Chai not Gaining Traction with Tax Court or IRS

Back in March, Steve blogged about the 2nd Circuit’s decision in Chai v. Commissioner reversing the Tax Court and finding that the IRS had a duty to prove that the immediate supervisor of the employee imposing a penalty met the requirements of the previously long forgotten IRC 6751.  The Chai decision came shortly after a fully reviewed Tax Court opinion in which the Court, in Graev v. Commissioner, held that the IRS did not have a duty to prove that the immediate supervisor had signed.  See my blog post here.  The 2nd Circuit essentially adopted the views of the dissent in Graev.  Because appellate venue for Graev lies in the 2nd Circuit, the decision in that case will unlikely stand; however, the opinion can still provide precedent for Tax Court cases appealable to other circuits as the Tax Court applies its Golsen rule.  This post will focus on what is happening post-Chai and how that might impact your clients who are unable to move to New York City or other fine locations in the 2nd Circuit.

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The first matter to discuss is Graev.  The IRS has chosen not to roll over and accept Chai as applying in a way that resolves the Graev case.  The IRS filed a motion with the Tax Court asking it to reconsider its opinion in Graev in light of the Chai decision.  The critical paragraph of the motion states:

“Respondent requests that the Court vacate its decision in this case and order additional briefing on what steps the Court should take in this case in light of the Chai opinion. Respondent has views which it believes will benefit the Court to consider in the changed circumstances of this case.”

The Tax Court granted this motion and issued an order vacating the decision and requiring the parties to file simultaneous briefs by June 1, 2017.  The petitioner and respondent timely filed these briefs.  The Court ordered the parties to file responsive briefs by June 20; however, petitioner filed a motion requesting until June 30 to file responsive briefs and permission to file a response to the responsive briefs by July 31.  The Court granted petitioner’s request so it will be at least a month before this case becomes fully at issue again.

The vacation of the decision raises an interesting question with respect to the Golsen rule.  Does the Graev opinion control future decisions of the Tax Court if the decision in the case is vacated at the request of the government?  The answer to that question appears to be yes as discussed further below.

While you might have expected that the IRS requested the vacation of the decision in Graev so that it could concede the IRC 6751 issue, the IRS has taken the fight to a new level, and in fact, in the first post-Chai brief filed in the Graev case, the IRS did not even cite to Golsen.  The brief filed by Frank Agostino’s firm cited Golsen four times and devoted the first of six sections of the brief to this issue.  In the statement of the case, petitioner’s brief states:

The issue is whether the rule in Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), and the United States Court of Appeals for the Second Circuit’s opinion in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), aff’a in part and rev’a in part, T.C. Memo. 2015-42, 109 T.C.M. (CCH) 1206 (2015), require this Court to vacate its decision determining the Graevs liable for 20% accuracy-related penalties under section 6662(a) and instead enter a decision for the Graevs adjudging them not liable for the penalties because the Commissioner failed to comply with the written-approval requirements of section 6751(b)(1).

So, the next opinion by the Tax Court in this case will have the opportunity to decide a number of issues concerning the application of the 2nd Circuit’s decision on the these types of cases.  Petitioner frames the issues in this manner:

The Second Circuit’s opinion in Chai requires this Court to vacate the March 7th Decision for five reasons. First, Chai is controlling in this case pursuant to the rule in Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), because this case is appealable to the Second Circuit, because the holdings in Chai are squarely on point and the facts are indistinguishable, and because the failure to follow Chai would result in inevitable reversal upon appeal.

Next, in rejecting the majority’s holding and reasoning in Graev II that the 6751(b)(1) issue was not ripe in a deficiency proceeding (i.e., it was premature), the Second Circuit in Chai held that the issue of the Commissioner’s compliance with the requirements of section 6751(b)(1) is ripe for review in a deficiency proceeding.

Third, by rejecting the concurrence’s holding and reasoning in Graev II that the Commissioner’s failure to comply with the written-approval requirements of section 6751(b)(1) is excusable as harmless error, the Chai Court held that the written-approval requirement in section 6751(b)(1) is a “mandatory, statutory element of a penalty claim” that is not subject to harmless error analysis.

Fourth, the facts of this case, as found in Graev I and Graev II, require a holding that the Commissioner did not comply with the requirements of section 6751(b)(1) in determining the 20% accuracy-related penalties at issue.

Fifth, the Chai Court rejected the Commissioner’s contention that an amended answer filed by his attorneys can cure his failure to comply with the written-approval requirement of section 6751(b)(1) because compliance at the time of the initial determination is a “mandatory, statutory element.” Thus, the Court must vacate the March 7th Decision and its determination that the 20% accuracy related penalties may be assessed.

In contrast, the IRS frames the issues as follows:

Because this case is appealable to the Second Circuit, this Court’s holding in Graev v. Commissioner, 147 T.C. No. 16 (2016), regarding the timing of the supervisory approval of the initial determination of a penalty assessment cannot stand on appeal. Therefore, this Court must face additional issues regarding whether there was adequate supervisory approval of the initial determination of a penalty assessment in this case.

Those issues are: (1) whether the timely supervisory approval of a 40 percent accuracy-related penalty was, in effect, approval of the alternative position of the 20 percent penalty; (2) whether an attorney’s recommendation to include the 20 percent penalty in the statutory notice of deficiency, which recommendation was approved and adopted, can constitute the initial determination of the penalty assessment in this case; and (3) if a penalty assessment arises from an assertion raised in the amendment to answer in this case, whether the initial determination of that penalty assessment was made by the attorney who asserted the penalty in the amendment to answer. To avoid the potential for piecemeal litigation of these issues, respondent requests a ruling on each one even if the Court decides more than one issue in respondent’s favor.

So, the next phase of Graev could focus on the ability of the Chief Counsel attorney and the supervisor of that attorney to initiate and provide the appropriate supervisory approval.  If the IRS wins this argument, it will win the case and it will avoid the problem that occurs in cases in which Chief Counsel attorneys in the answer or subsequent pleadings change the penalty from the penalty imposed by the Commissioner in the notice of deficiency.  We will closely watch the case and keep you informed.

Meanwhile, there are many other cases in which petitioners have suddenly decided to raise the failure of the IRS to obtain the proper supervisory approval for a penalty.  We blogged about such a case decided almost immediately after Chai.  A more recent case shows another side.  On June 12, 2017, Judge Lauber issued an order in the case of Zolghadr v. Commissioner in which he rejected their Chai argument for two reasons.  First, petitioners did not raise the argument in time in a deficiency case.  Remember that both Chai and Graev were also deficiency cases where  the timing of raising the argument was also a concern.  Second, and more important for this discussion, he addressed the merits and the current viability of Graev stating:

“Alternatively, even if petitioners’ argument were timely, their reliance on Chai is misplaced because this case is appealable to the U.S. Court of Appeals for the fourth Circuit, not to the U.S. Court of Appeals for the second circuit, which decided the chai case.  For cases in which the appellate venue is a court of appeals other than the second Circuit, the applicable Tax Court rule is that enunciated in Graev v. Commissioner, 147 T.C. (slip. Op. at 42 n.25).  Under that case respondent has no burden of production to demonstrate compliance with section 6751(b).”

While we are waiting for the “final answer” in Graev, you should not wait to raise the IRC 6751 argument in your case.  In addition, you now know that at least one judge on the Tax Court views Graev as controlling which means you may have to move your case into the applicable circuit court if your client lives outside the Second Circuit.  I think Judge Lauber’s view of the current applicability of the Golsen rule as it applies to Graev is a view shared by other judges on the Tax Court.  Do not expect to roll into Tax Court citing Chai and automatically winning.

More Fallout from Chai

The Second Circuit reversed the Tax Court’s decision in Chai v. Commissioner and made clear that the IRS had a duty to show it complied with the managerial approval process required by IRC 6751 prior to issuing a notice of deficiency.  Steve blogged on that decision last week.  We also posted last week on a designated order issued by Judge Cohen requiring compliance with IRC 6751 and citing Chai.  Judge Lauber issued a similar order.

On Friday the IRS took the very unusual step of filing a motion for reconsideration of the Graev v. Commissioner decision.  We reported on Graev here.  The Second Circuit largely adopted the view of the dissent in Chai.  Because the appeal in Graev would go to the Second Circuit, it was clear that the opinion would not stand.  Potentially preempting an appeal, the IRS has asked the Tax Court to reconsider its opinion in Graev.  Here is the relevant language of the motion, which can be found here:

  • Relief is justified here because a recent decision by the United States Court of Appeals for the Second Circuit created “exceptional circumstances” for this case.
  • On March 20, 2017, the United States Court of Appeals for the Second Circuit released an opinion in Chai v. Commissioner, No. 15-1653 (2d Cir. Mar. 20, 2017).
  • The Second Circuit’s opinion in Chai specifically disagreed with the majority opinion in this case. Chai, slip op. at *57, 59.
  • The court in Chai held that compliance with section 6751(b) is an issue in deficiency cases because it is part of Docket No. 30638-08 – 3 – respondent’s burden of production for penalties under section 7491(c). Chai, slip op, at *67.
  • Because an appeal in this case would be heard by the Second Circuit, the majority’s opinion in this case cannot be upheld under the precedent established by Chai.
  • Respondent requests that the Court vacate its decision in this case and order additional briefing on what steps the Court should take in this case in light of the Chai opinion. Respondent has views which it believes will benefit the Court to consider in the changed circumstances of this case.

It will be interesting to learn the views of the IRS on how Chai will impact its operation.  The IRS did not suggest what “views it believes will benefit the Court.”

We will keep you posted.  If you are contesting a case in Tax Court in which the IRS asserted a penalty, expect the IRS to begin a search of its records to determine if the required approval of the penalty occurred.  If the IRS does not come forward with the information proving the correct approval occurred prior to the issuance of the notice of deficiency, you may have a clear path to victory on the penalty.

Almost Immediate Impact of Chai

On March 21, Steve blogged about the important decision of the 2nd Circuit in  Chai v. Commissioner on March 20, holding that the IRS most show, as required by IRC 6721(b), that the immediate manager approved the imposition of a penalty.  In a designated order enter on March 22, 2017, in Henderson v. Commissioner, Docket No. 14187-16L, Judge Cohen cites to the Chai decision in a ruling on the motion for summary judgment filed by the IRS in this Collection Due Process Case.  Like the order in Vigon v. Commissioner issued by Judge Gustafson which we blogged about here, Judge Cohen requires the IRS to address the requirement of IRC 6751(b).  Specifically, she orders “on or before April 10, 2017, respondent may supplement the motion for summary judgment with any additional affidavit or argument concerning compliance with the requirements of law and administrative procedures supporting the notice of determination in this case, specifically with respect to compliance with Internal Revenue Code Section 6751(b)(1)….”

The fact that she added the requirement to show appropriate approval and that she made this order a designated order, signals what may be an important shift on the Court regarding the practice it will now take regarding the IRS obligation to prove the appropriate approval of penalties.  We will continue to monitor this issue because it suggests a potentially huge shift in practice.  Kudos again to Frank Agostino and the attorneys in his office for identifying and pursuing the argument in a statute that lay forgotten for almost 20 years.

For those of you not familiar with designated orders, the Tax Court has a wonderful feature available on the front page of its web site in which it posts the orders entered each day and provides a feature making the orders are searchable.  The searchable feature of the orders makes the Tax Court’s treatment of them vastly superior to PACER.  The feature became available in 2011 limiting the lookback period but that limitation grows less important with each passing day.  As the orders get posted, the judge issuing the order has the opportunity to “designate” the order.  If the judge designates the order, the judge is signaling that the order is somewhat special – at least in the view of that judge.  Keep in mind that orders do not go through the review in the Chief Judge’s office prior to issuance as is required with opinions.  Matters decided by orders also do not have precedential value as we have discussed before.  Yet, a not insignificant percentage of Tax Court cases get resolved through dispositive orders rather than opinions.  Designated orders allow the judge to alert practitioners that something about the order deserves attention; however, the designation of the order does not require, or really provide for, the judge to state explicitly why the judge has labeled it as a designated order.  The reader must surmise from context why the judge has chosen to designate the order.  On any given day the Tax Court may post five orders and maybe one order will be designated.

In the case of the order in the Henderson I surmise that Judge Cohen designated it because of the citation to Chai and the requirement that the IRS put on its proof about the authorization of the penalty.  This blog has regularly mined orders, and especially designated orders, as a source of information about Tax Court procedure that often goes unnoticed.  As mentioned before, Carl Smith has generally served as our eyes and ears on the Court’s orders.  We have decided to begin regularly posting about designated orders from the prior week in order to alert readers to those orders the judges on the Court deem most important.

The Henderson order, citing to Chai in a case which appears appealable to the 9th Circuit and not the 2nd, suggests a new day has dawned for the IRS in meeting its obligation when it asserts a penalty.  We will be watching closely for other orders and opinions.

Second Circuit Tosses Penalties Because of IRS Failure To Obtain Supervisor Approval

–Or, Tax Court Burnt by Second Circuit’s Hot Chai

Yesterday the Second Circuit decided a very important decision in favor of the taxpayer pertaining to the Section 6571 requirement that a direct supervisor approve a penalty before it is assessed.  In Chai v. Commissioner, the Second Circuit reversed the Tax Court, holding the Service’s failure to show penalties were approved by the immediate supervisor prior to issuing a notice of deficiency caused the penalty to fail.  In doing so, the Second Circuit explicitly rejected the recent Tax Court holdings on this matter, including Graev v. Commissioner, determining the matter was ripe for decision and that the Service’s failure prevented the imposition of the penalty.  Chai also has interesting issues involving TEFRA and penalty imposition that will not be covered (at least not today), and is important for the Second Circuit’s rejection of the IRS position that the taxpayer was required to raise the Section 6571 issue.   It is lengthy, but worth a read for practitioners focusing on tax controversy work.

PT regulars know that we have covered this topic on the blog in the past, including the recent taxpayer loss in the very divided Tax Court decision in Graev v. Commissioner.  Keith’s post on Graev from December can be found here.  For readers interested in a full review of that case and the history of this matter, Keith’s blog is a great starting point, and has links to prior posts written by him, Carlton Smith, and Frank Agostino (whose firm handled Graev and also the Chai case). Graev was actually only recently entered, and is appealable to the Second Circuit, so I wouldn’t be surprised if the taxpayer in that case files a motion to vacate based on the Second Circuit’s rejection of the Tax Court’s approach in Greav.

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Before discussing the  Second Circuit holding, I will crib some content from Keith, to indicate the status of the law before yesterday.  Here is Keith’s summary of the holding in Graev:

The Court split pretty sharply in its opinion with nine judges in the majority deciding that the IRC 6751(b) argument premature since the IRS had not yet assessed the liability, three judges concurring because the failure to obtain managerial approval did not prejudice the taxpayers and five judges dissenting because the failure to obtain managerial approval prior to the issuance of the notice of deficiency prevented the IRS from asserting this penalty (or the Court from determining that the taxpayer owed the penalty.)

That paragraph from Keith’s post regarding the holding doesn’t cover the lengthy and nuanced discussion, but his full post does for those who are interested.  The Second Circuit essentially rejected every position taken by the majority and concurrence in Graev, and almost completely agreed with the dissenting Tax Court judges (with a  few minor differences in rationale).

For its Section 6751(b) review, the Second Circuit began by reviewing the language of the statute.  It highlighted the fact that the Tax Court did the same, and found the language of the statute unambiguous, a conclusion with which the Second Circuit disagreed.

Section 6751(b)(1) states, in pertinent part:

No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination…[emph. added]

The Tax Court found the lack of specification as to when the approval of the immediate supervisor was required allowed the immediate supervisor to approve the determination at any point, even after the statutory notice of deficiency was issued or the Tax Court reviewed the matter.

The Second Circuit, however, found the language ambiguous, and the lack of specification as to when the approval was required problematic.  The Second Circuit stated “[u]understanding § 6751 and appreciating its ambiguity requires proficiency with the deficiency process,” and then went through a primer on the issue.  To paraphrase the Second Circuit, the assessment occurs when the liability is recorded by the Secretary, which is “essentially a bookkeeping notation.”  It is the last step before the IRS can collect a deficiency.  The Second Circuit stated the deficiency is announced to the taxpayer in a SNOD, along with its intention to assess.  The taxpayer then has 90 days to petition the Tax Court for review.  If there is a petition to the Court, it then becomes the Court’s job to determine the amount outstanding.  As it is the Court’s job to determine the amount of the assessment, the immediate supervisor no longer has the ability to approve or not approve the penalty.  The Second Circuit agreed with the Graev dissent that “[i]n light of the historical meaning of ‘assessment,’” the phrase “initial determination of such assessment” did not make sense.  A deficiency can be determined, as can the decision to make an assessment, but you cannot determine an assessment.

The Second Circuit then looked to the legislative history, and found the requirement was meant to force the supervisor to approve the penalty before it was issued to the taxpayer, not simply before the bookkeeping function was finalized.  The Court further stated, as I noted above, if the supervisor is to give approval, it must be done at a time when the supervisor actually has authority.  As the Court noted, [t]hat discretion is lost once the Tax Court decision becomes final: at that point, § 6215(a) provides that ‘the entire amount redetermined as the deficiency…shall be assessed.”  The supervisor (and the IRS generally) can no longer approve or deny the imposition of the penalty.  The Court further noted, the authority to approve really vanishes upon a taxpayer filing with the Tax Court, as the statute provides approval of “the initial determination of such assessment,” and once the Court is involved it would no longer be the initial determination.  Continuing this line of thought, the Second Circuit stated that the taxpayer can file with the Tax Court immediately after the issuance of the notice of deficiency, so it is really the issuance of the notice of deficiency that is the last time where an initial determination could be approved.

This aspect of the holding is important for two reasons.  First, the Second Circuit is requiring the approval at the time of the NOD, and not allowing it to be done at some later point.  Second, this takes care of the ripeness issue.  If the time is set for approval, and it has passed, then the Court must consider the issue.

Of potentially equal importance in the holding is the fact that the Second Circuit stated unequivocally that the Service had the burden of production on this matter under Section 7491(c) and was responsible for showing the approval. It is fairly clear law that the Service has the burden of production and proof on penalties once a taxpayer challenges the penalties, with taxpayers bearing the burden on affirmative defenses.   The case law on whether the burden of production exists when a taxpayer doesn’t directly contest the penalties is a little more murky (thanks to Carlton Smith for my education on this matter).  The Second Circuit made clear its holding that the burden of production was solely on the Service, and the taxpayer had no obligation to raise the matter nor the burden of proof to show the approval was not given.  The Service had argued the taxpayer waived this issue by not bringing it up earlier in the proceeding, which the Second Circuit found non-persuasive.

As to the substance of the matter, the Second Circuit held the government never once indicated there was any evidence of compliance with Section 6751.  Since the Commissioner failed to meet is burden of production and proof, the penalty could not be assessed and the taxpayer was not responsible for paying it.  A very good holding for taxpayers, and we would expect a handful of other case to come through soon.  Given the division within the Tax Court, and the various rationales, it would not be surprising to see other Circuits hold differently.

Judge Gustafson Continues His Primer for Chief Counsel Attorneys on Motions for Summary Judgment

I recently wrote about an order issued by Judge Gustafson in the case of Vigon v. Commissioner in which he explained to a Chief Counsel attorney what the attorney needed to provide in order to succeed in a motion for summary judgment in a case involving a penalty.  In the case of Hill v. Commissioner, Judge Gustafson continued his lessons to Chief Counsel attorneys on this subject.  It appears that the attorney in the Hill case may have missed my prior post since it came out before he submitted his motion and could have been helpful to him in drafting the motion.

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Judge Gustafson has the unusual background for a Tax Court judge of service as a career attorney at the Department of Justice Tax Division.  Few Tax Court judges have a background as career civil servants litigating cases for the government because becoming a Tax Court judge requires a political appointment and such appointments do not usually go to individuals who have spent their careers working for the federal government in the executive branch where opportunities for the kinds of relationships that lead to a political appointment do not come easy.  At the time of his appointment, Judge Gustafson was the chief of the court of claims section of the Tax Division.  That section, not surprisingly, represents the IRS in cases brought before the Court of Federal Claims.  The work in that section differs from the work in the other civil trial sections at the Tax Division because of the limitations of the Court of Federal Claims.  Attorneys in that section do not typically handle bankruptcy cases, do not get involved in collection suits brought by the government, do not have jury trials but do, like the Tax Court, have some unique jurisdictional issues because of the nature of that court and do handle large, high profile refund matters.  Like all civil trial sections at the Tax Division, attorneys in that section do have a substantial practice in motions for summary judgment.

Unlike Tax Division attorneys, Chief Counsel attorneys do not have a long tradition in summary judgment work.  Prior to the passage of the collection due process (CDP) provisions in 1998, summary judgment motions in Tax Court cases were rare.  Even after 1998, it took some time, maybe a decade or so, before Chief Counsel’s office settled upon summary judgment motions as a go to option for resolving CDP cases.  So, many of the managers in Chief Counsel’s office did not cut their teeth on summary judgment motions and may not be in the strongest position to review and guide the attorneys in preparing such motions.  Judge Gustafson, who would have prepared many summary judgment motions as a DOJ trial attorney and reviewed many as a supervisor there, is in a good position to provide guidance on these motions and he does so again in the Hill case.  Now, the question is whether the Chief Counsel attorneys are paying attention to his orders since orders do not get published by the Tax Court in a formal manner but do go up on the Court’s web site each day and can be searched by issue or by judge.  Because IRS attorneys may view summary judgment motions against pro se taxpayers as shooting fish in a barrel, they may not take the time to develop all of the evidence necessary to support such motions.  They are finding in the recent orders issued by Judge Gustafson that even unrepresented taxpayers may present a challenge in successfully obtaining a summary judgment if the Court carefully reviews the motions submitted.

The IRS assessed a frivolous tax submission penalty against Ms. Hill.  The case is set for trial on March 27, 2017.  The IRS filed a motion for summary judgment in the case on January 25, 2017.  The timing of the filing of the motion is not accidental.  For the first several years after the IRS adopted motions for summary judgment as their go to option for CDP cases, they tended to file the motions the week before the trial calendar.  Carl Smith and I wrote about this in an article back in 2011.  The Tax Court changed Rule 121(a) regarding the timing of filing motions for summary judgment in 2011 to require that they be filed at least 60 days before the calendar.  The Tax Court rule drove the timing of the IRS filing of the motion on January 25 for a calendar 61 days later.  Keep in mind that some Chief Counsel attorney had this case in their inventory since shortly after it was filed on March 30, 2016.  CDP cases do not go back to Appeals after the filing of the petition since the notice of determination always issues from Appeals.  Chief Counsel attorneys each handle many cases.  Here the attorney decided to wait to the very last minute to file the motion for summary judgment.  There could be many reasons for the timing of the filing including that the case was only recently assigned to the attorney filing the motion but the timing of the motion was typical of the cases I see.  As with the Vigon case, Judge Gustafson did not wait until the last minute to issue his order in response to the summary judgment motion and did not require a response from the pro se taxpayer.

Judge Gustafson finds that the IRS did not support some of the factual predicates in the motion as required by Tax Court Rule 121(d), sent. 3 and did not address patent legal questions.  The IRS did not attach the allegedly frivolous return to the motion.  So, the Court could not see what made the return frivolous.  The Court describes the Form 12153 submitted by petitioner as containing “handwritten notations, words, and symbols, none of which we can understand” together with a four page handwritten attachment of “similarly indecipherable writing.”  The description raises my curiosity and reminds me of some handwritten law school exams I have had to grade.  The Court goes on to say that the written matter “does not appear to assert typical tax protestor contentions.”  This is important if you remember the types of things that can trigger the frivolous return penalty which we have discussed in a prior post.  The gibberish, if that is the right word, made it past the IRS filters for frivolous CDP requests (also discussed here and here) which differ from the filters for application of the frivolous return penalties.

The notice of determination issued by Appeals interpreted the difficult to read Form 12153 as one in which it could not determine if the petitioner intended to dispute the liability and so it did not seek to determine if the IRS should have asserted the frivolous return penalty.  The Court, however, assumes that it did.  Apparently, Appeals made no mention of a prior opportunity to contest the penalty which might have barred petitioner from raising the penalty in the CDP hearing.  Since Appeals did not consider the merits of the penalty and since Counsel did not attach the allegedly frivolous return to the motion, the motion will fail at least in part but the failure does not stop here.  The Court notes that on the penalty issue the IRS bears at trial the burden of production under IRC 7491(c) and the burden of proof under IRC 6703(a) which it fails to meet.

The liability at issue here is a penalty which raises the issue of appropriate approval which raises the issue of verification by Appeals.  Appeals determination makes no mention of its efforts to verify the IRS gave the necessary approval for assertion of the penalty as required by IRC 6751(b)(1).  The motion for summary judgment does not address this issue.  To show compliance with this issue, which the IRS would have known had it read Judge Gustafson’s order from December in the Vigon case, it “must show (1) the identity of the individual who made the “initial determination”, (2) an approval “in writing”, and (3) the identity of the person giving approval and his or her status as the “immediate supervisor”.”  The IRS failure to address any of these elements in its motion, including attaching the Form 8248 designed for this purpose dooms the motion.

I suspect that the Vigon and Hill motions for summary judgment are not the only ones out there in which the IRS has failed to meet its burden under section 6751.  The IRS routinely files summary judgment motions and often does so in rote, cookie cutter fashion based on the last summary judgment motion it filed.  A high percentage of cases have penalties.  Until it clears out of its system the summary judgment motions that fail to mention the verification process, it may be easy to push back on such motions.  Of course, many of these motions involve pro se taxpayers.  It will be interesting to see if other judges begin to push back as Judge Gustafson has done on this issue.

 

 

 

 

Verifying the Approval of the Immediate Supervisor As Required by IRC 6751

Last month we wrote about the fully reviewed Tax Court opinion in Graev v. Commissioner, 147 T.C. No. 16 (Nov. 30, 2016) in which the majority of a deeply divided Court held that the Court could not decide if the IRS had failed to follow the requirement in 6751 that the IRS obtain managerial approval before assessing a penalty because the assessment had not yet occurred.  The majority suggested that the taxpayer could raise the issue in a Collection Due Process (CDP) case after the assessment but not a deficiency case.  The Graev case was heard by Judge Gustafson though he ended up writing the dissent in the case once it went to Court conference.  Conveniently, a CDP case involving 6751 just happened to be pending in Judge Gustafson’s inventory and unfortunately for the Chief Counsel attorney, who filed a not carefully worded motion for summary judgement, it came up right after the Graev decision was issued.  The Chief Counsel’s attorney’s misfortune was good luck for practitioners following this issue since it allowed Judge Gustafson to highlight the language of the statute he had recently discussed with his colleagues in Court conference and point out what the IRS must do if it wants to prove its 6751 case.  Chief Counsel attorneys filing summary judgment motions in future CDP cases may want to pay attention to this order.

In Vigon v. Commissioner Judge Gustafson issued an order denying the motion for summary judgment filed by the IRS.  He did so for several reasons each of which deserves mention.  The case points out once again the importance of orders in Tax Court decisional matters even though orders have no precedent setting value.  The turnaround time on this order is worth noting.  We have discussed before the length of time it can take for a taxpayer to receive a decision from the Tax Court.  That was no problem here.  The motion for summary judgment was filed on December 21, 2016 and the order was entered on December 23, 2016.  Swifter justice could hardly have occurred.

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Background

The order entered on December 23, 2016, was not the first order entered in this case.  Petitioner requested place of trial in DC.  Petitioner indicated to the Court that he would have difficulty attending the trial because he was in Canada.  Then Chief Judge Thornton issued an order directing the clerk to send to petitioner information about how to resolve his case without trial.  The letter sent by the clerk is not available on the Court’s electronic docket but I presume it talks about settlement.  Settlement here may prove difficult because the issue appears to be the imposition of several frivolous tax submission penalties under IRC 6702(a).  Surprisingly, the IRS does not contest the ability of the taxpayer to raise the merits of his liability for these penalties because it generally takes the position that an administrative opportunity to contest the penalties prevents the taxpayer from raising the merits of standalone penalties in the CDP context.

When the case was scheduled for trial, petitioner’s wife wrote to the Court requesting a continuance because her husband was incarcerated. (As a side note I will mention that if he was incarcerated in Canada at the time he received his CDP notice it is surprising that he was able to timely file a CDP petition.  Being out of the United States imposes a significant barrier on receiving the notice and turning it around into a timely petition without the additional difficulty factor of the mail delays encountered by those who are incarcerated.)  Judge Gustafson granted the request for continuance but provided the following guidance to respondent in the second paragraph of his order:

“ORDERED that, no later than May 25, 2016, respondent shall file a motion for summary judgment or another appropriate motion. Presumably, respondent’s motion will undertake to show that the “verification” by the Office of Appeals pursuant to section 6330(c)(1) included a verification of compliance with section 6751(b)(1). See IRM pt. 25.25.10.8.1 (08-13-2015) (“Pursuant to IRC Section 6751(b), written management approval must be indicated before assessing the IRC Section 6702 penalty. This written managerial approval should be indicated on Form 8278”).”

 

The Chief Counsel attorney assigned to the case must have discovered that Appeals did not bother to verify compliance with 6751 as a part of its CDP verification process (shocking), and he came back to the Court requesting a remand of the case to Appeals to allow it to complete the verification process it missed during its initial consideration.  The Court granted this request.  The case went back to Appeals in late July or August of 2016 and returned to Chief Counsel’s Office in time for it to file the motion for summary judgement that is the subject of this post.  On the second trip through Appeals a verification of the approval required by 6751 occurred although, as discussed below, the verification did not satisfy the Court.

The December 23 Order

The first paragraph of the Order sets the tone for the problems the IRS faces in getting the summary judgement it has requested.  The Court states:

 

“Some of the factual predicate for the Commissioner’s motion is not “supported as provided in this rule”, Rule 121(d), sent. 3; and legal argument needed to address patent questions is not given in the motion. We will therefore not require Mr. Vigon to file a response but will deny the motion and will schedule this case for trial….”

 

The first problem with the motion that the Court addresses is that the IRS argued that the documents mailed to it that caused the imposition of the frivolous submission penalties were not amended returns; however, the Court points out that three of the nine documents in question had the amended return box checked.

Another problem with the motion for summary judgement concerned its description of the documents as returns.  The Court points out that three of the documents were unsigned and could not qualify as returns.

The most relevant problem for purposes of this post, however, comes with the verification of the immediate supervisor as required by IRC 6751.  Before analyzing the legal issue presented the Court makes the following observation about the verification:

 

“The Commissioner’s motion for summary judgment asserts that “before each of the I.R.C. section 6702 penalties was assessed, an immediate supervisor of the individual making the determination to assess the penalty approved that determination in writing”. The Forms 8278 do name an “Originator” on line 10a and a “Reviewer” on line 16. However, not in keeping with the remand memorandum, neither the motion nor any of its attachments (as far as we can tell) identify the person approving the penalty determination as being in fact the immediate supervisor of the individual making the initial determination of the penalty. (Rather, in an email to counsel (Ex. V), the settlement officer observed, “[T]he form 8278 shows a ‘Reviewer’ signature which everyone seems to constitute as a manager signature but it would be better presented in a court situation if the form was changed to notate Manager or Supervisor as the actual person signing the form.”)”

 

Leaving aside the statutory problem the IRS has with IRC 6702 and whether some the documents filed by petitioner meet the requirement of being a return, the Court focuses on the verification requirement under 6751 of approval.  The statute requires the approval of the immediate supervisor of the person making the penalty determination.  Although the statute would also allow approval by mangers higher up in the pecking order it does so by stating that those non-immediate supervisors must be delegated by the Secretary of the Treasury.  To date, the Secretary as not delegated anyone who can make this approval.  This means that the IRS must show, and Appeals must verify in a CDP case, that the immediate supervisor of the person making the penalty determination has approved the assertion of the penalty.

Looking at the description from Appeals described above, the form shows the signature of a reviewer but does not make clear that it is the signature of the immediate supervisor of the person making the determination.  The IRS fails to address this in its motion and instead glosses over it with a reference to the generic term of manager which is a broader term that immediate supervisor.  Because of a mismatch between the terms used by the IRS in its forms and in its arguments with the language of the statute, the Court denies the motion for summary judgment.

Conclusion

Perhaps the settlement letter sent almost two years ago by Chief Judge Thornton will gain increased importance or perhaps the IRS will seek to remand the case again to search to find out if the person signing the penalty approval form was the immediate supervisor of the person making the penalty determination.  The Vigon case points again to the problems the IRS encounters in administering this long forgotten and only recently focused upon requirement of the 1998 legislative changes.  If Mr. Vigon wins, he needs to send Frank Agostino a thank you note for bringing the issue to light and Judge Gustafson a note for requiring that the IRS adhere to the statute.  Because Mr. Vigon is representing himself and has sent in nothing in his defense that I can see on the electronic docket, he would have lost already if the Court were not actively looking out for his interests.  This puts a significant burden on the Court and one that it cannot always meet because the system is not designed for the judge to find all of the arguments that a taxpayer might want or need to make.

 

 

 

The Timing of Penalty Approval

On November 30, 2016, the Tax Court issued a fully reviewed opinion in the case of Graev v. Commissioner, 147 T.C. No. 16 addressing the issue of the requirement for managerial approval of penalties.  In the Restructuring and Reform Act of 1998 (RRA 98), Congress created IRC 6751 which requires managerial approval of penalties.  We have discussed this issue previously here, here and here, one post each by me, frequent guest blogger Carl Smith and Frank Agostino, respectively.  The Court split pretty sharply in its opinion with nine judges in the majority deciding that the IRC 6751(b) argument premature since the IRS had not yet assessed the liability, three judges concurring because the failure to obtain managerial approval did not prejudice the taxpayers and five judges dissenting because the failure to obtain managerial approval prior to the issuance of the notice of deficiency prevented the IRS from asserting this penalty (or the Court from determining that the taxpayer owed the penalty.)

A number of IRC 6751 cases have been bottled up waiting for this opinion.  Look for a number of cases to now come out on this issue and look also for some of these petitioners to take the issue to the next level.

Because I had an extensive email exchange with Carl Smith about this case, I have placed his comments at the end of the post for those interested in a more in depth review of the issues presented.

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This issue first came to my attention through Frank Agostino and fittingly, Frank represents the petitioners in this case.  As we have mentioned in prior posts, this issue essentially went unnoticed for almost 15 years after the passage of RRA 98.  After a TIGTA report highlighted that the IRS had failed to notice and follow this requirement, Frank picked up on the issue and began asserting that the IRS failed to follow the provision.  In Graev he made the argument but with somewhat unusual facts.  I will briefly discuss the facts before getting to the three different views on the issue expressed by the members of the Court followed by views on the opinions by Carl Smith and me.

Facts

Petitioners claimed a charitable contribution for a façade conservation easement on a home they purchased in a historic preservation district in New York City.  The easement was donated to the National Architectural Trust (NAT).  In a previous opinion, Graev v. Commissioner, 140 T.C. 377 (2013), the Tax Court held that petitioners could not claim a charitable contribution deduction for the donation of the easement because NAT gave them a side letter guaranteeing that it would return the contribution if the IRS disallowed the charitable contribution.

At the time of the contribution, some concern existed about the ability to claim a deduction for a contribution of the façade easement because of a Notice the IRS had issued on a different type of conservation easement but one with enough overlap to suggest that the IRS might not allow a charitable contribution deduction for the type of easement being contributed by the Graevs.  The opinion details the letters sent by NAT before and after the donation regarding pronunciations by the IRS and Congress on the donation of easements.  It also recounts the actions, or inaction, of the Graevs in the face of the correspondence.

The IRS did audit the return filed by Graevs claiming the contribution of the easement.  The agent not only proposed disallowing the contribution but also recommended the imposition of the 40% gross valuation misstatement penalty of section 6662(h).  The agent prepared the penalty approval form – a form the IRS devised specifically to meet the requirements of section 6751 – and his manager signed the form.  Because the agent could not reach an agreement with the taxpayers, he prepared a statutory notice of deficiency, which, due to the issue, required Chief Counsel review.  The reviewing attorney agreed with the notice; however, he recommended that the IRS add to it, as an alternative position, the imposition of the 20% penalty under 6662(a) and (b)(1) for negligence or substantial understatement.  The manager in Chief Counsel’s Office agreed with this recommendation.

The IRS added the alternate penalty to the notice of deficiency but the agent did not go back to his manager for approval of the alternate penalty.  In the first Tax Court case the Court determined that petitioners were not entitled to the charitable contribution deduction because the side letter created a subsequent event that was not “so remote as to be negligible.”  Because of the basis for the decision, the IRS conceded that the 40% penalty did not apply and argued that the 20% penalty did.

In defense to the application of the 20% penalty, the Graevs argued that the IRS did not comply with section 6751 because the agent’s manager did not approve the 20% penalty.

Majority

The majority determines that because the IRS has not yet assessed the liability a determination that it has failed to follow the requirements of section 6751 is premature.  The statute requires “written approval of the ‘initial determination of … assessment’ before a penalty can be assessed.  Notably absent from section 6751(b), however, is any requirement that the written approval of the ‘initial determination of … assessment’ occur at any particular time before the ‘assessment’ is made.”

This is a 106 page opinion.  The majority (and the dissent) goes into many aspects of the statute in reaching its conclusion.  The majority also spends time explaining why the dissent is incorrect.  We may come back with subsequent posts about the opinion but at its core is the view that the language of the statute requires approval before assessment and the Tax Court is a pre-assessment forum.  This facially logical view of the statute leads to trouble in the ability of a taxpayer to challenge the application of section 6751 and raises questions about the Tax Court’s role as a pre-assessment forum.  Of course the drafters of the statute might have thought a little more about that before writing it.

Concurrence

The concurring judges looked to the purpose for the statute which is to prevent the use of penalties as bargain chips.  Here, these judges found that even if the IRS did not strictly comply with the requirements of section 6751(b) the failure to do so did not prejudice petitioners.  These judges would defer the detailed analysis of the statute until presented with a case where the facts did raise the possibility of prejudice.

Dissent

The dissent would require that the IRS obtain managerial approval prior to issuing the notice of deficiency.  Because the IRS issued the notice prior to obtaining approval of the alternative position, it would not sustain the penalty.  The dissent discusses the role of the Tax Court in the assessment process and concludes that to properly fulfill that role it should address the penalty issue as presented in the notice of deficiency.

Conclusion

The majority opinion suggests a taxpayer should never raise IRC 6751 in Tax Court, or anywhere, until liability is assessed and raise it instead in the Collection Due Process (CDP) context after assessment.  This seems contrary to the purpose of Tax Court and puts taxpayers in an awkward position.  By allowing assessment to occur, the panoply of IRS collection options becomes available.  The Tax Court may anticipate that CDP is a process available to everyone for reentry into the Court for a determination but for low income taxpayers and taxpayers with relatively low liabilities, the IRS may collect via offset and fully satisfy the liability without the need to send a CDP notice.  Of course, the taxpayer whose liability is fully satisfied can sue for a refund but if the penalty is $1,200 on a liability of $6000 for wrongfully claiming the EITC, how practical is it to file an expensive suit in district court to contest this issue?

The case is before the Tax Court because the penalty, at least the penalty at issue in this case and in many cases, is a part of the notice of deficiency.  For the reasons stated by the dissent, the Tax Court has jurisdiction to decide the issue. This should not be a post-assessment question.  After all, to borrow from Judge Gustafson, section 6501 also precludes an assessment being made after the SOL has expired, but the Tax Court has a long history of considering compliance with section 6501’s requirements during the deficiency case – i.e. pre-assessment.

If the opinion of the majority stands up on appeal, taxpayers who know or think that the IRS did not obtain the appropriate approval prior to issuing the notice of deficiency should consider making no mention of 6751 during the Tax Court case for fear of alerting the IRS to the defect prior to the making of the assessment and allowing it to cure that defect.  Here, I assume that the IRS will obtain managerial approval before it makes the assessment.  One possible outcome of the case if it comes back to the Tax Court in the CDP context is that the post-decision, pre-assessment managerial approval will satisfy the language of the statute in the eyes of the judges in majority, and perhaps concurring, opinion.

Comments on Opinion by Carl Smith

In  footnote 22 on page 40, the court fairly acknowledges that it is likely just kicking the issue of compliance with section 6751(b) (whatever it means) down the road until a post-assessment Collection Due Process proceeding.  Doubtless, the 6751(b) issues that the court avoids today will have to be addressed in a Tax Court CDP opinion — perhaps even one that the Graevs bring after the penalties are formally assessed and a notice of intention to levy or a notice of federal tax lien (i.e., a ticket to a CDP hearings) is issued.  Query, though, whether challenging an assessed penalty under section 6751(b) in a CDP hearing is prohibited by the language of section 6330(c)(2)(B), which prohibits CDP challenges to underlying liability where a taxpayer has received a notice of deficiency — as the Graevs did?  Or is a section 6751(b) challenge one going to the procedural correctness of the assessment under section 6330(c)(1), not a prohibited underlying liability challenge?

In his concurrence, Judge Nega (joined by two other judges) suggests that a CDP case would be an appropriate case in which to decide the issues avoided by the majority.  On page 68, he writes:  “The failure of the IRS to follow the statute or its administrative practices may be challenged as an abuse of discretion in a collection action. That case is not before us.”

If one can’t challenge non-compliance with section 6751(b) through CDP, then Judge Gustafson points out a statute that might also preclude a later refund lawsuit over the penalty.  See his quote and brief discussion of section 6512(a) on page 78. n. 5.

If neither CDP nor a refund suit is the way to challenge non-compliance with section 6751(b), then taxpayers would be left without a remedy.  The anti-injunction act of section 7421(a) has an exception if no adequate remedy exists; however, probably the exception would not apply, and the act would likely preclude a suit to restrain assessment or collection of the penalty.  And section 7433, which provides a suit for damages from wrongful collection actions would not apply, since the issue being challenged here is an assessment issue, not a collection issue.

This opinion has been a long time in coming.  The case was originally with Judge Gustafson.  And he foreshadowed his dissent in a brief order he issued more than two years ago on July 16, 2014. Clearly, he wrote a proposed opinion along the lines of his dissent, but then at court conference, his opinion did not prevail and Judge Thornton got the assignment to write the majority opinion.  On the day the opinion was issued, an order reassigning the case from Judge Gustafson to Judge Thornton was also entered in the case.

There is an interesting new entry on the Tax Court docket sheet accompanying this opinion that I have never seen before when an opinion is issued.  It reads:  “Internet Sources Cited in Opinion”.  The problem of URL links to court opinions disappearing over time has been a large one for all courts.  Perhaps this is a warning to the Tax Court about what it must think about doing when the government printing office formally prints the opinion in a T.C. volume.  Will the Tax Court later be revising its opinions in the same way that Supreme Court judges currently do?  It is my understanding that the Supreme Court recently has changed its practices of modifying opinions that have already been published.  Now, the court will let the public know of the post-issuance changes to the opinions.  Will the Tax Court do the same?  Perhaps it is worth asking the clerk’s office what the purpose of this new entry on the docket sheet implies.

Finally, Judge Gustafson decides a lot of the questions under section 6751(b) on which the majority postpones ruling.  Judge Gustafson’s opinion is joined by four other judges.  Readers of the opinion should not jump to the conclusion that any of the judges in the majority would disagree with those rulings of Judge Gustafson on the issues on which the majority deferred ruling if the arguments are again presented in a case (presumably a CDP case) where those arguments are ripe.  Thus, this victory for the IRS in allowing a deficiency including penalties to be incorporated into the Tax Court decision may turn into no penalties ever being collected by the IRS if a court, in a future case, decides the deferred issues adversely to the IRS.

My worry about whether compliance with 6751(b) is merely a procedural compliance issue in a CDP case is based in part on the way that the Tax Court has treated compliance with 6501.  The Tax Court has refused to consider 6501 arguments in a CDP case if a taxpayer previously received a notice of deficiency.  But, I am pretty sure the Tax Court judges are going to treat 6571(b) compliance as a CDP procedural issue, since to treat it as an issue barred by 6330(c)(2)(B) would be to deprive a taxpayer of any possibility of judicial review of compliance with 6751(b).

 

Fulfilling the Requirements of Section 6751 When the IRS Imposes a Penalty

Even though it has been around for over 17 years, little attention has been paid to IRC 6751. In Legg v. Commissioner, the Tax Court issued a division opinion concerning this little known provision that serves as a gatekeeper to the assertion of many penalties.  At issue in the case is whether the IRS met the requirements of 6751 and could assert the gross valuation overstatement penalty.  We have discussed the penalty before here in a guest blog by Carl Smith and here in a guest blog by Frank Agostino.  Steve also discussed a recent case in a SumOp in which the court sidestepped whether this requirement applied to the trust fund recovery penalty.

Frank’s 2014 post was our first on this issue and set the scene. As he discusses, the sudden interest in this code section followed a 2013 TIGTA report critical of the IRS for not following the requirements of section 6751.  That report entitled, “Improvements Are Needed in Assessing and Enforcing Internal Revenue Code Section 6694 Paid Preparer Penalties,” found that eight percent of the completed section 6694 preparer penalty case files randomly sampled did not contain the proper documentation that the manager had appropriately approved the penalty in accordance with section 6751(b)(1).

Carl’s post in 2015 discusses some of the first opinions coming out in the Tax Court which came out as orders rather than reported cases. As Carl has discussed before, the Tax Court decides many cases through orders that often go unnoticed and uncounted by those who track that Court.  These cases also carry no precedential value as guest blogger Andy Grewal has discussed in posts (found here, here, and here) and in his recent article, The Un-Precedented Tax Court, but now we have an opinion on the issue with precedent.

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The cases mentioned in Carl’s post bear a similarity to the Legg case in that they all involve the valuation overstatement penalty. The fact that these cases come up in the context of this penalty is not surprising when you think about the representation involved in a gross valuation penalty case which usually accompanies a high dollar valuation case.  In these cases taxpayers will have sophisticated counsel who look for all possible issues unlike the run of the mill penalty cases where taxpayers represent themselves or the penalty gets attention only as an afterthought.  As discussed below, the penalty in the Legg case deserves attention all by itself because of its size and it receives that attention from petitioner’s counsel and from the Court.

The Leggs donated a conservation easement which they valued at over $1.4 million. The donation occurred in 2007 but limitations on the amount of charitable contribution they could use in one year caused the claimed donation deduction to occur for the next several years thereafter.  The IRS determined that the Leggs did not satisfy the legal requirements for charitable contribution deductions and, alternatively, if they met the legal requirements the actual value of the conservation easement donation was zero.  The examiner determined that the Leggs were liable for the 20% accuracy related penalty under 6662(a) but alternatively determined that they were liable for the 40% accuracy related penalty for gross valuation misstatement under 6662(h). The examination report itself calculated a 20% penalty.

The Leggs filed a protest and went to Appeals where the Appeals Officer agreed with the Examination Division except that the AO determined the primary position should be the 40% penalty with the 20% penalty as the alternate position. The notice of deficiency was issued by Appeals with this position.  In the Tax Court case the parties stipulated that the value of the donated easement was $80,000 or over $1.3 million less than claimed on the original 2007 return.  The Leggs argued that the IRS could not assert the 6662(h) penalty because that penalty had not been approved in writing by the immediate supervisor of the individual making the penalty determination as required by section 6751.

As a part of their argument, the Leggs took the position that section 6751 applies to the first notice the IRS sends to the taxpayer making the revenue agent the only person qualified to make an “initial determination” of the appropriate penalty and the revenue agent’s manager the supervisor who must approve. The Leggs further took the position that the revenue agent’s manager only approved the 20% penalty of 6662(a).

The IRS took the position that the section 6751 only applies to require a determination and approval before assessment of the liability at issue meaning that any penalties determined by respondent in the examination report or the notice of deficiency could obtain the necessary approval during the Tax Court proceeding. The Court skirts this question by determining that the revenue agent did make an initial determination concerning the 6662(h) penalties and, therefore, satisfied the requirement of the statute.  Before discussing how the Court came to that conclusion, the opinion clearly leaves unanswered a very important question of timing which must still be decided in the case that does not have the alternative penalty determination made here.

The Court notes that the term “initial determination” is not defined in the Code or Regulations. The IRS argued that the revenue agent examining the Legg’s 2007 return made an initial determination that the 40% penalty did apply even though the revenue agent calculated the penalty in the report at the lower 20% amount.  The revenue agent’s report was approved in writing.  The Court finds that the 40% penalty was determined and approved but did not become the primary position because of the uncertainty of the value at that stage of the case.  The purpose of the statute was to alert taxpayers to the basis for asserting a penalty.  The IRS provided enough information to place the taxpayer on notice of the penalty and how it was calculated.  Nothing in the development of the case surprised the taxpayers because of the amount of information in the report.

The precedent set by this case will allow the IRS to obtain a liberal view of its reports for purposes of section 6751 in circumstances in which the reports make mention of the possibility of a penalty and adequately describe the basis for assertion of the penalty. From the taxpayer’s perspective, having conservation easement cases lead the way may not be the best test vehicles.  These cases do not evoke a great deal of sympathy.  It would be better to lead with a more sympathetic case but it is what it is since there is not a good way to coordinate this litigation from the private sector.