Rev. Rul. 74-61

Advice has been requested whether, for purposes of determining average base period income in connection with income averaging, taxable income for a base period year, that is barred by the statute of limitations for assessment and refund of tax, must be adjusted (where necessary) to arrive at the correct taxable income for such year.

Sections 1301 through 1305 of the Internal Revenue Code of 1954 provide general income averaging provisions for individuals whose income fluctuates widely from year to year or increases rapidly over a short period. These provisions permit a part of the unusually large amount of taxable income received in a taxable year to be taxed at lower rates of Federal income tax.

Section 1301 of the Code provides that if an eligible individual has averageable income for the computation year, and if the amount of such income exceeds $3,000, then the tax imposed by section 1 for the computation year which is attributable to averageable income shall be five times the increase in tax under section 1 which would result from adding 20 percent of such income to 120 percent of average base period income.

Section 1302(a) of the Code provides that "averageable income" means the amount by which taxable income for the computation year (reduced as provided therein) exceeds 120 percent of average base period income.

Section 1302(b) of the Code provides, in part, that the term "average base period income" means one-fourth of the sum of the base period incomes for the base period, and that "base period income" for any taxable year is the taxable income for such year adjusted as provided therein.

Section 1302(c) of the Code defines the term "computation year" to mean the taxable year for which the taxpayer chooses the benefits of income averaging and the term "base period" to mean the four taxable years immediately preceding the computation year.

Sections 1301 through 1305 of the Code and the regulations promulgated thereunder do not preclude adjustments in taxable income reported in a base period year in applying those provisions of law even though the assessment of a deficiency in, or allowance of a credit or refund of, Federal income tax is barred by the statute of limitations for the base period year.

In a recent decision involving the computation of averageable income under the income averaging provisions, the United States Tax Court held that a taxpayer is required to use the correct taxable income for each base period year "whether or not the assessment of a deficiency or the refund of an overpayment for such base period year is barred by the statute of limitations." Robert W. Unser, 59 T.C. 528, 530-531 (1973).

The court in the Unser case relied on ABKCO Industries, Inc., 56 T.C. 1083 (1971), which followed a series of court decisions and Revenue Rulings in holding that it was proper to recompute taxable income for a year barred by the statute of limitations to arrive at the correct amount thereof for purposes of determining, under section 172 of the Code, the amount of the net operating loss carryback or carryover to another taxable year. See Phoenix Coal Company v. Commissioner, 231 F. 2d 420 (2nd Cir. 1956); State Farming Company, 40 T.C. 774 (1963); and Rev. Rul. 56-285, 1956-1 C.B. 134.

Compare Commissioner v. Disston, 325 U.S. 442 (1945), 1945 C.B. 426, in which the Supreme Court of the United States held that the statute of limitations does not purport to preclude an examination into events of prior years for the purpose of correctly determining gift tax liability for years which are still open.

Since taxable income has no special definition under the income averaging provisions of the Code, the definition under section 63 of the Code must apply. Section 63 provides, in general, that taxable income is gross income minus all allowable deductions. The fact that a base period year is barred by the statute of limitations does not change the definition of taxable income for such year. Therefore, regardless of whether a base period year is barred, the proper determination of taxable income must be made. This is not in contravention of the statute of limitations since it is not the tax for the year which is barred by the statute of limitations that is being determined, but merely the establishment of a correct taxable income for that base year for the determination of the tax for the computation year.

Accordingly, in the instant case, the taxable income for any base period year, that is barred by the statute of limitations for assessment or refund, must be adjusted (where necessary) to arrive at the correct taxable income for such year in determining the average base period income for income averaging purposes.