Penalty Applied for Overvaluing Conservation Easement
In Roth, 1 the Court of Appeals for the Tenth Circuit affirmed the Tax Court's decision imposing a 40% penalty against the taxpayers for grossly misstating the value of a conservation easement that they donated to a Colorado land trust.
This case stems from the "gravel-pit cases" in which Colorado taxpayers claimed large deductions for their donations of conservation easements prohibiting the mining of gravel on what had been farmland. The easements were later determined by the IRS to be worthless because the land was more valuable for farming than for mining gravel.
In 2007, the taxpayers, John and Deanne Roth, donated a conservation easement encumbering 40 acres of land to the Colorado Natural Land Trust. The easement relinquished the Roth's rights to mine gravel from the property. The Roths valued the easement at $970,000. They claimed a charitable contribution deduction on their 2007 income tax return based on that amount and a carryover charitable contribution deduction on their 2008 return based on the unused portion. In 2011, the IRS audited the Roths' income tax return and hired an appraiser who found the easement to be worthless. The parties later stipulated to a value of $40,000. Thereafter, an IRS revenue agent issued a gross valuation misstatement penalty against the Roths under Section 6662(h) for unpaid taxes. The revenue agent's supervisor approved the penalty, and the Roths filed for administrative review. An IRS Appeals Officer issued a memorandum in support of the penalty and tax obligation, but stated a revised penalty calculated at 20%. The memorandum did not provide an explanation for the pivot from 40% to 20%, but the IRS later claimed it was a clerical error. The IRS then issued the notice of deficiency against the Roths for the revised 20% penalty.
In 2012, the Roths filed a petition in the Tax Court contesting the IRS's determination. The IRS filed a response re-asserting the Roth's liability for a 40% penalty under Sections 6662(a) and (h). An IRS special counsel and her supervisor signed the IRS's response pleading.
Separately, the Roths donated another conservation easement in 2006 and received $260,000 of tax credits that they later sold in 2007 for $195,000 and reported on their 2007 return. As a result of litigation, the Roths repaid portions of these proceeds in 2013 and 2014.
Section 6662(h) allows for a 40% penalty on unpaid taxes when the claimed value of the property exceeds its actual value by at least 200%. The Roths contended that the IRS may make only one "initial determination" in a given case, and once the IRS sent a notice of deficiency determining a 20% penalty, no other penalty could ever be assessed pursuant to Section 6751(b) . Section 6751(b)requires the IRS to obtain written, supervisory approval for its "initial determination" of a penalty assessment.
The first issue before the court was whether the IRS complied with Section 6751(b) 's requirement to obtain written supervisory approval for its "initial determination" before imposing a gross valuation misstatement penalty. The Roths contend that the IRS's notice of deficiency produced after the Appeals Officer's review is the IRS's initial determination of the penalty under Section 6751(b) . The Roths further argued that because that notice included only a 20% penalty under Section 6662(a), Section 6751(b) precludes the agency from imposing any other penalty.
The court stated that this dispute involved a narrow question of statutory construction, which required an analysis of Section 6751(b) 's plain language: "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 or such higher level official as the Secretary may designate."
- "Assessment" is the formal recording and establishment of a taxpayer's liability, fixing the amount owed by the taxpayer.
- "Penalty" includes any addition to tax or any additional amount, and is imposed to encourage compliance with tax laws.
- "Deficiency" is the amount by which the tax imposed by the IRS exceeds the amount reported by the taxpayer.
The court stated that Section 6751(b) 's phrase "the initial determination of such assessment" poses an obstacle to a plain-language interpretation because it does not require that "assessments" will be "determined." The statute's plain language leaves open to debate when an initial determination takes place and whether that determination pertains to the IRS's early decision to seek a penalty or the later affirming of that penalty and its resulting assessment. Therefore, due to this ambiguity, the court stated that a review of the statute's legislative history and underlying public policy was proper. The court found that Congress passed Section 6751 to clamp down on a perceived IRS practice of threatening to impose unjustified penalties to coerce taxpayers to settle.
The court found that read in light of its legislative history and underlying public policy, Section 6751(b) does not restrict the IRS's "initial determination" to the 20% penalty specified in the notice of deficiency. The court also found that the first IRS employee who imposed a penalty represents a logical "initial determination maker." In addition, the court found that the special counsel's answer to the Roth's petition in Tax Court, signed by her supervisor, could also take the form of an initial determination. Both the first IRS employee and the special counsel imposed a 40% penalty. The court found that the Code does not limit the employees who may make Section 6751(b) initial determinations. Therefore, the court held that the IRS may assess a 40% penalty despite its inclusion of a 20% penalty in the Roth's notice of deficiency.
The Tax Court also noted that Section 6214(a) explicitly allows the Tax Court to redetermine a deficiency and any additional penalties stated in the notice "if claim therefor is asserted by the Commissioner at or before the hearing or a rehearing." The court stated that if it adopted the Roth's proposed interpretation of Section 6751(b) , it would effectively repeal this jurisdiction. The court also noted that if it adopted the Roth's proposed interpretation, such a holding would also conflict with the Tax Court's jurisprudence in cases appealable to other circuits.
The court held that each of the IRS's penalty determinations in the Roth's case could be "initial" with respect to the actual penalty sought in accordance with Sections 6662(a) and (h). The court states that this reading of the statute harmonizes Section 6751(b) 's initial determination requirement with Section 6214(a) 's grant of jurisdiction to the Tax Court to consider new penalties asserted by the IRS in a deficiency proceeding.
The second issue before the court was whether Section 1341 or a similar doctrine entitles the Roths to a deduction in 2007 for repayments they made in 2013 and 2014 on proceeds from the sale of tax credits generated in 2007 by their donation of the 2006 easement.
Section 1341 permits taxpayers who include an amount received under a claim of right in their income but then repay that amount in a later tax year to either take a credit in the year of repayment or reduce taxable income in the year of repayment. The court found that the Roths' contention that the court used Section 1341 as a time bar to disallow their 2007 deduction was incorrect. The court stated that Section 1341 is a remedy for qualifying taxpayers subjected to the application of the claim-of-right doctrine. Furthermore, Section 1341 does not permit a taxpayer to reduce taxable income or take a tax credit in a year other than the year of repayment. The court held that the Roths were not entitled to a deduction in 2007 for repayments that they subsequently made in a later year.
The Court of Appeals relied on Section 6751(b) 's plain language and legislative intent to affirm the Tax Court's decision upholding the IRS's determination to impose a 40% penalty against the taxpayers. The statute permitted the IRS to assess a 40% penalty despite its inclusion of a 20% penalty in the Roth's notice of deficiency. Clearly, the court, similarly to the Tax Court, did not have a lot of sympathy for taxpayers claiming a charitable contribution deduction for a worthless, or nearly worthless, donation.
1 123 AFTR2d 2019-1676 (CA-10, 2019).
Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at (301) 657-0175 or firstname.lastname@example.org.
This article originally appeared in the August 2019 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.