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Business Tax

Proposed Penalty Assessment is not “Initial Determination”

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

The Tax Court has held that a Form 5701, Notice of Proposed Assessment, (NOPA) was not an “initial determination” of a penalty requiring written supervisory approval. Written supervisory approval is not required until the IRS’s first formal communication to the taxpayer that it has determined a penalty.

Background

A 40% penalty applies to a gross valuation misstatement under Chapter 1. (Code Sec. 6662(h))

Under Code Sec. 6751(b)(1), no penalty may be assessed unless the “initial determination” of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.

In Chai, (CA 2 2017) 119 AFTR 2d 2017-1158, the Second Circuit held that Code Sec. 6751(b)(1) requires supervisory approval of penalties to be secured no later than the date the IRS issues the Notice of Deficiency (NOD), or files an answer or amended answer asserting such penalty.

In Clay, (2019) 152 TC 223, the Tax Court held that Code Sec. 6751(b)(1) requires written supervisory approval of the “initial determination” of a penalty no later than the earlier of when

  • The penalty determination is communicated to the taxpayer in the form of a NOD, or
  • Another form of formal communication is sent to the taxpayer that both
    1. Advises the taxpayer that penalties were determined, and
    2. Gives the taxpayer the opportunity to appeal that determination.

In Belair Woods, LLC, (2020) 154 TC No. 1, the Tax Court held that the IRS’s issuance of a Letter 1807 and a summary report setting forth the Examination Division’s proposed adjustments and inviting the taxpayer to a conference to discuss them did not constitute the “initial determination” of a penalty that required prior supervisory approval under Code Sec. 6751(b)(1).

Facts

The IRS examined the 2009 returns filed by two related taxpayers, a media company organized as a corporation and a Limited Liability Company (LLC) baseball team taxed as a partnership. During the examination, the IRS held discussions on proposed adjustments, including the potential imposition of penalties against the taxpayers. Some of those discussions were held between IRS employees and other discussions between IRS employees and the taxpayers.

In the course of its discussions with the taxpayers, the IRS provided each of them with a NOPA, which included proposed gross valuation misstatement penalties. When the parties failed to come to an agreement regarding the proposed adjustments, the IRS issued an NOD to the media company and a FPAA to the baseball team LLC. Both the media company and the baseball team each filed petitions for review in the Tax Court, which consolidated the cases.

Parties arguments. The taxpayers argued that the 40% gross valuation misstatement penalty was not properly approved because the IRS examiner failed to obtain supervisory approval before the penalties were first proposed in the NOPA. The IRS argued that the penalty was properly approved because supervisory approval occurred before the NOD and the FPAA were issued.

Decision

The Tax Court held that the 40% gross valuation misstatement penalty was properly approved because Code Sec. 6751(b)(1) requires written supervisory approval of penalties before the IRS’s first formal communication to the taxpayers that it has determined a penalty and, in this case, the first formal communication to the taxpayers determining a penalty was the NOD and the FPAA that concluded the taxpayers’ examinations.

The Tax Court rejected the taxpayers’ argument that Code Sec. 6751(b)(1) required supervisory approval of the 40% penalty to occur before the penalties were first proposed to the taxpayer in the NOPA because that argument ignored the sense of formality implied by Congress’ use of the word “determination” in Code Sec. 6751(b)(1). According to the Tax Court, a “determination” is a written communication notifying the taxpayer of the IRS’s final decision. Thus, the NOPA was not a “determination” because it merely proposed the penalties and did not give the taxpayers the right to appeal those proposed penalties.

To continue your research on IRS management approval for non-computer generated civil penalties, see FTC 2d/FIN ¶V-1601.1A; United States Tax Reporter ¶67,514.02.

 

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