Tax Court: Defining “initial determination” for satisfying penalty procedural requirements

Tax Court: Defining “initial determination”

The U.S. Tax Court today issued an opinion concluding that a report by an IRS examiner, signed by the examiner’s immediate supervisor, satisfies the requirements of section 6751(b)(1) that no penalty may be assessed “unless the initial determination…is personally approved (in writing) by the immediate supervisor of the individual making such determination.” The court found that the examiner’s report was the “initial determination” as required by the statute and, thus, upheld the 40% gross valuation misstatement penalty imposed under section 6662(h) in this case.

Related content

The case is: Legg v. Commissioner, 145 T.C. No. 13 (December 7, 2015). Read the opinion [PDF 56 KB]

Background

The taxpayers made a donation of a conservation easement to a Colorado trust, and on their federal income tax return for 2007, they valued the donation at just over $1.4 and claimed a charitable contribution deduction. The taxpayers then claimed carryover charitable contribution deductions for 2008, 2009, and 2010. 

The IRS, on examining the returns for 2007-2010, determined that the taxpayers had not satisfied the requirements for a charitable contribution deduction and/or that the value of the donated property was zero ($0).  The examiner’s report included a detailed discussion of the applicability of the section 6662(h) penalty

In the examination report signed by the examiner’s immediate supervisor, it was determined that the taxpayers were liable either for a 20% accuracy-related penalty under section 6662(a), or for a 40% gross valuation misstatement penalty under section 6662(h). The examination report concluded that the taxpayers were subject to a 40% penalty under section 6662(h), but calculated the proposed penalty using the 20% rate under section 6662(a) due to uncertainty regarding whether the section 6662(h) penalty could be imposed when an underpayment was the consequence of an adjustment not based on valuation, but due to the failure of the conservation easement to qualify as a charitable contribution. 

The taxpayers sought administrative review by IRS Appeals, and the Appeals Officer issued findings that agreed with the examiner’s determination of a $0 valuation for the easement. The Appeals Officer issued a report finding that the 40% penalty under section 6662(h) was appropriate, and the Appeals Officer’s immediate supervisor approved that report.

After the IRS deficiency notice was issued containing the 40% penalty under section 6662(h), the parties agreed that the legal requirements for a charitable contribution deduction had been satisfied, but that the value of the conservation easement was only $80,000. 

The taxpayers, however, asserted that they were not liable for the 40% penalty because the IRS did not make an “initial determination” regarding the penalties as required by section 6751(b). The taxpayers contended that the 20% penalty proposed in the IRS examiner’s report suggested that the IRS never considered imposing the 40% gross valuation misstatement penalty and that consequently the examiner’s immediate supervisor could not have approved, in writing, such penalty. 

Tax Court’s opinion

The Tax Court today concluded that the IRS’s determination of the section 6662(h) penalties was proper because the IRS had satisfied the procedural requirements of section 6751(b). 

The court—while noting that the phrase “initial determination” was not defined by the Code or in the regulations—determined that the requirement of section 6751(b) was satisfied by the findings set forth in the IRS examiner’s completed examination report (thus constituting an initial determination) and that determination was signed by the immediate supervisor. 

 

“We find that even though the gross valuation misstatement penalties were posed as an alternative position, the report made an ‘initial determination’ that [the taxpayers] were liability for the 40% penalties.… The examination report clearly explained why [the taxpayers] were liable for the gross valuation misstatement penalties….  [The taxpayers] cannot contend that they lacked an understanding of the penalties imposed upon them because the penalties were posed as an alternative position.”

 

The court pointed out that the fact that the examiner calculated the penalty at a lower rate did not nullify the “initial determination” that the taxpayers were liability for the 40% gross valuation misstatement penalties.

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