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Thompson v. Commissioner (155 T.C. No. 5)

On August 27, 2020, the Tax Court issued its opinion in Thompson v. Commissioner, 155 T.C. No. 5. The primary issue presented in Thompson was whether the offer of settlement of the petitioners’ tax liabilities under reduced penalty rates on any later-determined underpayment arising out of an abusive tax transaction was an “initial determination” of a penalty for purposes of IRC § 6751(b)(1)’s prior written supervisory approval requirement.

Background

The petitioners engaged in an abusive transaction known as a distressed asset trust transaction, which they reported on their 2005 return. The IRS audited multiple years including 2005. In 2007, the IRS mailed a letter to the petitioners which stated that the IRS was aware that the petitioners participated in an abusive transaction and offered them the opportunity to resolve their tax liabilities associated with that transaction in accordance with the terms set forth in Announcement 2005-80. The Announcement offered settlements to investors in various types of tax transactions with the accuracy-related penalty is below the statutory rates to encourage participation.

The 2007 letter instructed the petitioners to complete a Form 13750 (Election to Participate in Announcement 2005-80 Settlement Initiative) if they chose to accept the settlement terms. The Form 13750 required petitioners to pay a § 6662 accuracy-related penalty in an amount equal to 10% of the underpayment attributable to the abusive transaction. The 2007 letter did not identify tax. Or tax form to which it related, did not provide an underpayment amount, and did not request petitioners’ consent to assessment and collection.

The petitioners did not accept the settlement offer in the 2007 letter, nor did they accept the same settlement offer in an identical 2009 letter. The 2009 letter explained that if the petitioners did not accept the settlement terms, the IRS would complete its examination and fully developed the facts of petitioners’ case and impose applicable penalties under the Code.

The IRS completed its examination of the petitioners’ returns in 2009. The IRS concluded that the petitioners owed tax and penalties under IRC § 6662(h) (gross understatement) and IRC § 6662A (accuracy-related penalty for reportable transactions). Critically, the IRS obtained prior written supervisory approval approving the conclusion as to the assertion of penalties. Subsequent to the approval, the IRS sent petitioners a notice of deficiency in 2012, wherein the IRS determined deficiencies in penalties under IRC § 6662(h) and IRC § 6662A.

Swing…and a Miss

You certainly can’t fault the petitioners for creativity. The petitioners dealt themselves a losing hand, or to use another aphorism, they tried their best to make lemonade from rotten lemons.

Earlier in 2020, the Tax Court decided the case of Belair Woods, LLC v. Commissioner, 154 T.C. No. 1, *24-25 (Jan. 6, 2020).  In Belair Woods, the Tax Court held that the IRC § 6751(b)(1) “initial determination” is embodied in the document by which the Exam formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties. Id. This means supervisory approval is required no later than (1) the date the IRS issues the notice of deficiency, or, if earlier, (2) the date the IRS formally communicates to the taxpayer Exam’s determination to assert a penalty and notifies the taxpayer of his right to appeal that determination. Id. at *4; Clay v. Commissioner, 152 T.C. 223, 249 (2019).

In an income tax deficiency case, the latter document is often a 30-day letter, see, e.g., Clay v. Commissioner, 152 T.C. at 249, which gives the taxpayer 30 days to seek a conference with Appeals, or else the IRS may issue a notice of deficiency determining the penalties. See § 601.105(d)(1), Statement of Procedural Rules. Supervisory approval is required for a letter that asserts a penalty and offers the taxpayer a right to pursue an Appeals conference, even if the letter is not the colloquially termed “30-day letter.” See Kroner v. Commissioner, T.C. Memo. 2020-73, at *29-*30.

The Tax Court found that the offer letters did not reflect an “initial determination” because they did not notify the petitioners that Exam had completed its work. Rather than determining that the petitioners were liable for penalties of specific dollar amounts, subject to the review by Appeals or the Tax Court, each letter offers to settle penalties arising from the distressed asset trust transactions on certain terms, including lower penalty rates, which are based not on an audit but on Announcement 2005-80.

Critically, the letters clarified that if the petitioners did not accept the settlement, Exam still had work to do, insofar as the IRS would need to complete its examination prior to assessing additional tax and penalties. This is not the type of concrete, unequivocal determination that is contemplated by IRC §6751(b)(1) and its body of interpretive case law, including Belair Woods. As such, and offer letter like the ones that issued does not require supervisory approval because it is not a “determination” at all, but a preliminary proposal of Exam within an ongoing examination.

(155 T.C. No. 5) Thompson v. Commissioner

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