On November 4, 2021, the Tax Court issued a Memorandum Opinion in the case of Excelsior Aggregates v. Commissioner (T.C. Memo. 2021-125). The primary issue presented in Excelsior Aggregates was whether the IRS complied with the prior supervisory approval requirement of IRC § 6751(b)(1) with respect to the numerous penalties asserted against the petitioner (IRC § 6662A and IRC § 6662(a), (b)(1)-(3), (d), (e), and (h)).
Executive Summary from the Tax Court in Excelsior Aggregates v. Commissioner
As we have discussed in a number of previous posts and articles (including this one I wrote for Tax Notes), IRC § 6751(b)(1) requires that the “initial determination” of a penalty assessment be personally approved (in writing) by the immediate supervisor of the person making that determination. In Excelsior Aggregates, the IRS argued that the “initial determination” of the penalties in question was communicated in the notice of final partnership administrative adjustment (FPAA), which was issued on July 27, 2018. Because supervisory approval for the penalties was secured before that date, the IRS urged that approval was timely.
The petitioner, however, argued that supervisory approval came too late because the “initial determination” of the penalties against it occurred nine months earlier, when the IRS “mentioned the possibility of penalties” during a telephone call with the petitioners’ representative. The petitioner advanced an alternative argument with respect to the IRC § 6662(e) and (h) penalties in particular, contending that the “initial determination” of those penalties occurred four months before the FPAA was issued, when the IRS assessed penalties against Excelsior’s appraiser under IRC § 6695A(a).
The Tax Court concluded that the IRS “had the better argument on both points,” and, thus, the Tax Court granted its motion for partial summary judgment.
The petitioner is a Georgia partnership. It acquired 301 acres in Alabama in September 2014. In mid December, the petitioner granted to the National Wild Turkey Federation Research Foundation a conservation easement over the land.
The petitioner timely filed its Form 1065 (U.S. Return of Partnership Income), for its short 2014 tax year. On that return it claimed a charitable contribution deduction of $12,525,000 for the donation of the easement. The petitioner included with its return a copy of an appraisal prepared by Clayton M. Weibel. The IRS selected Excelsior’s return for examination.
The revenue agent examined multiple appraisals prepared by Weibel, including the one he prepared for the petitioner. A team of IRS appraisers completed their work in January 2018. They concluded that Weibel made a gross overvaluation misstatement as defined in IRC § 6662(h) and that IRC § 6695A penalty should be asserted against him. In January, Weibel received a Form 5701 (Notice of Proposed Adjustment) stating that the IRC § 6695A penalty ($12,500) was being imposed on poor Clayton for the overvaluation of the appraisal for the petitioner.
To Clayton Weibel’s defense in the present case, his appraisal was not uncommon. The IRS appraisers concluded that Mr. Weibel had also overvalued 11 other easements in cases involving conservation easements…and the IRC § 6695A penalty was asserted in each. So, he had that going for him.
The RA made the decision to assert penalties against the petitioner for gross valuation misstatement under IRC § 6662(h) and (in the alternative) substantial valuation misstatement under IRC § 6662(e). She also decided to assert penalties under IRC § 6662(b)(1) and (2), as well as under IRC § 6662A. The RA’s recommendations to this effect were set forth in a “Penalties Lead Sheet,” which she digitally signed on July 24, 2018, and which her immediate supervisor digitally signed on July 25, 2018.
Prior Supervisory Approval – A Recap
We have discussed IRC § 6751(b)(1) enough that we won’t go through the gyrations of Chai or Williams. Nonetheless, as you will remember from previous posts, IRC § 6751(b)(1) provides that no penalty may be assessed unless “the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination.” In Belair Woods, LLC v. Commissioner, the Tax Court explained that the “initial determination” of a penalty assessment is typically embodied in a letter by which the IRS formally notifies the taxpayer that Exam has completed its work and has made a definite decision to assert penalties.
In a TEFRA case such as this, supervisory approval generally must be obtained before the FPAA is issued to the partnership. If supervisory approval was obtained by that date, the partnership must establish that the approval was untimely, i.e., “that there was a formal communication of the penalty before the proffered approval” was secured.
The definite decision to assert penalties was communicated to the petitioner in the FPAA two days after the RA obtained supervisor approval in writing. The FPAA also contained a Form 886-A explaining the determination. Consequently, the RA secured timely approval of these penalties.
The Earlier “Communication of Penalties”
The petitioner contends that the IRS communicated to the petitioner its decision to assert penalties nine months earlier, when the RA conducted a telephone conference with petitioner’s representative. In preparation for that conference, the RA faxed the petitioner’s counsel an agenda that proposed several topics for discussion, including valuation of the easement, whether the easement had “a valid conservation purpose,” and whether any penalties should apply. The letter provided a summary of the RA’s tentative position on each topic.
The first line of the agenda included the word “Disclaimer” that read as follows: “The 12/31/2014 [examination] is substantially completed. This discussion is based on current findings. It is possible that the results could change before the examination officially concludes.” The second page of the agenda indicated that the parties’ discussion would include the “reportable transaction understatement penalty,” the “valuation misstatement” penalty, and the “substantial understatement of tax” penalty.
At the end of the telephone conference, the RA offered the petitioner’s counsel the opportunity to respond to each topic in writing and to assert any defenses to the penalties that the petitioner believed applicable. The petitioner’s counsel did so.
An Initial Determination by Fax? Not so Much.
The petitioner contends that the agenda that the RA faxed to its counsel manifested her “initial determination” to assert penalties. The Tax Court disagreed. It noted that the word “determination” has “an established meaning in the tax context and denotes a communication with a high degree of concreteness and formality.”
An “initial determination” thus signifies a “consequential moment” of IRS action. The “initial determination” of a penalty is typically embodied in a document by which the examining agent makes clear to the taxpayer that the IRS “has completed its work and made an unequivocal decision to assert penalties.” The agenda that the RA sent to the petitioner’s counsel, however, did not so inform him that the IRS “had completed its work.”
In fact, it said the opposite…which was a bad fact for the petitioner.
The Tax Court observes that the petitioner’s counsel understood that the results could change, as evidenced by his submission of a written response five weeks later. In that document he urged the RA to reconsider her tentative conclusions regarding the issues presented, including the applicability of penalties. Indeed, the results in fact did change (albeit to the petitioner’s detriment) when the RA ultimately decided to assert the negligence penalty as well as the other penalties the parties had discussed. Consequently, neither the agenda nor the telephone conference informed the petitioner of any “unequivocal decision” by the IRS.
Differentiation of the Beland Case
The petitioner hung its hopes on the 2021 case of Beland v. Commissioner, which involved a closing conference between the taxpayers and an IRS team of examiners. The IRS team presented the taxpayers with a revenue agent report (RAR) that included the examining agent’s signature, a fraud penalty of a determinate amount, and a signature box where the taxpayers could consent to the fraud penalty by affixing their signatures. During the meeting the examining agent informed the taxpayers that, if they did not sign the RAR, then she would issue a notice of deficiency.
This case differs from Beland in at least three respects.
First, the RA’s letter proposed an agenda for discussion headed by a disclaimer that “[t]his discussion is based on current findings” and that “the results could change before the examination officially concludes.”
Second, the letter did not inform the petitioner that the audit was over or that the IRS was closing the examination file. Rather, the RA encouraged the petitioner’s counsel to present his side of the story during the telephone conference, and he was invited to submit (and did submit) a written response subsequently.
Third, and finally, the RA’s letter did not set forth specific penalties “of a determinate amount.” Rather, the letter listed several penalties without identifying amounts or percentages, e.g., as to whether a 20% or a 40% valuation misstatement penalty (or both) would be asserted.
Penalty Against Clayton Weibel Not Initial Determination for the Petitioner
With respect to the IRC § 6662(e) and (h) penalties for valuation misstatement, the petitioner argues that the initial determination was embodied by the Notice of Penalty Charge, issued to Mr. Weibel. According to the petitioner, the decision to assess penalties under IRC § 6695A against an appraiser reflects an initial determination to propose valuation misstatement penalties against the taxpayer who used the appraisal. Once again, the Tax Court disagreed.
The Tax Court observed that it is “well established” that “each penalty stands on its own” for purposes of IRC § 6751(b)(1). The notice of penalty charge issued to Mr. Weibel did not reflect the “initial determination” to impose IRC § 6662(e) and (h) penalties upon the petitioner; rather, it reflected the decision to impose IRC § 6695A penalties upon poor, unsuspecting Mr. Weibel.
Finally, although IRC § 6662(e) and (h) share a common element with IRC § 6695A(a)(2), insofar as they all require that a substantial or gross valuation misstatement occurred, the imposition of the latter penalty against an appraiser does not automatically trigger a penalty against the taxpayer who relied on the appraisal. Indeed, even after penalizing an appraiser the IRS might determine that the taxpayer, in addition to obtaining such appraisal, made a good faith investigation of the value of the contributed property under IRC § 6664.
- 154 T.C. 1, 14-15 (2020). ↑
- See Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. 75, 83 (2019). ↑
- Frost v. Commissioner, 154 T.C. 23, 35 (2020). ↑
- See Frost, 154 T.C. at 35; Belair Woods, 154 T.C. at 15. ↑
- Belair Woods, 154 T.C. at 15. ↑
- Id. (quoting Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo. 2015-42). ↑
- Id. ↑
- See Thompson v. Commissioner, 155 T.C. 87, 92-93 (2020) (holding that a preliminary proposal of penalties in an offer letter was not an “initial determination” because the examination was not yet complete); Belair Woods, 154 T.C. at 12 (holding that a preliminary proposal of penalties in a summary report was not an “initial determination”); Tribune Media Co. v. Commissioner, T.C. Memo. 2020-2 (holding that a proposal of penalties in a Form 5701 was not an “initial determination” where the form stated that “additional information could alter or reverse” the proposal). ↑
- Beland, 156 T.C. 80 (2021). ↑
- Id. at 86-87. ↑
- Id. at 87. ↑
- See Kestin v. Commissioner, 153 T.C. 14, 29 (2019) (noting that an IRS document inviting a taxpayer to provide further input falls short of an “initial determination”). ↑
- See Beland, 156 T.C. at 87. ↑
- See IRC § 6664(c)(3)(B). ↑