Even though it has been around for over 17 years, little attention has been paid to IRC 6751. In Legg v. Commissioner, the Tax Court issued a division opinion concerning this little known provision that serves as a gatekeeper to the assertion of many penalties. At issue in the case is whether the IRS met the requirements of 6751 and could assert the gross valuation overstatement penalty. We have discussed the penalty before here in a guest blog by Carl Smith and here in a guest blog by Frank Agostino. Steve also discussed a recent case in a SumOp in which the court sidestepped whether this requirement applied to the trust fund recovery penalty.
Frank’s 2014 post was our first on this issue and set the scene. As he discusses, the sudden interest in this code section followed a 2013 TIGTA report critical of the IRS for not following the requirements of section 6751. That report entitled, “Improvements Are Needed in Assessing and Enforcing Internal Revenue Code Section 6694 Paid Preparer Penalties,” found that eight percent of the completed section 6694 preparer penalty case files randomly sampled did not contain the proper documentation that the manager had appropriately approved the penalty in accordance with section 6751(b)(1).
Carl’s post in 2015 discusses some of the first opinions coming out in the Tax Court which came out as orders rather than reported cases. As Carl has discussed before, the Tax Court decides many cases through orders that often go unnoticed and uncounted by those who track that Court. These cases also carry no precedential value as guest blogger Andy Grewal has discussed in posts (found here, here, and here) and in his recent article, The Un-Precedented Tax Court, but now we have an opinion on the issue with precedent.
The cases mentioned in Carl’s post bear a similarity to the Legg case in that they all involve the valuation overstatement penalty. The fact that these cases come up in the context of this penalty is not surprising when you think about the representation involved in a gross valuation penalty case which usually accompanies a high dollar valuation case. In these cases taxpayers will have sophisticated counsel who look for all possible issues unlike the run of the mill penalty cases where taxpayers represent themselves or the penalty gets attention only as an afterthought. As discussed below, the penalty in the Legg case deserves attention all by itself because of its size and it receives that attention from petitioner’s counsel and from the Court.
The Leggs donated a conservation easement which they valued at over $1.4 million. The donation occurred in 2007 but limitations on the amount of charitable contribution they could use in one year caused the claimed donation deduction to occur for the next several years thereafter. The IRS determined that the Leggs did not satisfy the legal requirements for charitable contribution deductions and, alternatively, if they met the legal requirements the actual value of the conservation easement donation was zero. The examiner determined that the Leggs were liable for the 20% accuracy related penalty under 6662(a) but alternatively determined that they were liable for the 40% accuracy related penalty for gross valuation misstatement under 6662(h). The examination report itself calculated a 20% penalty.
The Leggs filed a protest and went to Appeals where the Appeals Officer agreed with the Examination Division except that the AO determined the primary position should be the 40% penalty with the 20% penalty as the alternate position. The notice of deficiency was issued by Appeals with this position. In the Tax Court case the parties stipulated that the value of the donated easement was $80,000 or over $1.3 million less than claimed on the original 2007 return. The Leggs argued that the IRS could not assert the 6662(h) penalty because that penalty had not been approved in writing by the immediate supervisor of the individual making the penalty determination as required by section 6751.
As a part of their argument, the Leggs took the position that section 6751 applies to the first notice the IRS sends to the taxpayer making the revenue agent the only person qualified to make an “initial determination” of the appropriate penalty and the revenue agent’s manager the supervisor who must approve. The Leggs further took the position that the revenue agent’s manager only approved the 20% penalty of 6662(a).
The IRS took the position that the section 6751 only applies to require a determination and approval before assessment of the liability at issue meaning that any penalties determined by respondent in the examination report or the notice of deficiency could obtain the necessary approval during the Tax Court proceeding. The Court skirts this question by determining that the revenue agent did make an initial determination concerning the 6662(h) penalties and, therefore, satisfied the requirement of the statute. Before discussing how the Court came to that conclusion, the opinion clearly leaves unanswered a very important question of timing which must still be decided in the case that does not have the alternative penalty determination made here.
The Court notes that the term “initial determination” is not defined in the Code or Regulations. The IRS argued that the revenue agent examining the Legg’s 2007 return made an initial determination that the 40% penalty did apply even though the revenue agent calculated the penalty in the report at the lower 20% amount. The revenue agent’s report was approved in writing. The Court finds that the 40% penalty was determined and approved but did not become the primary position because of the uncertainty of the value at that stage of the case. The purpose of the statute was to alert taxpayers to the basis for asserting a penalty. The IRS provided enough information to place the taxpayer on notice of the penalty and how it was calculated. Nothing in the development of the case surprised the taxpayers because of the amount of information in the report.
The precedent set by this case will allow the IRS to obtain a liberal view of its reports for purposes of section 6751 in circumstances in which the reports make mention of the possibility of a penalty and adequately describe the basis for assertion of the penalty. From the taxpayer’s perspective, having conservation easement cases lead the way may not be the best test vehicles. These cases do not evoke a great deal of sympathy. It would be better to lead with a more sympathetic case but it is what it is since there is not a good way to coordinate this litigation from the private sector.