,870. The four partners held a collective
majority stake in Bakersfield and thus caused a technical
termination of the Bakersfield partnership and the formation of a
new partnership in which Resources held a majority interest under
sec. 708(b)(1)(B); (3) the new Bakersfield partnership elected to
increase its basis in partnership assets by the $19,924,870 sale
price of the partnership interests sold to Resources following
the transfer of partnership interest pursuant to secs. 754 and
743. Bakersfield allocated $16,515,194 of its new $19,924,870
basis to its oil and gas property and the rest to its other
assets; (4) Bakersfield sold its oil and gas property to a third
party for $23,898,611.
                              - 9 -

involved in the sale of goods and services.5   First, respondent

argues that Colony’s interpretation of section 275(c) of the 1934

Revenue Act is not binding because its successor statute, section

6501(e)(1)(A), is materially different (the materiality argument).

Second, respondent argues that Colony interpreted section 275(c)

of the 1934 Revenue Act as having the same meaning as section

6501(e)(1)(A)(i) and thus Colony should apply only to taxpayers

who realize gross receipts from sales or services in the course of

a trade or business (the interpretation argument).

     The Commissioner raised these same arguments with regard to

Bakersfield in the Court of Appeals for the Ninth Circuit.

Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d at 775.

Addressing the materiality argument, the Court of Appeals for the

Ninth Circuit noted that Congress did not change the language in

the body of section 6501(e)(1)(A), which is identical to the


     5
      Several cases have questioned the continuing viability of
Colony, Inc. v. Commissioner, 357 U.S. 28 (1958) in the light of
the 1954 amendments to sec. 6501(e)(1)(A). For example, in CC &
F W. Operations Ltd. Pship. v. Commissioner, 273 F.3d 402, 406
n.2 (1st Cir. 2001), affg. T.C. Memo. 2000-286, the Court of
Appeals for the First Circuit stated that “Whether Colony’s main
holding carries over to section 6501(e)(1) is at least doubtful”,
suggesting that the Supreme Court’s gross income test applies
only to sales of goods and services covered by sec.
6501(e)(1)(A), but not to other types of income. That position,
however, was not adopted by other Courts of Appeals. Most
recently, the Court of Appeals for the Federal Circuit determined
that there was no “basis for limiting Colony’s holding concerning
the ‘omits from gross income’ language of I.R.C. § 275(c) to
sales of goods or services by a trade or business.” Salman Ranch
Ltd v. United States, __ F.3d __ (Fed. Cir., July 30, 2009) (slip
op. at 20).
                              - 10 -

language in section 275(c) of the 1934 Revenue Act that the

Supreme Court construed in Colony.6    Id. at 775-776.    Addressing

the interpretation argument, the Court of Appeals noted that the

Supreme Court expressly avoided construing the 1954 Code and “did

not even hint” that its interpretation of section 275(c) of the

1934 Revenue Act was limited to cases in which the taxpayer was

engaged in a trade or business.   Id. at 778.

     We believe that it would be inappropriate to “distinguish and

diminish the Supreme Court’s holding in Colony”.     Bakersfield

Energy Partners, LP v. Commissioner, 128 T.C. at 215.       The

principles of Colony apply where a taxpayer overstates his basis.

In both Colony and Bakersfield the taxpayers artificially inflated

their bases in assets that were subsequently sold.       Although

Colony dealt with the sale of land and Bakersfield with the sale


     6
      The Court of Appeals for the Ninth Circuit also dismissed
the Commissioner’s sub-argument that applying Colony to the 1954
Code would render sec. 6501(e)(1)(A)(i) superfluous:

     Section 6501(e)(1)(A) requires a comparison of two
     numbers: (1) the “gross income” omitted with (2) the
     “gross income” stated in the return. If the first
     number divided by the second number is greater than
     25%, then the 6-year limitations period applies.
     Because § 6501(e)(1)(A)(i) changes the definition of
     “gross income” for taxpayers in a trade or business, it
     potentially affects both the numerator (the omission
     from gross income) and the denominator (the total gross
     income stated in the return). Colony’s holding,
     however, affects only the numerator, by defining what
     constitutes an omission from gross income.

Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d 767,
776 (9th Cir. 2009), affg. 128 T.C. 207 (2007).
                                 - 11 -

of oil and gas property, in neither case did the taxpayer fail to

report gross income on a return for purposes of the extended

limitations period.

     We assume that petitioners overstated the bases of their S

corporations on their 1999 return.    Under Colony and Bakersfield,

petitioners did not omit income from their return such as would

subject them to the extended period of limitations.   Accordingly,

petitioners’ motion for summary judgment will be granted.

     In reaching these holdings, the Court has considered all

arguments made and, to the extent not mentioned, concludes that

they are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                          An appropriate order and

                                     decision will be entered.
