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Pankratz v. Commissioner (T.C. Memo. 2021-26)

On March 3, 2021, the Tax Court issued a Memorandum Opinion in the case of Pankratz v. Commissioner (T.C. Memo. 2021-26). The primary issue presented in Pankratz was whether the failure to attach appraisals can be due to reasonable cause when a taxpayer admits that he did not review his tax returns before filing.

Introductory Notes:

I cannot say for sure whether the return preparers were actually the fire chief and the village idiot, but they might be.  The only thing that cuts against this supposition is that if Judge Holmes had caught wind of such a happening, you can be damn sure that he would have mentioned it in a footnote.  Or seven.

Background

The petitioner was a successful veterinarian, who (on a dare, it seems) invented a vaccine for a particular animal virus that caught the attention of the USDA.  Though the petitioner came to work for the USDA, he also founded a laboratory to produce the vaccine, the success of which “went viral.”  (It’s a Judge Holmes’ opinion, so that pun was bound to pop up at some point.)  Ultimately, the petitioner sold his laboratories to Novartis for $85 million.

Success did not go to the petitioner’s head, and he began purchasing small businesses, ranches in South Dakota, and other real estate in Florida and Mississippi. He kept these businesses open, helping a number of small economies in even smaller communities.  He operated these businesses under the umbrella of two LLCs, one for the tourism-related businesses, and one for his ranching operations.  One of his endeavors was a taxidermy museum, which he desired to make “one of those unexpected roadside attractions that set small children to bothering their parents to please, please stop.”  (This in a footnote by Judge Holmes.) Unfortunately, the petitioner also relied on small town bookkeepers and a buddy with an accounting degree but not a CPA license to manage his finances and prepare his taxes.

The petitioner made several large noncash charitable contributions in 2008 and 2009.  The first, four oil and gas projects, he donated to a South Dakota church.  The petitioner valued the donation at $2 million based on his purchase price as well as what he said he expected its appreciation to be. He did not, however, obtain a professional appraisal of these interests before he filed his return.  The second, 5.78 acres of land in Rapid City, South Dakota, he donated for road and utility improvements.  Once again, no appraisal was secured—and even the petitioner acknowledged that this deduction should be disallowed.  The third, a conference center, he donated to another South Dakota church.  The petitioner hired an appraiser, but the appraiser took one look at the property, adjudged that it was above his paygrade and skillset, and balked.  The petitioner did not try to get another appraisal; instead he simply totaled up the cost of the conference center and claimed that amount as a deduction.

The tax return preparation “process” was a bit backwoods, too, it appears.  Though the petitioner was aware of the issues before he filed his 2008 and 2009 returns, the petitioner did not want to ruffle any small-town feathers, and he stuck with his return preparers, who were also (I’m just guessing here) the town’s fire chief and village idiot.

The Form 8283 (Noncash Charitable Contributions)

Here, Judge Holmes gets a bit snippy with the petitioner…which the editors of Briefly Taxing support wholeheartedly.

We [read: Judge Holmes] think that four mentions of “appraisal”, “appraiser”, or “appraised” on one page of one form is pretty good notice that substantial noncash donations need to be backed up by an appraisal. Yet despite all these warning signals, [the petitioner] never had a professional appraisal performed or attached one to either his 2008 or 2009 return for any of the large noncash charitable donations that he claimed.

Though the fire chief and the village idiot confirmed that no appraisals had been obtained for the 2008 return, they did not raise the issue with the petitioner—whether out of fear that they would become a display in his taxidermy attraction, the Tax Court does not mention.  In 2009, fear of the IRS got the better of the fire chief and the village idiot, and they raised the appraisal issue with the petitioner.  The taxpayer asked the fire chief if he could just deduct the cost of the building. The petitioner and the village idiot discussed it and finally decided this informal valuation would work, though the fire chief was never consulted regarding this informal valuation.  Critically, the petitioner never reviewed the final draft of the return prepared by the fire chief.

Charitable Contributions

We discuss compliance with the valuation rules in the article “Excuse me, are you DEFRA (Compliant)?”  So, click here to read that sage piece of legal analysis if you want a more in-depth guide to the DEFRA requirements discussed below.

IRC § 170(a)(1) states that a charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the IRS. The Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, sec. 155(a)(1)(A), 98 Stat. at 691, ordered the IRS to prescribe regulations under IRC § 170(a)(1) that would require a taxpayer who claims a deduction for the donation of property worth more than $5,000 to “obtain a qualified appraisal for the property contributed.” Section 155 of DEFRA defined “qualified appraisal” to

include any “additional information as the Secretary prescribes in such regulations.” Id. at 692. Congress codified that concept in 2004 by adding IRC § 170(f)(11) to the Code. See American Jobs Creation Act of 2004, Pub. L. No. 108-357, sec. 883(a), 118 Stat. at 1631.

IRC § 170(f)(11)(A) provides that for any noncash contribution of more than $500, certain information must be included with the taxpayer’s return. Specifically, a taxpayer must include a description of the property, and he must attach a full qualified appraisal to his return when claiming a deduction of more than $500,000.  IRC § 170(f)(11)(B)-(D); Treas. Reg. § 1.170A-13(c)(1) and (2). The purpose of these requirements is to provide the IRS with sufficient information to evaluate the claimed deduction and deal more effectively with the prevalent use of overvaluations. Scheidelman v. Commissioner, 682 F.3d 189, 198 (2d Cir. 2012); Hewitt v. Commissioner, 109 T.C. 258, 265 (1997), aff’d, 166 F.3d 332 (4th Cir. 1998). Taxpayers must report this information on Form 8283. See Jorgenson v. Commissioner, T.C. Memo. 2000-38.

Although the petitioner concedes that he did not attach appraisals, qualified or otherwise, to his Form 8283, all is not lost.  IRC § 170(f)(11)(A)(ii)(II) provides a potential escape hatch for “well-intentioned” taxpayers. Specifically, IRC § 170(f)(11)(A)(ii)(II), permits a deduction if the taxpayer shows that the failure to meet such requirements is due to reasonable cause and not to willful neglect.  Reasonable cause in this context is given the same meaning as in cases that look to reasonable cause as a defense to penalties.  See Presley v. Commissioner, T.C. Memo. 2018-171, *64-*65, aff’d, 790 F. App’x 914 (10th Cir. 2019); Crimi v. Commissioner, T.C. Memo. 2013-51.

Reasonable Cause

Reasonable cause requires a taxpayer to exercise ordinary business care and prudence. See, e.g., United States v. Boyle, 469 U.S. 241, 246 (1985); Presley, T.C. Memo. 2018-171 at *65. Whether a taxpayer had reasonable cause is a fact intensive inquiry that requires a case-by-case examination of all the facts and circumstances presented. Presley, T.C. Memo. 2018-171 at *65. When a taxpayer claims to have relied on the advice of a professional, he must show that (a) the professional was a competent tax adviser with sufficient expertise to justify reliance; (b) the taxpayer provided necessary and accurate information to the professional who gave him advice; and (c) the taxpayer actually relied in good faith on that advice. See Alt. Healthcare Advocates v. Commissioner, 151 T.C. 225, 246 (2018); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

Competent Tax Adviser

There is no precise threshold of competence that a tax adviser must have to justify reliance. The Tax Court’s practical test looks for expertise commensurate with the facts of each case. CNT Inv’rs, LLC v. Commissioner, 144 T.C. 161, 224 (2015); see also Neonatology, 115 T.C. at 99 (insurance agent lacked sufficient expertise to advise on complex, group whole/term hybrid life insurance plan); Thousand Oaks Residential Care Home I, Inc. v. Commissioner, T.C. Memo. 2013-10 (longtime accountant who prepared tax returns full time, was an enrolled agent, and had a master’s degree in business administration was competent professional to advise on employment-plan contributions).

When the Tax Court applied this test, they found that the fire chief (tax preparer) was not a competent tax adviser.  He is not a CPA. He is not an attorney. He is not a full-time return preparer. He has no professional license of any kind. He is just a longtime employee who provides financial-related support to the petitioner and has a bachelor’s degree in accounting.  Also, he’s been burned one too may times, literally.

Importantly, the Tax Court is quick to note that a professional license is always required for a reliance defense to penalties, only that the fire chief’s experience was not enough to make him competent to prepare a large and complex tax return which included information from over a dozen businesses and farms. The petitioner himself knew that the fire chief’s usual way of preparing returns for his businesses had led to understatements of tax in the past. And it led the Tax Court to find again, as it did in Kirman v. Commissioner, T.C. Memo. 2011-128, that a longtime preparer (qua-fire chief) may not be a competent adviser on whom a taxpayer could reasonably rely.

Provision of Information

The regulations clarify that the taxpayer cannot fail to disclose a fact that it knows, or reasonably should know, to be relevant to the proper tax treatment of an item. Treas. Reg. § 1.6664-4(c)(1)(i). A taxpayer is not obliged to share details that a reasonably prudent taxpayer would not know, or that he would neither know nor reasonably should know are relevant. CNT Inv’rs, LLC, 144 T.C. at 228. In the present case, the petitioner did not provide all of the necessary information to the village idiot.  The Tax Court found it reasonable that the taxpayer may not have known about the appraisal requirement when he first submitted information to the village idiot, but he knew once the issue was brought to his attention in 2009.

Good Faith Reliance

The last requirement is that a taxpayer must have actually relied on advice in good faith. Neonatology, 115 T.C. at 99. Advice is any communication, including the opinion of a professional tax adviser, setting forth the analysis or conclusion of a person, other than the taxpayer, provided to (or for the benefit of) the taxpayer and on which the taxpayer relies, directly or indirectly. Treas. Reg. § 1.6664-4(c)(2). Once it is established that advice has been given, the Tax Court next looks to see whether the taxpayer relied on the adviser’s judgment. See Woodsum v. Commissioner, 136 T.C. 585, 593 (2011). The fire chief, for example, did not advise; he simply prepared the return by inputting data into his firm’s tax software. See Parker v. Commissioner, T.C. Memo. 2012-357 (no advice because no evidence return preparer exercised judgment).

A taxpayer’s failure to review a return, though troubling, is not by itself fatal.  The Tax Court observes that there can be cases where even diligent taxpayers wouldn’t be able to see a subtle problem in their tax returns. CNT Inv’rs, LLC, 144 T.C. at 234. However, “that’s not the case here,” according to Judge Holmes.

Although the petitioner tried to represent himself as a lowly farm hand, the Tax Court found that he was a sophisticated and savvy businessman. He was able to create a vaccine laboratory conglomerate from nothing and sell it for $85 million, and he then invested his money in several different ventures in several different states. He may lack formal tax training, but the Tax Court found that he possessed a sharp and sophisticated mind for business. Had the pt simply looked at Form 8283 he would have noticed that, at the very least, he likely needed to get appraisals. This makes his case unlike CNT Investors, LLC, because there the taxpayer met with his adviser, and his review of the return would not have shown any issues. See CNT Inv’rs, LLC, 114 T.C. at 234.

“One does not have to be a tax expert to be able to read Form 8283.”  Ouch.  “For a man as smart as the petitioner, this would have suggested that there was a potential major error on the return, and it should have prompted him (at the very least) to ask [the village idiot] whether an appraisal was needed.” With neither advice nor good faith reliance on that advice, the Tax Court denied the deduction for the 2008 deductions for the gas fields.

In 2009, the petitioner’s fortune is no better.  He was told he needed an appraisal.  Though he sought one out, the appraiser did not perform an appraisal because the property was unique and appraising it was too complex.  Even if the petitioner was told to just add up the cost and take the deduction, there is no evidence that the would-be appraiser—who seems to be a competent and honest appraiser—was also a competent tax adviser.  Ergo, reliance on his opinion is inappropriate.  See Neonatology, 115 T.C. at 99 (insurance agent lacked expertise to advise on tax rules for insurance plan).

Interesting Bit on Prior Supervisory Approval

The IRS introduced Civil Penalty Approval Forms that showed that a manager approved the penalties in writing before the notices of deficiency were sent to the petitioner, as well as before a revenue agent’s report or any other communication from the IRS that one might plausibly consider an “initial determination.” The petitioner argues that there is no evidence that the individual who proposed the penalties prepared the forms or that the person who signed the forms is the immediate supervisor of the person who proposed the penalties. The parties, however, stipulated the introduction of the penalty-approval forms. The petitioner reserved his right to object to their admission on the grounds of relevance, materiality, and an objection under Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324 (1974). But he never made any of these objections, and he did not introduce any evidence to undermine their credibility. With these forms, the IRS satisfied the procedural requirements for imposing penalties.

Though Judge Holmes doesn’t go out and actually say it, this provides a bit of a roadmap for those practitioners who face an IRC § 6751(b)(1) issue, especially when the penalty approval form bears a signature that is handwritten and illegible.  In this case, the practitioner should object to the introduction of the form on the basis that the IRS has not offered any evidence of the identity of the signatory, and whether such signatory is the immediate supervisor of the person who proposed the penalties.  This hurdle is not insurmountable by the IRS, but it is a hurdle, nonetheless.  Even when the penalty approval form is electronically signed, make the IRS work for their dinner—which is to say, make the IRS prove that the individual that signed the form is the acting supervisor of the individual who made the initial determination.  Again, it’s not foolproof, but it is just one more way to utilize (note that I did not say “exploit”) the IRC § 6751(b)(1) procedural safeguard for taxpayers.

(T.C. Memo. 2021-26) Pankratz v. Commissioner

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