The partnership case of RERI Holdings I, LLC v. Commissioner, No. 17-1266 (D.C. Cir May 24, 2019) recently decided by the DC Circuit addresses in part of the opinion an argument by petitioner that the penalty imposed by the IRS and sustained by the Tax Court should be abated because the IRS did not affirmatively prove that the initial supervisor timely and properly approved the imposition of the penalty. Carl discussed the Tax Court opinion and set up the argument presented in the appeal of this case in a post here. The DC Circuit determines that petitioner could not raise this issue on appeal where it did not raise the issue below sustaining the imposition of the penalty. Thanks to Carl for noticing the decision and providing some of the write up.
This is a charitable contribution case where the substantive issue was substantial compliance with the requirement to complete a Form 8323, where the taxpayer left the line for basis blank. Petitioner claimed a huge charitable contribution for a gift of land to the University of Michigan. The IRS disallowed the deduction and imposed a penalty for gross overvaluation.
The Tax Court held that the basis was necessary — even applying the rule that substantial compliance would be enough. On appeal, the Department of Justice (DOJ) argued that there should be a much higher level of test than substantial compliance, but the D.C. Cir. found it unnecessary to decide the legal issue, since it agreed with the Tax Court that, even if the substantial compliance rule applied, the omission of the basis did not satisfy substantial compliance. If you are interested in this issue, the opinion goes into some detail. This post will focus on the IRC 6751(b) issue also raised by petitioner.
The Circuit Court took relatively little time in agreeing with the Tax Court that the contribution should not be allowed and spent most of its time in the opinion with various issues regarding the penalties imposed. One issue the taxpayer raised in the appeal was that the IRS hadn’t introduced into the Tax Court record evidence of compliance with 6751(b). Citing Chai, the taxpayer argued that the IRS hadn’t met its burden of production on the penalty. (BTW, RERI is a TEFRA partnership and so the Tax Court would probably today hold that 7491(c), which applies to individuals, doesn’t shift the burden of production to the IRS on the 6751(b) issue, but the D.C. Cir. makes no mention of the TEFRA issue and doesn’t decide who has the burden of production,) The D.C. Circuit, unlike Chai, holds that the taxpayer waived the issue by not raising it in the Tax Court. Here’s what the D.C. Circuit wrote on this point:
RERI asks us to excuse its failure to raise this argument before the Tax Court on the ground that prior to Chai it did not clearly have a claim the IRS violated § 6751(b)(1). Fiddlesticks. The fact is that when RERI was before the Tax Court, it “was free to raise the same, straightforward statutory interpretation argument the taxpayer in Chai made” there. Mellow Partners v. Comm’r, 890 F.3d 1070, 1082 (D.C. Cir. 2018); accord Kaufman v. Comm’r, 784 F.3d 56, 71 (1st Cir. 2015). We therefore see no reason to excuse RERI’s failure to preserve its claim.
The decision creates a split in the way the two circuits approach the case. Maybe these types of issues will slowly fade away as everyone argues from the outset that the IRS must prove supervisory approval; however, for at least the next few years there will continue to be cases in which taxpayers did not raise the 6751(b) issue at the first level because they were unaware of the strength of the issue. The RERI case shows the importance of raising IRC 6751(b) from the outset and in raising all of the possible issues presented by that provision. Rarely will the taxpayer be a sympathetic party. Just keeping up with all of the IRC 6751 litigation may turn into a stand-alone blog soon. For those representing parties like RERI with huge tax dollars and huge corresponding penalties, too much is at stake to fail to lay the foundation for all possible permutations of IRC 6751. Even for low income taxpayers paying a penalty of $1,000 presents a huge challenge. All practitioners must pay attention and make appropriate arguments.
It’s hard to fault the practitioners in this case for not having a crystal ball that could see into the future. It will not be hard to fault practitioners who fail to make the arguments now.
Bonus material
We occasionally write back and forth with Jack Townsend who writes a tax procedure blog at http://federaltaxprocedure.blogspot.com/. On this case Jack sent me the following note on the burden of proof issue raised by the case. If you are into tax procedure, you should check out his blog and his book.
If a defense to a new matter “is completely dependent upon the same evidence,” id., as a defense to the penalty originally asserted, then there is no practical significance to shifting the burden of proof. Furthermore, “the taxpayer would not suffer from lack of notice concerning what facts must be established.” Id. Here, the facts required to establish the two elements of the reasonable cause and good faith exception are the same regardless whether the alleged misstatement was “substantial” or “gross.” In other words, although the IRS may theoretically have had the burden of proof as to the increase in penalty, there was no additional fact to which that burden applied.
From that opinion, in my [Federal Tax Procedure] book, I added the following:
I think it would be helpful to illustrate the new matter issue. Recall that § 6662 provides a 20% substantial understatement penalty that is then increased to 40% if the understatement attributable to a gross valuation misstatement. If the notice of deficiency asserted the 20% penalty but, in its answer, the IRS asserts the 40% penalty, the IRS will have the burden of proof on the increase in the penalty. That seems to be the straight-forward reading of the rule shifting the burden of proof to the IRS. But, let’s focus on one issue raised in this setting. The taxpayer can avoid the accuracy related penalties if there was reasonable cause for the position on the return. This is like an affirmative defense to the penalty. Thus, as to the 20% penalty asserted in the notice and contested in the petition, the taxpayer bears the burden of proving reasonable cause even after the IRS meets its production burden under §7491(c); as to the increased 40% penalty, the IRS bears the burden of proof, including establishing absence of reasonable cause. fn
fn See Blau, TMP of RERI Holdings I, LLC v. Commissioner, ___ F.3d ___, ___ (D.C. Cir. 2019) (discussing the Tax Court authority and expressing “no opinion as to whether Rule 142 requires the IRS to negate affirmative defenses when it pleads a new penalty in an answer;” the Court of Appeals accepted the Tax Court’s holdings that the burden on the reasonable cause defense did shift to the IRS as new matter; but “If a defense to a new matter “is completely dependent upon the same evidence,” id., as a defense to the penalty originally asserted, then there is no practical significance to shifting the burden of proof;” the Court then held that the burden had been met on the record but the facts were fully developed so “there was no additional fact to which that burden applied;” I am not sure exactly what that holding means, because, assuming that the trier (the Tax Court) were in equipoise as to reasonable cause (equipoise being a possible, although rare phenomenon), the IRS could have prevailed on the 20% penalty but the taxpayer on the 40% penalty.).