IRS: Multiple penalties don’t need initial determination at same time or by same person

Tax Hot Topics newsletterThe Tax Court ruled on Feb. 28 that where the IRS asserts multiple penalties, the supervisory approval requirements of Section 6751(b)(1) do not require that the “initial determination” of all penalties be made at the same time, or by the same individual.

Under Section 6751(b)(1), penalties may not be assessed by the IRS unless the initial determination of such assessment is approved in writing by the immediate supervisor of the person making the determination. Congress enacted Section 6751(b)(1) to ensure that penalties would be imposed appropriately, and not used as a “bargaining chip.” See Chai v. Commissioner, 851 F.3d 190, 219 (2d. Cir. 2017)(quoting S. Rept. No. 105-174, at 65 (1998), 1988-3 C.B. 537, 601, aff’g in part, rev’g in part T.C. Memo. 2015-42.

In Palmolive Building Investors LLC et al. v. Commissioner, 152 T.C. No. 4 (Feb. 28, 2019), the Tax Court confronted the issue of multiple penalties initially determined and subsequently approved, by different people at different times. The taxpayer, which was a partnership, owned an office building in Chicago and executed a conservation easement deed that generated a charitable contribution deduction of approximately $33 million. The IRS examined the taxpayer’s tax return and concluded that the deduction should be disallowed and penalties should be imposed. In the Notice of Proposed Adjustment (NOPA), the agent proposed two alternative penalties: a gross valuation misstatement penalty under Section 6662(h)(1) and a negligence penalty under Section 6662(b)(1). The agent did not sign the NOPA, but his supervisor did.

Nevertheless, while the case was under consideration in Appeals Court, the appeals officer concluded that two additional, alternative penalties should be imposed. The appeals officer, on the proposed final partnership administrative adjustment (FPAA) proposed the 40% gross valuation misstatement penalty, and in the alternative, a 20% penalty due to (1) negligence or intentional disregard of the rules; (2) substantial understatement of tax; or (3) substantial valuation misstatement. The appeals officer’s supervisor signed the FPAA and the Appeals Transmittal and Case Memo.

The Tax Court addressed the issue of whether the penalties met the requirements of Section 6751(b)(1) and found that two of the penalties (gross valuation misstatement and negligence) were initially determined by the examiner, and that the other two penalties (substantial valuation misstatement and substantial understatement) were initially determined by the appeals officer.  In each situation, those penalties were communicated to the taxpayer after they had been approved by the supervisors.

The taxpayer argued that the examiner and the supervisor did not follow the Internal Revenue Manual’s (IRM) procedures for supervisory approval. The court was not sympathetic with that argument, ruling that the IRM does not carry the force of law and that regarding compliance by the IRS, the case law and regulations do not proscribe specific procedures with respect to the method of approval.  

The Tax Court’s decision in Palmolive comes just days after its decision in Walquist v. Commissioner, 152 T.C. No. 3 (Feb. 25, 2019), where the court addressed the issue of Section 6751(b) in the context of computer-generated penalties.

David Auclair
National Managing Principal
Washington National Tax Office
T +1 202 521 1515

Shamik Trivedi
Senior Manager
Washington National Tax Office
T +1 202 521 1511

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