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Variance Doctrine Trumps IRS Failure to Obtain Administrative Approval of Penalty

Posted on May 6, 2019

Another variation on the Graev issue just popped up.  This one is in the refund context where the decision turned on who had the most important duty.  Did the duty of the IRS to obtain managerial approval before imposing a penalty override the duty of the taxpayer to raise the issue in the claim for refund?  The district court finds that the duty to exhaust administrative remedies by giving the IRS a chance to address the issues on which the taxpayer’s claim for refund is based must be satisfied and the taxpayer cannot rely on the duty of the IRS to properly approve a penalty to absolve the taxpayer’s duty to let the IRS know why the refund is sought.  The case is Ginsburg v. United States, 123 A.F.T.R.2d 2019-553 (M.D. Fla. 3/11/2019).

Mr. Ginsburg engaged in a tax shelter promotion known as short option strategy. He realized an economic loss of $113,950, and claimed a net loss of $10,069,506 for tax purposes. He did not disclose the transaction on his tax return but simply reported the loss on a partnership return and netted a tax savings of over $3 million. When the IRS audited his 2001 return, it disallowed the claimed loss and hit him with a 40% gross valuation misstatement penalty on the underpayment of tax attributable to partnership items. Of course this occurred long before Frank Agostino taught us all, including the IRS, about the importance of IRC 6751 which was enacted not long before the year at issue. It seems that the IRS did not obtain the necessary written supervisory approval before imposing the penalty.

Mr. Ginsburg paid the taxes, penalties and interest in full as required by the Flora rule and then filed a claim for refund. On his claim Ginsburg requested a refund of the gross valuation misstatement penalty, the interest paid on the penalty, and a portion of the underpayment interest he paid. He asserted that he reasonably and in good faith relied on accounting advice, legal advice, a tax opinion, his return preparer and a financial advisor. This situation is classic in tax shelter situations because professionals do provide advice to the taxpayer about these types of transactions and taxpayers always want to use the professional advice to insulate themselves from the penalties that result when abusive tax shelters get picked up by the IRS. In his refund claim, however, Mr. Ginsburg did not mention that he wanted a refund because the IRS did not fulfill its obligations under IRC 6751 as interpreted by Graev and other cases.

The IRS disallowed his claim for refund and he filed suit. By the time his suit rolled around Mr. Ginsburg, or his representative, had read about the Graev case and realized that they might have a winner based on this case. Hundreds of thousands of dollars are at stake so he wanted to make this argument even though he did not alert the IRS to it when he filed his claim for refund. In his summary judgment motion, Mr. Ginsburg argued that the IRS had a duty to comply with IRC 6751 whether or not he raised the issue in his refund claim and, therefore, the court should allow his claim despite the variance between the claim and the basis for his argument in court. The IRS, of course, disagreed and argued that the Court lacked jurisdiction because of the failure to exhaust administrative remedies.

The district court denied his claim pointing out he cited to no authority in support of his position that the duty to properly approve the penalty overrode the variance doctrine.  Citing Logan v. United States, 121 A.F.T.R.2d 2018-2193 (M.D. Fla. 6/21/2018), the court stated that it lacked subject matter jurisdiction to hear the case in the absence of a claim clearly identifying the issue the taxpayer now sought to use to overturn the decision.

Mr. Ginsburg also argued that the variance did not apply because he did not know that the IRS had failed to comply with IRC 6751. In making this argument he relied on El Paso CGP Co. v. United States, 748 F.3d 225; 113 A.F.T.R.2d 2014-1420 (5th Cir. 2014); however, the court here pointed out that the IRS took action subsequent to the filing of the claim in El Paso which the taxpayer there could not have known about. Here, the taxpayer knew of the relevant facts, or could have known of them, but did not realize the importance of the supervisory approval until after making the claim. The IRS did nothing to keep the taxpayer from knowing and nothing after the submission of the claim. So, the court determined that the El Paso case did not provide any assistance to Mr. Ginsburg.

Mr. Ginsburg also argued that he should not be penalized because he relied on the advice of professionals. The IRS responded with respect to each of the advisors he listed. For several of the advisors, the IRS argued, and the court agreed, that he could not rely on their advice because the advisor promoted the scheme or was an agent of the promoter. For one advisor he mentioned, the court found that he did not allege that the advisor knew the full facts and for one the court found that he did not list the advisor in his claim for refund triggering the variance doctrine with respect to that advisor. The IRS also argued that he could not obtain relief from the penalty because as a businessman he knew that the deal was too good to be true. In response to this argument the court stated:

The improbable tax advantages offered by the transaction should have alerted Plaintiff that the transaction was too good to be true, especially in light of his business experience. See Gustashaw, 696 F.3d at 1141–42 (finding transaction too good to be true where sophisticated taxpayer claimed a loss of $9,938,324 in exchange a $800,000 fee) ….

I find the decision consistent with the variance doctrine.  The taxpayer here did not give the IRS a chance to fix the mistake administratively and brought a new theory to court.  The decision shows that it is easier to raise the Graev issue in Tax Court where the variance doctrine does not apply.  I suspect there may be others out there in the same situation as Mr. Ginsburg who have a large penalty imposed against them for tax shelter activity that occurred well before the IRS appreciated its responsibility under IRC 6751.  This case reminds those individuals to make sure that their claim for refund includes a Graev argument.  It’s hard to fault Mr. Ginsburg for failing to put this argument into his refund claim but it’s also hard to say the Court got this wrong.  I doubt this will be the last case on variance and Graev.

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