A Taxpayer Victory on Section 6751(b) Grounds
Jesus R. Oropeza v. Comm’r, 155 T.C. No. 9 | October 13, 2020 | Lauber, J. | Dkt. No. 15309-15
Short Summary: The case involved the issuance of a notice of deficiency without the proper written supervisory approval provided by I.R.C. sec 6751(b)(1).
The IRS opened an examination to review Mr. Oropeza’s (the “taxpayer”) tax return for the 2011 tax year. The period of limitations for 2011 was set to expired on April 15, 2015.
On January 14, 2015, the revenue agent assigned to the case sent Letter 5153 and Form 4549-A to the taxpayer, proposing adjustments to his reported capital gains. The revenue agent report asserted a 20% penalty under section 66662(a) attributable to negligence, substantial understatement of income tax, substantial valuation misstatement or transaction lacking economic substance, without stating whether the IRS was asserting the penalty for one or more of these bases or for all four as alternative bases. Letter 5153 also gave the taxpayer three options: (i) agree to the proposed adjustments, (ii) extend the statute of limitations in case he wanted Appeals to consider the case or (iii) decline and wait for the issuance of the notice of deficiency. On the same date, the revenue agent completed the Civil Penalty Approval Form.
The taxpayer did not agree to the adjustments nor extended the period of limitations. The revenue agent closed the case on January 28, 2015 and the following day, his supervisor authorized the assertion of a 20% penalty for a substantial understatement of income tax. On May 2015, the revenue agent prepared and signed a memorandum addressed to the IRS Chief Counsel, where it recommended the increase of the 20% penalty to a 40% because the underpayment was attributable to a nondisclosed transaction. His manager signed this memo on the same date.
The IRS issued the notice of deficiency on May 6, 2015 where it determined a 40% section 6662(b)(6) penalty or in the alternative a 20% penalty based on negligence. Taxpayer filed a petition against such determination and claimed that the IRS did not obtain a timely supervisory approval for the 40% penalty and the alternative 20% penalty for a substantial understatement. The Tax Court agreed with the taxpayer and ruled that the IRS did not met the timely supervisory approval requirement as provided by I.R.C. section 6751(b)(1).
Key Issues: (i) Whether the IRS complied with section 6751(b)(1) before the issuance of the revenue agent report; (ii) Whether the revenue agent report should be read as asserting a penalty under section 6662(a) and (b)(6); (iii) Can the IRS satisfy section 6751(b)(1) by a later determination that section 6662(i) applied because the transaction was not disclosed on the return.
Primary Holdings: (i) The IRS did not satisfies the requirements of section 6751(b)(1) when it issues a Letter 5153 and a revenue agent report communicating the taxpayer its definite determination to assert a 20% penalty, and obtains supervisory approval after such communication. (ii) Section 6662(i) does not impose a different penalty that those provided in sections 6662(a) and (b)(6), and if the IRS fails to satisfy section 6751(b)(1), no penalty exists to which section 6662(i) could be applied.
Key Points of Law:
Section 6751(b) establishes that no penalty can be assessed by the IRS, unless the initial determination of such assessment is personally approved by the immediate supervisor of the individual making the determination. An initial determination is embodied in a letter “by which the IRS formally notified the taxpayer that the Examination Division has completed its work and had make a definite decision to assert penalties”. See Belair Woods, LLC v. Commissioner, 154 T.C. 1, 14-15 (2020).
In this case, Letter 5153 constitutes an initial determination considering the options that it offered to the taxpayer: to accept the adjustments, to extend the period of limitations and go to Appeals or receive the notice of deficiency. Whatever the election made by the taxpayer, the Court argued that it was clear that the Examination Division had completed its work, and its remaining responsibilities were only “ministerial” in nature. Based on this premise, supervisory approval must be obtained for the penalty assessed by Letter 5153, which did not occur in the instant case.
As for the second and third questions concerning whether the revenue agent report should be read as asserting a penalty under section 6662(a) and (b)(6) and whether the IRS satisfies section 6751(b)(1) by a later determination that section 6662(i) applied because the transaction was not disclosed on the return, the Court reasoned as follows:
Section 6662(a) provides a penalty of 20% of the portion of the underpayment attributable to one or more of eight specified grounds, which includes the “disallowance of claimed tax benefits by reason of a transaction lacking economic substance” provided by 6662(b)(6).
Section 6662(i) provides that in the case of any portion of an underpayment which is attributable to one or more undisclosed noneconomic substance transactions, subsection (a), meaning section 6662(a), shall be applied with respect to such portion by substituting 40% for 20%. In the Court’s eyes, Section 6662(i) does not constitute or imposes a different penalty but rather, it simply provides an increase of the rate of the penalty imposed by Section 6662(a) and (b)(6).
Under this approach, a revenue agent report that uses language that asserts a 20% penalty attributable to multiple grounds, or in other words, that uses a “boilerplate determination of an accuracy-related penalty”, will be seen by the Court as an assessment of the penalty for each of such grounds, unless other portion of the communication explicitly limits the penalty determination to a subset of the grounds. Consequently, the IRS must secure timely supervisory approval for all these grounds, which did not occur in this case.
Secondly, section 6662(i) does not impose a different penalty than section 6662(a) and (b)(6) but rather it is similar to an “aggravating factor” in criminal law that justifies a harsher penalty for the basic offense. Moreover, legislative history supports the view that the 20% and the 40% enhancement penalty constitute a single penalty. Statutory interpretation also favors this view, in section 6664(c)(2) which provides the reasonable cause defense, applicable to penalties, does not mention section 6662(i)but only mentions 6662(b)(6), making it clear that Congress intended the reasonable cause to be not available for the for the 40% and the 20% version of the penalty.
Considering these arguments, the Court concludes that section 6662(a) and (b)(6) and 6662(i) constitute a single penalty, for which timely supervisory approval is required. If such approval was not obtained for the 20% version of the penalty, there is no penalty, consequently, there can be no increase of the rate of an inexistent penalty. The Court argued that the policy underlying section 6751(b)(1) supports this conclusion and prevents situations where the IRS fails to obtain approval for the basic version and later assess an increased penalty, creating a dilemma to the taxpayer who will have to decide between making concessions to the first penalty or risk to a higher penalty.
Insight: This case presents a new argument to taxpayers in cases where the IRS uses boilerplate language to assess penalties under multiple grounds of section 6662(b). First, the IRS must comply with section 6751(b)(1) for all of the grounds mentioned in any assessment of penalties, and secondly, in cases where the IRS assesses a higher penalty under 6662(i), the taxpayer must verify if the IRS complied with section 6751(b)(1) for the penalties initially assessed under 6662(b).
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