In the
United States Court of Appeals
For the Seventh Circuit
No. 09-3741
K ENNETH H. B EARD and S USAN W. B EARD ,
Petitioners-Appellees,
v.
C OMMISSIONER OF INTERNAL R EVENUE,
Respondent-Appellant.
Appeal from
the United States Tax Court.
No. 13372-06
A RGUED S EPTEMBER 27, 2010—D ECIDED JANUARY 26, 2011
Before R OVNER, E VANS, and W ILLIAMS, Circuit Judges.
E VANS, Circuit Judge. This case presents the seemingly
simple question of whether an overstatement of basis
in ownership interests is an omission of income under
the Internal Revenue Code Section 6501(e)1 , thereby
triggering a six-year, rather than the standard three-year,
1
Unless otherwise noted, all citations to the Internal Revenue
Code are to the 1954 Code.
2 No. 09-3741
statute of limitations. But things are not always as they
appear—the answer to the seemingly simple question
requires a rather lengthy discussion of a case decided
more than a half-century ago, in 1958, the year Elvis
Presley was inducted into the army.
At issue here is a variant on a Son-of-BOSS (Bond
and Option Sales Strategy) transaction, a type of abusive
(so says the government) tax shelter that was popular a
few years back. On the other side of this dispute,
Kenneth and Susan Beard give the transaction a much
more benign handle calling it simply “a tax advantaged
transaction.” We think the government’s characteriza-
tion is closer to the mark.
In a Son-of-BOSS transaction, an individual uses a
short sale mechanism to artificially increase his basis in a
partnership interest prior to selling the interest, thereby
limiting his capital gains tax on the sale. A short sale is
a “sale in which an investor sells borrowed securities in
anticipation of a price decline and is required to return
an equal number of shares at some point in the future.”
http://www.investopedia.com/terms/s/shortsale.asp (last
visited Jan. 5, 2011). As such, a short sale produces
proceeds from the sale of the shares as well as an out-
standing liability in the amount of the number of bor-
rowed shares multiplied by the current price per share.
This liability disappears when the short is closed out,
and the hope of the usual short seller is that between
the time he borrows the shares and the time he closes
out the short, the price per share will have dropped so
that he makes more selling the borrowed shares up front
No. 09-3741 3
than he spends later to replace them. The tax gain or
loss recognition in a short sale is delayed until the seller
closes the sale by replacing the borrowed property.
Hendricks v. Commissioner of Internal Revenue, 51 T.C. 235,
241 (1968), aff’d 423 F.2d 485 (4th Cir. 1970).
Short selling is often a way to hedge against the
market, but a Son-of-BOSS transaction relies on the
delayed tax recognition of a short sale for a gamble of a
different kind. In Son-of-BOSS, the taxpayer contributes
the proceeds of the short and the corresponding obliga-
tion to close out the short to another legal entity in
which he has ownership rights (usually a partnership).
The taxpayer (or, perhaps more accurately, the tax-
avoider) then sells his rights in the partnership, claiming
an inflated outside basis in the partnership corre-
sponding to the amount of the transferred proceeds
without an offsetting basis reduction for the trans-
ferred liability. This is advantageous for the taxpayer
because the capital gains tax on such a transaction is
calculated by subtracting the outside basis from the
amount recognized in the sale of the ownership rights,
so a higher outside basis means lower capital gains tax
and more money in the pocket of the taxpayer. Therefore,
the gamble in the Son-of-BOSS transactions was that
the participant could legally increase his outside basis in
a partnership by not reporting the offsetting trans-
ferred contingent liability of the short position on his
tax return.
In 2000, the IRS issued Notice 2000-444, effectively
invalidating future Son-of-BOSS transactions, and courts
4 No. 09-3741
began to invalidate these transactions as lacking
economic substance. Bernard J. Audet, Jr., One Case to Rule
Them All: The Ninth Circuit in Bakersfield Applies Colony
to Deny the IRS An Extended Statute of Limitations in Over-
statement of Basis Cases, 55 Villanova Law Review 409, 411-
12 (2010). In 2004, the IRS offered a settlement initiative
to approximately 1,200 identified taxpayers, but that left
a large number of taxpayers who did not qualify or
who had not yet been identified as taking part in a Son-of-
BOSS transaction. Id. at 412.
With this in mind, we turn to the facts of this case. In
1999, Kenneth Beard participated in a short sale of U.S.
Treasury Notes, recognizing cash proceeds of $12,160,000.
Beard used these proceeds to buy more Treasury Notes
in two transactions of $5,700,000 and $6,460,000. He then
transferred these Treasury Notes to two companies in
which he was majority owner, MMCD, Inc. and MMSD,
Inc., respectively, along with the obligation to close out
the short positions. On that same day, MMCD and
MMSD sold these Treasury Notes and closed out the
short positions for $7,500,000 and $8,500,000, respec-
tively. Beard then sold his ownership interests in the
two companies.
On their 1999 tax return, the Beards reported long-
term capital gains of $413,588 and $992,748 from the sale
of the MMCD and MMSD stock, respectively. They
arrived at these numbers by subtracting bases of
$6,161,351 and $6,645,463 from the sale prices of
$6,574,939 and $7,638,211. The Beards also reported gross
proceeds from the sale of Treasury Notes of $12,125,340,
No. 09-3741 5
a cost basis of $12,160,000, and a resulting net loss of
$34,660. The high bases in MMCD’s and MMSD’s
stock resulted from the asymmetric treatment of the
short sale transactions—Beard had increased his outside
bases in the companies by the amount of the short sale
proceeds contributed to each company, but had not
reduced the bases by the offsetting obligation to close
the short positions. The 1999 tax returns of MMCD and
MMSD did not indicate that these S-corporations had
assumed the liability to cover the short positions.
In 2006, almost six years after the Beards filed their
1999 tax return, the IRS issued a notice of deficiency,
reducing the Beards’ bases in the MMCD and MMSD stock
by the amount of the transferred Treasury Notes, and
thereby increasing the Beards’ taxable capital gains on
the sales of the companies by $12,160,000. The Beards
contested this deficiency in tax court, and, rather than
disputing the facts, moved for summary judgment
on the grounds that overstatement of basis is not an
omission from gross income for the purpose of the ex-
tended six-year statute of limitations under Section
6501(e) of the Code, and so the IRS was out of luck as
the notice of deficiency came too late. The tax court
agreed and granted summary judgment, finding that
the principles of Colony, Inc. v. Commissioner of Internal
Revenue, 357 U.S. 28 (1958), applied in this case. The
Commissioner of the Internal Revenue Service appeals.
We review the tax court’s decision de novo. See Bell
Federal Savings & Loan Ass’n v. Commissioner of Internal
Revenue, 40 F.3d 224, 226 (7th Cir. 1994).
6 No. 09-3741
Although decided after the 1954 revisions, Colony
(which was decided in 1958) interprets Section 275(c) of
the 1939 Code, the predecessor to current Section
6501(e)(1)(A). Section 275(c) allowed for a five-year
statute of limitations for tax assessment, rather than
the normal three-year limit, in cases where “the tax-
payer omits from gross income an amount properly
includible therein which is in excess of 25 per centum
of the amount of gross income stated in the return.”
Essentially the same language is found in current
Section 6501(e)(1)(A), although the extended statute of
limitations is now six years, rather than five.
The taxpayer in Colony was a real estate company
which understated its business income from selling
residential lots by erroneously including unallowable
items of development expense in the calculation of the
lots’ bases. Colony, 357 U.S. at 30. In finding that the
overstatement of basis was not an omission from gross
income that triggered the longer statute of limitations,
the Court noted that although “it cannot be said that
the [statutory] language is unambiguous,” the legislative
history of Section 275(c) provides “persuasive evidence
that Congress was addressing itself to the specific situ-
ation where a taxpayer actually omitted some income
receipt or accrual in his computation of gross income,
and not more generally to errors in that computation
arising from other causes.” Id. at 33.
After reviewing the legislative history, the Court be-
lieved that Congress’ purpose was to provide extra time
to investigate tax returns in cases where “because of a
No. 09-3741 7
taxpayer’s omission to report some taxable item, the
Commissioner is at a special disadvantage in detecting
errors. In such instances the return on its face provides
no clue to the existence of the omitted item.” Id. at 36.
Finally, the Court concluded that “the conclusion we
reach is in harmony with the unambiguous language of
§ 6501(e)(1)(A) of the Internal Revenue Code of 1954.” Id.
at 37. The question facing us then is: Was the tax court
correct to apply the principles of Colony to this dispute
involving the 1954 Code?
The question has been addressed by multiple federal
courts, with differing results. Some have found that
Colony does not apply and an overstatement of basis can
be an omission from gross income. See, e.g., Phinney v.
Chambers, 392 F.2d 680 (5th Cir. 1968); Home Concrete &
Supply, LLC v. United States, 599 F. Supp. 2d 678 (E.D. N.C.
2008), appeal docketed, No. 09-2353 (4th Cir. Dec. 9, 2009);
Burks v. United States, 2009 WL 2600358 (N.D. Tex. June 13,
2008), appeal docketed, No. 09-11061 (5th Cir. Oct. 26, 2009);
Brandon Ridge Partners v. United States, 100 A.F.T.R. 2d
2007-5347, 2007 WL 2209129 (M.D. Fla. Jul. 30, 2007).
Others have found that Colony does apply and an over-
statement of basis is not an omission of gross income.
See, e.g., Salman Ranch Ltd. v. United States, 573 F.3d 1362
(Fed. Cir. 2009); Bakersfield Energy Partners LP v. Commis-
sioner of Internal Revenue, 568 F.3d 767 (9th Cir. 2009);
Grapevine Imports, Ltd. v. United States, 77 Fed. Cl. 505
(2007), appeal docketed, No. 2008-5090 (Fed. Cir. June 27,
2008). Although it is clearly a contentious issue and a
close call, the plain meaning of the Code and a close
reading of Colony lead us to the conclusion that, given
8 No. 09-3741
the changes to Section 6501(e)(1)(A), Colony does not
control here and an overstatement of basis can be
treated as an omission from gross income under the
1954 Code.
Although, as we have mentioned, the language of
Section 275(c) is essentially duplicated in Section
6501(e)(1)(A), the new section also has two additional
subsections. They read:
(i) 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 (if such
amounts are required to be shown on the return)
prior to the diminution by the cost of such sales or
services;
and
(ii) 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.
Therefore, it appears that subsection (i) addresses the
situation faced by the Court in Colony where there is an
omission of an actual receipt or accrual in a trade or
business situation, while subsection (ii) provides a safe-
harbor for improperly completed returns where the
return on its face still provides a “clue” to the omitted
amount. Could the Court have been referring to this
No. 09-3741 9
synchronicity with subsections (i) and (ii) when it con-
cluded that its interpretation of legislative history gave
the “ambiguous” Section 275(c) a meaning harmonious
with that of “unambiguous” Section 6501(e)(1)(A)?
The Salman Ranch majority says no, stating, “We are
not prepared to conclude—based simply upon the
Court’s reference to ambiguity in § 275(c) and the
lack thereof in § 6501(e)(1)(A)—that the Court’s facially
unqualified holding nevertheless carries with it a quali-
fication.” Salman Ranch, 573 F.3d at 1373. We disagree.
We think the dissent said it better:
My colleagues on this panel hold that Colony requires
that an erroneous overstatement of basis can never
serve to extend the period of limitations. That is an
unwarranted enlargement of the holding in Colony. In
Colony the taxpayer reported its gross receipts as a
developer and seller of real property . . . .
Id. at 1380 (Newman, J., dissenting). In other words,
Colony’s holding is inherently qualified by the facts of the
case before the Court, facts which differ from our case,
where the Beards’ omission was not in the course of
trade or business.
The Salman Ranch dissent then suggests, as do we, and as
did the Fifth Circuit in Phinney, that subsection (ii) is on
all fours with Colony’s suggestion that Congress’ intention
in enacting the longer time period was to give the IRS
a fighting chance in situations where the taxpayer’s
return doesn’t provide a clue to the omission. Id.;
Phinney, 392 F.2d at 685. Said the Phinney court:
10 No. 09-3741
[w]e conclude that the enactment of subsection (ii) as
part of section 6501(e)(1)(A) makes it apparent that
the six year statute is intended to apply where there
is either a complete omission of an item of income of
the requisite amount or misstating of the nature
of an item of income which places the “commis-
sioner . . . at a special disadvantage in detecting
errors.”
392 F.2d at 685 (quoting Colony, 357 U.S. at 36). We believe
that distinguishing Colony as the Phinney court did
does not “[overread] Colony’s brief references to
Section 6501(e)(1)(A),” but rather that the facts of Colony
and the changes from the 1939 to the 1954 Code must
distinguish our case from Colony; “a fair reading of Col-
ony,” suggests that the Court was aware of as much.
Bakersfield, 568 F.3d at 778. Therefore, we take the view
that Colony is not controlling here.
We are now left without precedential authority and
must return to the text of Section 6501(e)(1)(A) to deter-
mine whether the three-year or six-year limit should
apply to the Beards’ case.
Congress did not change the language in the body of
§ 6501(e)(1)(A), which is identical to the language in
§ 275(c) that the Supreme Court construed in Col-
ony. As a general rule, we construe words in a new
statute that are identical to words in a prior statute
as having the same meaning. We therefore interpret
§ 6501(e)(1)(A) in light of Colony.
Bakersfield, 568 F.3d at 775-76 (internal citations omitted).
However, in so interpreting, we must bear in mind that
No. 09-3741 11
Congress did add subsections (i) and (ii) to Section
6501(e)(1)(A) and that the section as a whole should
be read as a gestalt.
Although Colony found the language of Section 275(c)
to be ambiguous, the Court did feel that “the statute on
its face lends itself more plausibly to the taxpayer’s in-
terpretation.” Colony, 357 U.S. at 33. The Court considered
the Commissioner’s argument that use of the word
“amount” rather than, for example, “item,” suggests a
concentration on a quantitative aspect of the error, an
argument which it believed was bolstered if one
“touches lightly on the word ‘omits’ and bears down
hard on the words ‘gross income.’ ” Id. at 32. However,
the Court found more persuasive the taxpayer’s argu-
ment that the use of the word “omits,” (defined as “to
leave out or unmentioned; not to insert, include, or
name”), rather than “reduces” or “understates” suggests
a limitation of the statute only to situations in which
specific receipts or accruals of income items are left out.
Id. at 32-33.
One key phrase in the statutory language which
Colony does not address in depth is “gross income” which
is defined generally in Section 61 of the Code as “all
income from whatever source derived.” 2 There is no
general definition of gross income found in Section
6501(e)(1)(A), however subsection (i) does provide a
special definition of gross income in a trade or business
2
Section 61(a)(3) specifically includes “[g]ains derived from
dealings in property” in gross income.
12 No. 09-3741
setting. Therefore, for situations not involving trade or
business, we think it makes logical sense to use the
Code’s general gross income definition when reading
Section 6501(e)(1)(A).
Using these definitions and applying standard rules
of statutory construction to give equal weight to
each term and avoid rendering parts of the language
superfluous, we find that a plain reading of Section
6501(e)(1)(A) would include an inflation of basis as an
omission of gross income in non-trade or business situa-
tions. See Regions Hospital v. Shalala, 522 U.S. 448, 467
(1997); Hawkins v. United States, 469 F.3d 993, 1000 (Fed. Cir.
2006). It seems to us that an improper inflation of basis
is definitively a “leav[ing] out” from “any income from
whatever source derived” of a quantitative “amount”
properly includible. There is an amount—the difference
between the inflated and actual basis—which has been
left unmentioned on the face of the tax return as a candi-
date for inclusion in gross income.
Further support for this reading comes from the addi-
tion of subparagraph (i). If the omissions from gross
income contemplated by Section 6501(e)(1)(A) were only
specific items such as receipts and accruals, then the
special definition in subsection (i) would be, if not super-
fluous, certainly diminished. The addition of this sub-
section suggests that the definition of gross income for
the purposes of Section 6501(e)(1)(A) is meant to encom-
pass more than the types of specific items contemplated
by the Colony holding.
The Ninth Circuit in Bakersfield disagrees, saying that
the addition of subparagraph (i) does not necessarily cast
No. 09-3741 13
the language in the body of Section 6501(e)(1)(A) in a
different light, but rather that “we can equally infer that
Congress in 1954 intended to clarify, rather than rewrite,
the existing law.” Bakersfield, 568 F.3d at 776. The
Ninth Circuit goes on to say:
In enacting the 1954 Code, Congress was presumably
aware of the dispute over the interpretation of § 275(c),
and it could have expressly added a definition of
“omits” if it wanted to overrule the cases that con-
cluded, as the Supreme Court later did in Colony, that
“omits” did not include an overstatement of basis. . . .
Clarifying that an overstatement of basis is not an
omission from gross income in the case of a trade or
business does not establish that Congress also in-
tended to alter the general judicial construction of
“omits” in all other contexts. Nor has the IRS
pointed to any legislative history evincing an intent
to alter the law outside the context of a trade or busi-
ness.
Id.
We agree with our colleagues to the west that
the additions to the 1954 Code could indeed be seen as
clarifications, rather than a rewriting. However, we
must quickly part ways, as we don’t believe a full
rewriting was necessary in order to cast the language of
Section 6501(e)(1)(A) in a different light, nor do we
believe that Congress needed to redefine “omits” in
order to clarify the existing law. We think it is important
to remember that the revisions to the 1954 Code predate
the decision in Colony, and so the law at the time was the
14 No. 09-3741
1939 Code and any precedential decisions within the
circuits. This means that Congress, when revising the
Code, was responding not to a unifying decision such as
Colony, but rather to the confusion throughout the cir-
cuits. We do not find it hard to believe that Congress
added subsections (i) and (ii) to Section 6501(e)(1)(A) with
the belief that this would clarify a plain reading of the
statute and quell the confusion. Indeed, as we explain
above, we think the additions did just that.
The same simplicity of statutory construction can be
applied to the arguments made in Bakersfield and Salman
Ranch, refuting the superfluity of subsection (i) in the
face of those courts’ reading of Section 6501(e)(1)(A). This
argument, simply put, is that the trade or business defini-
tion contained in subsection (i) was not included to
clarify what counts as an omission, but rather to clarify
the calculation of whether an omission exceeded 25%
of gross income. Salman Ranch, 573 F.3d at 1375 (quoting
Bakersfield, 568 F.3d at 776). The Federal Circuit arrives
at this conclusion via a deep-dive into legislative
history, while the Ninth Circuit wades through a convo-
luted discussion of numerators and denominators to
reach the same place. Id.; Bakersfield, 568 F.3d at 776-77.
While we are great fans of underwater archaeology,
we don’t believe our wetsuits are needed at this time. To
us, the clear, dry line from the language to the plain
meaning of Section 6501(e)(1)(A) is preferable. To say
that subsection (i) was included simply to clarify the
25% calculation diminishes the plain meaning of the
statute. Certainly, we should be mindful of the applica-
No. 09-3741 15
bility of subsection (i) when calculating the 25%, and we
should be equally mindful of this subsection and its
interplay with the rest of Section 6501(e)(1)(A) and the
entirety of the Code when determining what counts as
an omission from gross income. Reading Section
6501(e)(1)(A) as a gestalt, the meaning is clear, and an
inflation of basis should be considered an omission
from gross income such that it triggers the extended six-
year statute of limitations.
Much ink has been spilled in the briefs over whether
temporary Treasury Regulation Section 301.6501(e)-
1T(a)(1)(iii) would be entitled to Chevron deference if
Colony were found to be controlling. This temporary
regulation, which was issued without notice and com-
ment at the same time as an identical proposed regula-
tion, purports to offer taxpayers guidance by resolving
an open question and stating definitively that in the
case of a disposition of property, an overstatement of
basis can lead to an omission from gross income. This
temporary regulation has since been replaced by a nearly
identical final regulation, issued after a notice and com-
ment period. T.D. 9511 (eff. Dec. 14, 2010), 75 Fed. Reg.
78,897. Because we find that Colony is not controlling, we
need not reach this issue. However, we would have
been inclined to grant the temporary regulation Chevron
deference, just as we would be inclined to grant such
deference to T.D. 9511. We have previously given defer-
ence to interpretive Treasury regulations issued with
notice-and-comment procedures, see Kikalos v. Commissioner
of Internal Revenue, 190 F.3d 791, 795 (7th Cir. 1999); Bankers
Life and Casualty Co. v. United States, 142 F.3d 973, 979-84
16 No. 09-3741
(7th Cir. 1998), and the Supreme Court has stated that
the absence of notice-and-comment procedures is not
dispositive to the finding of Chevron deference. Barnhart
v. Walton, 535 U.S. 212, 222 (2002).
For the foregoing reasons, the grant of summary judg-
ment by the tax court is R EVERSED.
1-26-11