Tax Law Updates | New Judicial Opinions

April 10, 2009

Ninth Circuit Applies Six-Year Statute of Limitations on Failure to Declare Constructive Dividends

Benson v. Commissioner of Internal Revenue
No. 07-72272, U.S. Court of Appeals for the Ninth Circuit, 3/31/2009

Ninth Circuit Applies Six-Year Statute of Limitations on Failure to Declare Constructive Dividends

Holding:

The U.S. Court of Appeals for the Ninth Circuit upheld the Commissioner of Internal Revenue’s notice of deficiency against spouses Burton and Elizabeth Benson even though the Commissioner's assessment was made more than the three-year statutory limit. Burton owned Energy Research and Generation (“ERG”) and a controlling interest in New Process industries (“NPI”). In certain years, the Bensons acquired millions of dollars funneled from ERG to NPI, and did not declare such constructive dividends in their tax returns. The Commissioner issued notices of deficiency more than three years but less than six years after the returns were filed. The Tax Court affirmed the Commissioner’s actions, stating that because the income “omitted” was more than 25 percent of the Bensons’ reported gross income for each relevant year, the six-year statute of limitations under 26 U.S.C. § 6501(e), and not the ordinary three-year period under § 6501(a), should apply. On appeal, the Ninth Circuit sustained the Tax Court’s determination. According to the Ninth Circuit, the Bensons’ failure to report the dividends in their tax returns did not result from an overstatement of basis or other technical miscalculation, nor were the amounts accounted for elsewhere in the returns. Rather, the Ninth Circuit held, Bensons did not include these amounts in their returns at all. Thus, under Supreme Court precedents, the Bensons “omitted” gross income, and the extended six-year limitation should apply.

Detailed Summary:

Burton and Elizabeth Benson, husband and wife, filed joint tax returns between September 1994 and December 1995 for the years 1989, 1990, 1993, and 1994. Burton was the 100 percent owner of ERG. ERG, a subchapter C corporation, filed its own tax returns and paid its own taxes. Burton Benson also owned a controlling interest in NPI.  NPI was a subchapter S corporation, or a pass through entity, and therefore filed information returns.

The Tax Court found that there were transactions that functioned only to funnel money from ERG to NPI. Benson then used NPI’s bank account funds for the “sole and exclusive benefit of himself and his family.” Opinion, pp. 3874-75, citing Benson v. Comm’r, 88 T.C.M. (CCH) 520 (2004).  The Ninth Circuit, upholding the Tax Court’s determination, found that ERG’s payments to NPI were constructive dividends to the Bensons because there was no expectation of reimbursement. Id., citing Inland Asphalt Co. v. Comm’r, 756 F.2d 1425, 1429 (9th Cir. 1985).  The Bensons did not declare these payments in their tax returns.

As a result of these deficiencies, the IRS opened investigations of the Bensons’ 1993 return in August 1995, and their other returns in March 1997. In September 2000, more than three but fewer than six years after the returns were received, the Commissioner issued the Bensons notices of alleged fraud and deficiency for tax years 1989, 1990, and 1993. About a year later, the Commissioner issued a notice of deficiency for tax year 1994.

The Bensons challenged the Commissioner’s determinations in the Tax Court. The Tax Court found no evidence of fraud, but mostly upheld the Commissioner’s substantive deficiency determinations.

The Bensons filed a motion for reconsideration on the grounds that the Commissioner’s assessment was time-barred by 26 U.S.C. § 6501(a)’s customary three-year statute of limitations.

In response, the Tax Court issued a supplemental opinion. It held that, because the income “omitted” was more than 25 percent of the Bensons’ reported gross income for each relevant year, the six-year statute of limitations applied under § 6501(e).

In this appeal, the Ninth Circuit had the occasion to apply Section 6501(a).  This law requires the IRS, after a return is filed, to assess taxes within three years. 26 U.S.C. § 6501(a). However, if the return omits gross income totaling more than 25 percent of the amount stated in the return, § 6501(e) extends the statute of limitations to six years. 26 U.S.C. § 6501(e)(1)(A). The three-year limit under § 6501(a) would bar assessment of deficient taxes for the Bensons’ 1989, 1990, 1993, and 1994 returns. The six-year limit under § 6501(e) would not.

The question is therefore whether the IRS is entitled to the six-year limit for those returns.

On appeal, the Bensons’ do not dispute that for each of these years, their return did not properly account for income in excess of 25 percent of the income stated on the return. Nor do they dispute the Tax Court’s computations or figures.

Instead, the Bensons contend that their tax position was not an “omission” of gross income under the statute, but a “recharacterization” of the amounts in question.

In reporting their gross income, the Bensons left out the ERG disbursements and NPI transfers that were later held to be constructive dividends. The Bensons’ failure to report the dividends in their tax returns did not result from an overstatement of basis or other technical miscalculation, nor were the amounts accounted for elsewhere in the returns.

Rather, the Ninth Circuit held, Bensons did not include these amounts in their returns at all.

Thus, under the Supreme Court’s definition in Colony, Inc. v. Comm’r, 357 U.S. 28, 36-38 (1958), the Bensons “omitted” gross income, and the extended limitations period applies.

According to the Ninth Circuit, the cases of Slaff v. Comm’r, 220 F.2d 65 (9th Cir. 1955)  and Lawrence v. Comm’r, 258 F.2d 562 (9th Cir. 1958) indicate that the extended limitations period does not apply where a taxpayer made an error in his or her computation of gross income, yet fully disclosed the amounts underlying the error elsewhere in the tax return. These cases do not preclude application of the extended limitations period here. Unlike the taxpayers in Slaff and Lawrence, the Bensons did not disclose any of the amounts underlying their error.

On the basis of the foregoing, the Ninth Circuit affirmed the Tax Court’s decision.

View a PDF of the judicial opinion

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