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Oropeza v. Commissioner (155 T.C. No. 9)

On October 13, 2020, the Tax Court issued its opinion in Oropeza v. Commissioner, 155 T.C. No. 9. The primary issue presented in Oropeza was whether the IRS obtained prior supervisory approval pursuant to IRC § 6751(b)(1) prior to its initial determination to assess a penalty against the petitioner for tax year 2011.  Specifically, the issue in Oropeza was whether a Letter 5153 accompanied by a Form 4549-A (an RAR) constituted an initial determination of a penalty.

Procedural Background

The petitioner was the sole shareholder of a microcaptive insurance company organized as an S corporation for tax purposes.  In March 2014 an RA in Phoenix opened an examination of petitioner’s 2011 tax year, which was later expanded to subsequent years.

On January 15, 2015, facing an expiring period of limitations, the revenue agent sent the petitioner a Letter 5153 and accompanying report. The RAR asserted a 20% accuracy-related penalty attributable to one or more of negligence, a substantial understatement of income tax, a substantial valuation misstatement, and a “transaction lacking economic substance. See IRC § 6662(a), (b)(1), (2), (3), (6). The Letter 5153 explained that the petitioner could agree to the RAR adjustments, consent to extend the limitations period and have his case reviewed by Appeals, or he would receive a notice of deficiency. The petitioner called the IRS’s bluff and declined the first two options. The RA closed the case.

On January 29, 2015, the RA’s immediate supervisor signed a Civil Penalty Approval Form authorizing the assertion of a 20% penalty for a substantial understatement of income tax. On May 1, 2015, the RA recommended assertion of an IRC § 6662(b)(6) penalty, calculated at a 40% rate under IRC § 6662(i) for a transaction lacking economic substance not disclosed on the petitioner’s return. The RA’s supervisor signed the memo making that recommendation, and on May 6, 2015, the IRS issued a notice of deficiency determining a 40% penalty under IRC § 6662(b)(6) for a nondisclosed noneconomic substance transaction and (in the alternative) a 20% penalty for a substantial understatement or negligence.

The Initial Determination

The “initial determination” of the penalty assessment is 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. Belair Woods, LLC v. Commissioner, 154 T.C. 1, 14-15 (2020). Depending on how a particular examination is conducted, the taxpayer may receive this notification in a notice of deficiency, or he may receive the notification in a document that the IRS sent him at an earlier date.

In the present case, the RAR informed the petitioner that the IRS had determined a 20% penalty “attributable to one or more” of four specified grounds, including a “substantial understatement of income tax.” The Letter 5153 accompanying the RAR gave the petitioner three options: accept the adjustments set forth in the RAR, sign a Form 872 and go to Appeals, or receive a notice of deficiency. This letter made clear that the Examination Division had concluded its work and had made a definite decision to assert penalties. Id. Whichever option petitioner selected, Exam’s typical responsibilities from that point forward would be ministerial in nature.

A 30- or 60-day letter is one way of communicating to a taxpayer that Exam has concluded its work, but it is not the only way. The Letter 5153 clearly communicated the same message to the petitioner. To wit, the letter told him that he could now go to Appeals, but only if he first executed a Form 872 that would give Appeals enough time to consider his case.  The Tax Court has reached a similar conclusion in previous cases where the taxpayer refused to extend the limitations period and thus could not receive a 30- or 60-day letter. See Oropeza v. Commissioner, T.C. Memo. 2020-111, *8 (concluding that a Letter 5153 and attached RAR embodied the “initial determination” of the penalties included in the RAR); Carter v. Commissioner, T.C. Memo. 2020-21, *29-*30 (same).

The Curious Case of IRC § 6662(i)

The IRS, desperate at this point, threw up a hail Mary when it asked the court whether IRC § 6751(b)(1) is satisfied if approval is later secured to assert an increased penalty under IRC § 6662(i) because the “noneconomic substance transaction” was not disclosed on the return.

IRC § 6662(i) does not impose a distinct penalty; it simply increases the rate imposed for the penalty determined under IRC § 6662(a) and (b)(6). It increases the accuracy-related penalty from 20% to 40% when a noneconomic substance transaction is not disclosed on the return.

In Oropeza, the Tax Court held that failure to disclose the transaction on the return is not a separate penalizable offense. Rather, it is analogous to an “aggravating factor” in criminal law that justifies a harsher penalty for the basic offense. Both the text of the statute and its legislative history show that Congress viewed IRC § 6662(a) and (b)(6), amplified where appropriate by IRC § 6662(i), as imposing a single penalty. See also, H.R. Rept. No. 111-443 (I), at 298-305 (2010) (viewing the 20% and 40% penalty as one).

IRC § 6751(b)(1) provides that no penalty under this title shall be assessed unless the initial determination of such assessment receives supervisory approval. Here, “the penalty” whose initial determination required approval was the penalty imposed under IRC § 6662(a) and (b)(6) for engaging in a “transaction lacking economic substance.” Because the penalty under IRC § 6662(a) and (b)(6) was not timely approved, there is no applicable penalty for which the rate may be increased under IRC § 6662(i).

Ultimately, Boilerplate Language Bites the IRS in the Ass

The RAR accompanying the Letter 5153 asserted a 20% penalty “attributable to one or more of the following: (1) negligence or disregard of rules or regulations; (2) substantial understatement of income tax; (3) substantial valuation misstatement (overstatement); (4) transaction lacking economic substance.” This appears to be form text that appears frequently in RARs and notices of deficiency. See, e.g., McGuire v. Commissioner, 149 T.C. 254, 262-263 (2017) (referring to this text as making “a boilerplate determination of an accuracy-related penalty”). The Tax Court observed that a taxpayer reading these words would assume that the IRS had reserved the right to establish penalty liability on any of these grounds. He would assume, in other words, that the RAR was asserting all four bases as alternative grounds for imposing a penalty.  This reading is consistent with Tax Court precedent.

In Ocampo v. Commissioner, T.C. Memo. 2015-150, the notice of deficiency included boilerplate text similar to that here, determining a 20% penalty “attributable to one or more of” negligence, a substantial understatement of income tax, and a substantial valuation overstatement. The Tax Court held that these represent alternative grounds for imposition of the penalty, as the accuracy-related penalties “do not stack.” Id.; see also Treas. Reg. § 1.6662-2(c).

In Estate of Ronning v. Commissioner, T.C. Memo. 2019-38, the notice of deficiency included the same boilerplate text as in Ocampo. But the following page of the notice “clarified that the underpayment was determined to be due to a substantial understatement of income tax.” Id.  Because the notice of deficiency determined that the underpayment was due to one cause—a substantial understatement of income tax—the Tax Court found the relevant question to be “whether imposition of the IRC § 6662(a) penalty for a substantial understatement had been supervisor-approved.” Id.

Hard and Fast Rule

The rule the Tax Court distilled and extracted from these cases is that boilerplate text in an IRS communication, determining liability for an accuracy-related penalty attributable to one or more of specified grounds, will be interpreted to assert all of the specified grounds as alternative bases for the penalty, unless other portions of the communication explicitly limit the penalty determination to a subset of those grounds.

(155 T.C. No. 9) Oropeza v. Commissioner

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