Overstated S corporation costs did not create omitted gross income

Plain-English summary

Chief Counsel considered whether an S corporation shareholder triggered the six-year assessment period by overstating cost of goods sold and the resulting loss. For section 6501(e), the relevant omitted income from a trade or business is omitted gross receipts, not an understatement of ordinary business income caused by overstated costs. The shareholder had reported 100 percent of the shareholder’s share of the S corporation’s gross receipts. Chief Counsel therefore concluded that there was no omission from gross income for purposes of the extended limitations period, even though the return overstated the S corporation loss.

Ruling snapshot

• Question: Whether overstated cost of goods sold and an overstated S corporation loss caused a substantial omission from gross income
• Outcome: No; all relevant gross receipts were reported
• Key authorities: I.R.C. § 6501(e); Treas. Reg. § 1.1366-1(c)(2); United States v. Home Concrete & Supply, LLC; The Colony, Inc. v. Commissioner

Full text (IRS public release)

ID:        CCA_2015020609494546
UILC:      6501.07-00, 6501.07-13, 6501.04-
           14
Number: 201543015
Release Date: 10/23/2015
From:
Sent: Friday, February 06, 2015 9:49:45 AM
To:
Cc:
Bcc:
Subject: RE: Question involving 6 year statute: I.R.C. § 6501(e)(1) and Treas. Reg. § 1.1366-1(c)(2).


-------,

Regarding your first question, the overstated COGS on the Form 1120S does not result in
“unreported flow-through income,” because the amount of pass-through entity income
that constitutes “omitted income” for the purpose of § 6501(e)(1)(A) is the amount of
gross receipts omitted on Form 1120S, rather than the understatement of ordinary
business income (overstatement of loss) on line 21. See § 6501(e)(1)(B)(ii); see also,
e.g., United States v. Home Concrete & Supply, LLC, 132 S. Ct. 1836 (2012); The
Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).

Regarding your second question, “a shareholder’s gross income includes the
shareholder’s pro rata share of S corporation gross income (as described in section
6501(e)(1)(A)(i)).” Treas. Reg. § 1.1366-1(c)(2)(i) (T.D. 8852, Dec. 21, 1999). When
Treasury Regulation § 1.1366-1 was published in 1999, § 6501(e)(1)(A)(i) read: “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 diminution by the cost of such sales or services . . . .” “The
amount of S corporation gross income used in deriving the shareholder's pro rata share of
any item of S corporation income, loss, deduction, or credit (as included or disclosed in
the shareholder's return) is considered as an amount of gross income stated in the
shareholder's return for purposes of section 6501(e).” Treas. Reg. § 1.1366-1(c)(2)(i)
(emphasis added).

Because the overstated COGS on the Form 1120S is not “omitted income,” the
calculation of the amount omitted on the Form 1040 per Treasury Regulation § 1.1366-
1(c)(2)(ii) is as follows when using your estimated numbers:

S-Corporation Gross Receipts: $----------(reported as $----------on Form 1120S)

                                                         2

Taxpayer’s required amount to report as 100% shareholder: -$--------(-$---------+ $-------)
      (presuming the $-------underreported as the S-Corp gross receipts translated
      directly to a $-------difference in ordinary business income, which may not have
      been the case)
Reported Share of S-Corporation Gross Receipts: If the share of gross receipts is
      multiplied directly by gross income, as the example in § 1.1366-1(c)(2)(ii) might
      otherwise indicate, the result where a shareholder, as here, overstates the loss
      from an S-Corp would be an overstatement of income. Because such result would
      be nonsense that could effectively negate the effect of other income omitted on the
      Form 1040, I construe “the amount of S corporation gross income used” to be a
      maximum of 100% of the shareholder’s pro-rata share of S-Corp’s gross receipts,
      with any additional loss claimed being unrelated to the S corporation gross
      income. Thus, rather than using a ratio of 105.94% (-$--------/ -$--------), which
      would result in an amount of $----------(105.94% * -----------) being stated in the
      shareholder’s return, I merely use 100% * $---------.
Taxpayer’s reported Gross Income from S-Corp: $---------

Taxpayer’s total gross income, as you calculated, is $----------($----------+ ---------+ $------
------------). But there is no omission from gross income for the purpose of § 6501(e)—
100% was reported.

Please let me know if you have any questions or wish to discuss further.

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