In Legg v. Commissioner, 145 T.C. No. 13 (Dec. 7, 2015), the Tax Court looked at whether the Internal Revenue Service followed the procedural requirements of Internal Revenue Code Section 6662(h), which mandates the IRS to make an “initial determination” of whether a taxpayer is liable for a 40 percent accuracy-related penalty before it imposes the penalty. The court held that the IRS properly made an “initial determination,” and the taxpayers were liable for accuracy-related penalties for a gross valuation misstatement.
Donation Value of the Easement
In 2007, Brett and Cindy Legg donated a conservation easement to a Colorado trust. On their federal income tax returns for that year, they valued their donation at $1,418,500 and claimed a charitable contribution deduction. For the next three tax years, they claimed carryover charitable contribution deductions.
The IRS determined that the Leggs didn’t meet the legal requirements for a charitable contribution deduction or alternatively, that the donated property had a value of zero. The IRS concluded that the Leggs had thus underpaid tax for each of the tax years at issue. An IRS examiner determined, in writing, that that the Leggs were liable for 20 percent accuracy–related penalties under Section 6662(a) or in the alternative, for 40 percent penalties under Section 6662(h) for gross valuation misstatement. An IRS supervisor signed the IRS examiner’s report regarding the Leggs’ liability for the penalties.
Stipulations and Settlements
The Leggs and the IRS stipulated that the Leggs satisfied the legal requirements for a charitable contribution deduction and that the value of the easement was $80,000. However, the IRS mailed a notice of deficiency to the Leggs, advising them that they were liable for 40 percent penalties due to a gross valuation misstatement. The penalties in the IRS examiner’s report, however, were calculated based on the 20 percent accuracy related rate.
The Leggs filed a written protest with the IRS Appeals Office in 2011. In 2013, the IRS Appeals Office issued a decision agreeing with the IRS examination report and affirming that penalties should be imposed. The Appeals Office stated that the 40 percent gross valuation misstatement penalties should be the IRS’ primary position, because the conservation easement value the Leggs reported on their tax returns exceeded more than 200 percent of the correct value, which was zero. The Appeals Office also stated that the IRS should take the alternative position that 20 percent accuracy-related penalties should be imposed. In late 2013, the IRS issued a notice of deficiency, determining that the 40 percent gross valuation misstatement penalties under Section 6662(h) was appropriate.
The parties agreed to settle all issues except for the Section 6662(h) 40 percent gross valuation misstatement penalties. The parties agreed that the Leggs’ reported value of $1,418,500 was a gross misstatement of value, and they couldn’t assert a reasonable cause defense against the 40 percent penalty. The parties also agreed that the Leggs satisfied the reasonable cause defense against the 20 percent valuation misstatement penalties. Thus, the Tax Court’s sole determination was whether the IRS’ determination of 40 percent penalties under Section 6662(h) for gross misstatement of value was proper.
Computation of Penalties
The Tax Court first looked to IRC Section 6751(b)(1), which states that a penalty can’t be imposed unless an immediate supervisor personally approves, in writing, an initial determination by an examiner. The rationale behind Section 6751(b)(1) is that taxpayers are entitled to an explanation of how penalties are imposed.
The Leggs argued that the IRS examiner was the only person qualified to make an “initial determination” of penalties, and the examiner had determined that the 20 percent penalty was appropriate. The IRS argued, however, that Section 6751(b)(1) applies before penalties are assessed, not before the determination of penalties is made in a notice of deficiency. The Tax Court ruled that the timing of the determination of penalties, in this case, didn’t matter, because, as explained below, the IRS examiner properly made an “initial determination” regarding the 40 percent penalties.
The Leggs claimed that the examiner didn’t make an “initial determination” of the 40 percent penalties because: 1) he calculated the adjustment using the 20 percent penalty, which meant that 2) he didn’t consider imposing the 40 percent penalties. Thus, said the Leggs, the IRS supervisor couldn’t have approved in writing the imposition of the 40 percent penalties.
The IRS argued that the examiner had made an “initial determination” that the 40 percent penalties were appropriate and stated so in the report. The examiner used the 20 percent penalties, claimed the IRS, because he was uncertain whether he could impose the 40 percent gross valuation misstatement penalties if the donation of the conservation easement didn’t meet the charitable contribution deduction requirements of the IRC. This uncertainty was now resolved. And, even with the imposition of the 20 percent penalties in the report, the report contained a detailed analysis of the applicability of the 40 percent penalty. The IRS further claimed that because a supervisor approved the report in writing, the procedural requirement of Section 6751(b)(1) was satisfied.
Detailed Examiner Report
In ruling in favor the IRS, the Tax Court held that even though the 40 percent penalties were stated as an alternative position in the report, the IRS made an “initial determination.” The court stated that Congress enacted Section 6751(b) to make sure that taxpayers understood penalties imposed on them. In the instant case, the report was clear in its explanation of why the Leggs were liable for gross valuation misstatement penalties of 40 percent. The report was detailed in applying the law to the Leggs’ donation and concluding that the 40 percent penalty was appropriate.
Moreover, stated the Tax Court: “The fact that the respondent’s examiner calculated the penalties at a lower rate does not nullify the ‘initial determination’ that petitioners were liable for the 40% gross valuation misstatement penalties.” Because the 40 percent penalty was included as an alternative position in the report, the IRS satisfied the procedural requirements of Section 6751(b). Thus, the determination of Section 6662(h) penalties was proper.