The Tax Court’s recent opinion in Roth v. Commissioner, T.C. Memo. 2017-248, raises interesting issues about the need for supervisor approval when the IRS asserts penalties. In 2007, the petitioners in Roth donated a conservation easement encumbering 40 acres of land in Colorado to a charitable organization. The petitioners claimed a charitable contribution deduction of $970,000, but the IRS disallowed the deduction.
On examination, the IRS determined that the petitioners improperly valued the conservation easement and that the easement was actually worthless. The examiner also determined that the petitioners were liable for a 40% gross valuation misstatement penalty under section 6662, and his determination was approved in writing by his immediate supervisor. The examiner determined that the petitioners were alternatively liable for a 20% accuracy-related penalty.
The petitioners submitted a protest letter to IRS Appeals. The parties did not reach an agreement, however, and Appeals ultimately issued a notice of deficiency. In a closing memorandum, the Appeals officer informed the petitioners that “[t]he proposed penalties are fully sustained for the government.” The closing memorandum was signed by the Appeals officer’s immediate supervisor.
The notice of deficiency omitted the 40% penalty and included only the 20% accuracy-related penalty. The petitioners then filed a petition in Tax Court. In its answer – which was signed by an IRS senior counsel and her immediate supervisor – the IRS asserted the 40% penalty.
The parties eventually settled the case. They agreed that the petitioners were entitled to a charitable contribution deduction of $30,000 and that the petitioners had reasonable cause for the value of the conservation easement. As a result, the IRS conceded that the petitioners were not liable for a 20% accuracy-related penalty.
The difference between the settlement value of $30,000 and the claimed value of $970,000, however, met the gross valuation misstatement test under section 6662(h). Unlike for the 20% accuracy-related penalty, taxpayers cannot claim reasonable cause to avoid liability for the 40% penalty. So the petitioners tried another escape route – they argued that the 40% penalty was inappropriate because the IRS failed to comply with the procedural requirements of section 6751(b).
Section 6751(b)(1) states that “[n]o penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.” Complying with this requirement is part of the IRS’ burden of production under section 7491(c). See Graev v. Commissioner, 149 T.C. __ (Dec. 20, 2017), supplementing 147 T.C. __ (Nov. 30, 2016).
The petitioners argued that “initial determination” means the issuance of the notice of deficiency. Although written approval for the 40% penalty was obtained before the notice of deficiency was issued, the petitioners argued that the Appeals officer made the “initial determination,” not the examiner. As a result, the petitioners argued that, because the Appeals officer did not receive approval from his immediate supervisor before issuing the notice of deficiency, the IRS did not comply with section 6751(b) and could not assess the penalty.
The court observed that this issue was controlled by its decision in Graev and Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), vacating and remanding in part, aff’g in part, and rev’g in part T.C. Memo. 2015-42. The court held that each time the IRS sought to assert penalties, the individual proposing the penalties received approval from his or her immediate supervisor. The examiner who proposed the 40% penalty received written approval from his group manager. The Appeals officer received written approval from his team manager. The senior counsel who filed the IRS’ answer received written approval from her associate area counsel, which was demonstrated by the associate area counsel’s signature on the answer.
The Tax Court held that regardless of which of these instances was the initial determination of the 40% penalty, section 6751(b) was satisfied because each instance was approved in writing by an immediate supervisor. Thus, the court concluded that the IRS complied with section 6751(b) and found the petitioners liable for the 40% penalty.