147 T.C. 460
Tax Ct.2016Background
- Lawrence and Lorna Graev donated a facade conservation easement to the National Architectural Trust (NAT) in 2004, received a NAT "side letter" promising refund if deductions were disallowed, and claimed charitable deduction on their 2004 return (with a carryover on 2005 return).
- IRS examination disallowed the deductions, asserted a 40% gross valuation-misstatement penalty (I.R.C. §6662(h)) and—after Chief Counsel review—added an alternative 20% accuracy-related penalty (I.R.C. §6662(a)) to the notice of deficiency.
- The examining agent obtained written supervisor approval for the 40% penalty but not for the 20% alternative; Chief Counsel attorney Mackey recommended adding the 20% penalty and his supervisor initialed that memorandum; the revised notice as issued calculated the 20% penalty as zero (to avoid stacking) but listed it as an alternative.
- The Tax Court previously sustained disallowance of the charitable deductions in Graev I, and respondent conceded the 40% penalty; the remaining dispute here is liability for the 20% accuracy-related penalty and whether statutory supervisory-approval and computation requirements were met (I.R.C. §6751(a) and (b)).
- The Court (majority) held that the notice complied with §6751(a), that §6751(b) challenges were premature because assessment occurs after finality, and on the merits sustained the 20% penalty for 2004 and 2005 (taxpayers failed to prove reasonable cause, substantial authority, or adequate disclosure/reasonable basis).
Issues
| Issue | Plaintiff's Argument (Graev) | Defendant's Argument (Commissioner) | Held |
|---|---|---|---|
| Whether the notice of deficiency satisfied §6751(a) (must include penalty name, Code section, and computation) | The notice failed §6751(a) because the 20% penalty computation was shown as zero and thus allegedly not computed | The 20% and 40% penalties are alternative; showing the 20% computation reduced to zero (to avoid stacking) satisfies §6751(a) | Court: Held for Commissioner — §6751(a) complied (zero computation was proper) |
| Whether lack of written supervisory approval under §6751(b)(1) for the 20% penalty bars assessment | The examining agent never approved the 20% penalty in writing, so §6751(b)(1) bars assessment | Approval requirement applies before assessment; no assessment has yet occurred so challenge is premature; Chief Counsel's memorandum was approved by his supervisor | Court: Held the §6751(b) objection is premature (no assessment yet); did not decide whether Chief Counsel’s action qualified as the “initial determination” |
| Whether taxpayers had reasonable cause and acted in good faith (to avoid §6662 penalty) | Taxpayers relied on their CPA (Lerman) and appraisal; they reasonably relied and acted in good faith | Taxpayers failed to provide CPA the side letter or evidence he considered it; taxpayers ignored repeated warnings and did not seek independent advice | Court: Held for Commissioner — no reasonable cause/good faith proved; penalty applies |
| Whether taxpayers had substantial authority or adequate disclosure/reasonable basis to avoid the substantial-understatement penalty under §6662(d)(2)(B) | Relied on O’Brien, a General Counsel Memorandum, and a PLR as supporting authority and argued issue was of first impression | O’Brien and older guidance were inapposite or weak; authorities supporting taxpayer were not substantial relative to contrary authority; returns did not adequately disclose the critical side-letter contingency | Court: Held for Commissioner — no substantial authority or adequate disclosure/reasonable basis; 20% penalty sustained |
Key Cases Cited
- Graev v. Commissioner, 140 T.C. 377 (2013) (prior Tax Court decision disallowing the Graevs' charitable deductions on side-letter grounds)
- Legg v. Commissioner, 145 T.C. 344 (2015) (discussion of timing/interpretation issues under §6751 and the Court's approach to those disputes)
- John C. Hom & Assocs., Inc. v. Commissioner, 140 T.C. 210 (2013) (procedural-error/prejudice analysis for notice defects)
- Higbee v. Commissioner, 116 T.C. 438 (2001) (burden of production for penalties under §7491(c))
- Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000) (three-part test for reasonable reliance on professional advice)
- O'Brien v. Commissioner, 46 T.C. 583 (1966) (older Tax Court decision on charitable contributions with contingencies; distinguished in Graev I)