The Grinch That Stole Their Reasonable Cause…

Today we welcome first time guest blogger Brad Ridlehoover. Brad works in my hometown, Richmond, Virginia, where he is a business tax associate at McGuireWoods LLP with a practice focused heavily on tax controversy.  He co-authored the chapter on penalties in the forthcoming 6th Edition of Effectively Representing Your Client before the IRS. He also teaches practice and procedure in the School of Business at Virginia Commonwealth University (a class I previously taught there) and is heavily invested in pro bono work with The Community Tax Law Project (the first non-academic clinic representing low income taxpayers that Nina Olson founded over two decades ago.)

While Brad writes the post in the spirit of the season, the outcome does not match traditional holiday stories. At the end of the post he alludes to the last-ditch attempt by the taxpayers to latch on to a concession in a similar case by the IRS. We hope to come back with a later post to discuss the impact of a concession in one case on subsequent cases involving different taxpayers. When can such concessions cause the Grinch to bring seasonal joy? Keith

All Mr. Reisner and Ms. Weintraub wanted for the holidays was to have the Tax Court accept their claims of reasonable cause for underpayments attributable to a gross valuation misstatement.  Instead, the Tax Court handed out coal and stated that Congress’ 2006 amendments to Section 6662(h) stole their ability to claim a reasonable cause defense to the imposition of these accuracy-related penalties.  Reisner, et al. v. Comm’r, T.C. Memo. 2014-230 (Nov. 6, 2014).  The Tax Court rejected the taxpayers’ argument that Congress did not intend to eliminate the reasonable cause defense for underpayments resulting from carryover deductions attributable to events that occurred years before the statute was amended.  Whenever Congress makes changes to the Code, taxpayers should review, prior to filing a tax return, the nature of any carryover deductions.

While this case is in the context of a gross valuation misstatement penalty, a broader principle should be observed that filing a return taking advantage of carryover deductions of any kind is a reaffirmation of the validity of the initial claiming of such deduction and can subject the taxpayer to penalties.


In 2004, the taxpayers entered into a preservation restriction agreement with the National Architectural Trust pursuant to which they granted to it a façade easement on their townhouse in Brooklyn, New York.  For the 2004 tax year the taxpayers claimed charitable contribution deduction which resulted in the claiming of carryover deductions in 2005 and 2006.  The IRS challenged the value of the façade easement and asserted accuracy-related penalties for the underpayment of tax attributable to the claimed charitable deduction.

As part of the fully-stipulated case, the taxpayers conceded that the $190,000 noncash charitable contribution they claimed in 2004 for their donation of a façade easement should be disallowed as the donation had zero value.  The parties further agreed that there would not be an imposition of the gross valuation misstatement penalty for either 2004 or 2005 because the taxpayers satisfied the reasonable cause exception of sections 6664(c)(1) and (2).  The only dispute left for the Tax Court to decide related to the imposition of penalties for the 2006 tax year.  Section 6662(h)(1) imposes a 40% penalty on the portion of an underpayment of tax that is attributable to a gross valuation misstatement.  To determine if a gross valuation misstatement penalty is applicable, the value of the property claimed on the return must be 200% or more of the amount determined to be the correct value.

Generally, section 6664(c)(1) provides that no penalty will be imposed under section 6662 if the taxpayer can show that there was reasonable cause for the underpayment and that the taxpayer acted in good faith.  Prior to the enactment of Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780 (“PPA”), taxpayers could assert a reasonable cause defense to the imposition of a gross valuation misstatement penalty if they could show that the claimed value of the property was based on a qualified appraisal by a qualified appraiser and the taxpayer made a good-faith investigation of the value of the property.  The PPA eliminated the reasonable cause exception in its entirety for underpayment attributable to gross valuation misstatement of charitable deduction property.  The elimination of the reasonable cause exception applies to returns filed after July 25, 2006.

Note — If the overvaluation is substantial but not a gross misstatement, the taxpayers can still assert a reasonable cause defense (150% overvaluation instead of 200% ).  See section 6662(e)(1)(A))).

In Reisner, the taxpayers argued that their claiming of a carryover charitable deduction based on their 2004 donation of the façade easement was not precluded by the PPA’s changes to section 6664 even though they filed their return after July 25, 2006.  They claimed that imposing such a strict liability on taxpayers is not a required construction of the statute and in essence is a retroactive imposition of a penalty on conduct that occurred before the enactment of PPA.  They asserted that this result was contrary to Congress’ intent.  As a basis for this argument, the taxpayers asked the Court to look at the other changes contained in the PPA.  For example, the new rules requiring contributed easements to include a restriction that preserves the entire exterior of a building rather than simple its façade applied to contributions made after July 25, 2006.  Therefore, Congress must have intended that the “after July 25, 2006” effective date of the elimination of the reasonable cause defense meant to only apply to the claiming of deductions for events that occurred after July 25, 2006.

The Tax Court was not persuaded by the taxpayers’ arguments and stated that their claims cannot be “reconciled with the statute’s clear terms.”  The revisions to this section were intended to apply to tax returns filed after July 25, 2006 and it is irrelevant when the activity occurred that gave rise to the deduction.

The Tax Court further held that the imposition of the penalty was not retroactive as the taxpayers claimed.  Citing to Chandler v. Comm’r, 142 T.C. No. 16 (slip op. at 25) (May 14, 2014), the Tax Court said that the taxpayers “reaffirmed” their gross valuation overstatement when they filed the 2006 tax return after the enactment of PPA.  Taxpayers do not have to take advantage of carryover deductions when filing a return; it is a choice.  The Tax Court stated that the taxpayers could have chosen not to claim the carryover deduction for 2006 in view of the change in the law.  Their choice to claim the carryover deduction caused the imposition of the penalty.

In a final effort to give the Tax Court a basis to hold in their favor, the taxpayers in Reisner argued that the Court must agree with them because in a factually similar case, Pollard v. Comm’r, T.C. Memo 2013-38, the Tax Court did not impose a gross valuation misstatement penalty for 2006 and 2007.  The Tax Court stated that the basis for not imposing the penalty in Pollard was based on the IRS’ stipulated concession of the gross valuation misstatement penalties for 2006 and 2007 provided that the taxpayer proved reasonable cause existed for 2003, 2004, and 2005.  The Court determined that the taxpayer had shown reasonable cause for the prior years resulting in no penalties imposed for the later years by concession of the IRS.

Unfortunately for the taxpayers in Reisner, the IRS’ made no concessions.