IRS Fraud Penalties, TEFRA, and Conservation Easements
A recent IRS Chief Counsel Memorandum addresses the issue of how the IRS determines the applicability of the civil fraud penalty in a TEFRA examination of a partnership involved in a syndicated conservation easement case. As we have discussed in multiple Insight posts, the IRS has prioritized enforcement efforts focused on syndicated conservation easements. See also Charitable Conservation Easements Remain Under Attack—The Latest IRS Data and Senate Finance Committee Releases Conservation Easement Data.
IRS Chief Counsel’s office provided the following position on the assertion of fraud penalties in the TEFRA context:
Under TEFRA, the IRS determines the applicability of the civil fraud penalty at the partnership level and then the penalty is directly assessed on the partners of the partnership through a notice of computational adjustment.
Section 170(f)(3)(B)(iii) of the Internal Revenue Code allows a deduction for a qualified conservation contribution. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. I.R.C. § 170(h)(1)-(5).
Section 6663(a) imposes a penalty equal to 75% of the portion of any underpayment which is attributable to fraud. In any proceeding involving the issue of whether a taxpayer has been guilty of fraud, the IRS has the burden of proving fraud and must do so by clear and convincing evidence.
Under TEFRA, the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item shall be determined at the partnership level. As a result, the IRS”s position, as announced in the recent CCM, is that “the fraud penalty under section 6663(a), as it relates to fraud on the partnership return, must be determined at the partnership level, even if there are partner-level determinations that may need to subsequently be made.”
The Service went on to further elaborate on its position as follows:
If fraud is established at the partnership level, then all partners will be liable for the fraud penalty on any underpayments of tax resulting from the adjustments to partnership items that are attributable to fraud (assuming the IRS can establish that the partner has an actual underpayment and assuming there are no partner-level defenses). In addition, if the IRS can also establish that an individual partner has an additional underpayment (unrelated to the adjustments to the partnership items that are attributable to fraud) for the same taxable year, that additional underpayment may be treated as attributable to fraud and subject to the section 6663(a) penalty. See I.R.C. § 6663(b).
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In a claim under section 6230(c), the applicability of the penalty determined at the partnership level is conclusive, and the partners may only raise partner-level defenses as to why the penalty should not be imposed. I.R.C. § 6230(c)(4). With respect to the fraud penalty on the partnership items that are attributable to fraud, this includes a reasonable cause defense. See I.R.C. § 6664(c)(1). With respect to the fraud penalty that may be applied to additional underpayments (unrelated to the adjustments to the partnership items that are attributable to fraud) for the same year, the taxpayer may avoid the penalty by establishing (by a preponderance of the evidence) that the additional underpayments are not attributable to fraud. See I.R.C. § 6663(b).
When it comes to partnerships, fraud is generally determined by conduct that occurred at the partnership level. See Arbitrage Trading, LLC v. United States, 108 Fed. Cl. 588, 608 (2013) (citing “the legislative intent that penalties be applied to partnership conduct in partnership-level proceedings”); Tigers Eye Trading v. Comm’r, 138 T.C. ); H.R. Rept. 105–148, at 594 (1997), 1997–4 C.B. (Vol.1) 319, 915–916. For purposes of penalties, the “partnership conduct,” including the partnership’s intent, is determined by looking to the conduct and intent of those managing the partnership. See Jade Trading, LLC v. United States, 81 Fed. Cl. 173, 176-77 (2008) (looking to the conduct of the managing member to determine whether the partnership acted negligent).
For more on conservation easements, see IRS Attorneys Issue Guidance for Imposing Civil Fraud Penalties on Syndicated Conservation Easement Transactions
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