On February 28, 2019, the United States Tax Court in Palmolive Building Investors, LLC v. Commissioner held that where the IRS asserts multiple penalties, section 6751(b)(1) does not require that the “internal determination” of all the penalties be made at the same time and by the same IRS employee. In Palmolive Building Investors, the IRS asserted four different penalties, which were all upheld in court. In addition, the court held that section 6751(b)(1) does not require supervisory approval be made on a particular document.

Background

Palmolive owns the Palmolive Building on North Michigan Avenue in Chicago, Illinois (the “building”). In 2004, Palmolive executed a conservation easement deed in favor of the Landmarks Preservation Council of Illinois (“LPCI”), a qualified organization within the meaning of section 170(h)(3). The stated purpose of the deed was to preserve the exterior perimeter walls of the building’s facade. The deed obligated Palmolive and any subsequent owner of the building to maintain the facade in perpetuity. Palmolive asserts that at the time of the donation of the easement in 2004, the total value of the property was $257 million, of which 13 percent, i.e., $33.41 million, was attributable to the easement. On its Form 1065 (“U.S. Return of Partnership Income”) for 2004, Palmolive claimed a charitable contribution deduction of $33.41 million for the facade easement contribution.

The IRS examined Palmolive’s 2004 return and concluded that, for multiple reasons, the facade easement contribution deduction should be disallowed and that penalties should be imposed. As to the proposed penalties, IRS Agent Wozek prepared a Form 5701 (“Notice of Proposed Adjustment”) with the caption “Accuracy Related Penalty (Gross Valuation Misstatements)”. To the Form 5701, Agent Wozek attached a three-page Form 886A (“Explanation of Items”) that proposed and justified a penalty for gross valuation misstatement under section 6662(h)(1), and an additional two-page Form 886A, with a heading titled “Alternative Position on Penalty,” that proposed and justified a negligence penalty under section 6662(b)(1). The documents thus proposed two alternative penalties. Agent Wozek did not sign the documents. He gave the Form 5701 and its attachments to his immediate supervisor, Michael Lynch, and Mr. Lynch signed it on July 30, 2008.

30-day letter

In October 2008, Mr. Lynch sent Palmolive a 30-day letter. Attached to the letter was a Form 4605-A (“Examination Changes * * *”), which bore Agent Wozek’s name and included the statement: “The gross valuation misstatement penalty per IRC 6662(h) is applicable * * *. See F886A-2”. Also attached to the 30-day letter was the Form 886A justifying the penalty for gross valuation misstatement, but not the other Form 886A justifying the negligence penalty.

60-day letter

On May 11, 2009, the IRS sent to Palmolive a “60-day letter” (Letter 1827), proposing adjustments to its partnership return and giving Palmolive 60 days within which to file a protest and request a conference before the IRS Office of Appeals (“Appeals”). Attached to the 60-day letter was a Form 870-PT (“Agreement for Partnership Items * * *”), which contained a summary of the proposed adjustments to Palmolive’s return. The “Remarks” on Form 870-PT’s “Schedule of Adjustments” stated: “In addition, the penalty for gross valuation misstatement penalty under IRC section 6662(h) shall apply with respect to the full amount of the adjustment to charitable contributions.” This remark did not mention the negligence penalty. However, also attached to the 60-day letter was the Form 5701 signed by Mr. Lynch, with its two Forms 886A—one justifying the penalty for gross valuation misstatement and the other justifying the negligence penalty. In response to the 60-day letter, Palmolive submitted a protest and requested a conference before IRS Appeals.

While the case was under consideration in Appeals, Appeals Officer Trevor Holliday concluded that additional alternative penalties should be imposed. He prepared and signed a Form 5402-c (“Appeals Transmittal and Case Memo”), to which he attached a proposed FPAA, on the last page of which (a Form 886A) the penalties were described as follows:

Accuracy Penalty

Any underpayments of tax resulting from the adjustments and determinations above for the tax year ended December 31, 2004, are subject to the following accuracy related penalties imposed by I.R.C. section 6662:

A 40% penalty for gross valuation misstatement under I.R.C. section 6662(a) and (h);

Or, in the alternative,

A 20% penalty due to negligence or intentional disregard of the rules and regulations, substantial understatement of tax, or a substantial valuation misstatement under I.R.C. section 6662(a) and 6662(b)(1), 6662(b)(2), or 6662(b)(3).

Thus, the proposed FPAA determined all four penalties at issue here.

His immediate supervisor, Darren Lee, signed both the Form 5402-c (on a signature line preceded by the phrase “Approved by”) and the proposed FPAA. The IRS issued the FPAA on July 28, 2014. In it, the IRS determined that Palmolive did not adequately substantiate the value of the contribution and that the deed did not meet the requirements of section 170. In the alternative, the IRS asserted that even if the contribution of the easement met those requirements, Palmolive did not establish that the easement had a value of $33,410,000. The FPAA asserted the four penalties that had been on Appeals Officer Holliday’s proposal.

On October 1, 2014, Palmolive’s petition was timely filed in the Tax Court.

Analysis

Section 6751(b)(1) provides:

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 * * * .

Congress’ purpose in enacting section 6751(b)(1) was to help ensure “that penalties [w]ould only be imposed where appropriate and not as a bargaining chip.” To comply with section 6751(b), the Commissioner must secure written supervisory approval for the penalty before issuing an FPAA to a partnership. The parties agreed that the penalties at issue were subject to the requirements of section 6751(b)(1).

The parties stipulated the identities of the pertinent immediate supervisors—i.e., Mr. Lynch for Agent Wozek and Mr. Lee for Appeals Officer Holliday. Moreover, Palmolive did not dispute the authenticity of the two documents that the Commissioner asserted reflected the necessary approvals, i.e., Mr. Lynch’s Form 5701 in July 2008 (approving the gross valuation misstatement penalty and, in the alternative, the negligence penalty) and Mr. Lee’s Form 5402-c (approving two additional alternatives—the substantial understatement penalty and the substantial valuation misstatement penalty). Thus, the undisputed facts show that each of the four penalties at issue in this case were initially determined by an individual who obtained his supervisor’s written approval before the penalty determination was communicated to Palmolive.

Palmolive argued that the penalties asserted did not satisfy the requirement of section 6751 because the penalties were not approved by the same IRS supervisor. The court acknowledged that Agent Wozek did not determine and Mr. Lynch did not approve the latter two penalties (substantial valuation misstatement and substantial understatement) in July 2008. Nonetheless, the court found that the undisputed facts show that those two penalties were first determined by Appeals Officer Holliday and approved by Mr. Lynch in June 2014 and that those two penalties were not communicated to Palmolive until after that approval. Section 6751(b)(1) includes no requirement that all potential penalties be initially determined by the same individual or at the same time.

Next, Palmolive asserted that the IRS failed to comply with its own internal instructions in the Internal Revenue Manual section 20.1.5.1.4 (3), which makes the penalty determinations and approvals invalid. However, the court noted that “that it ‘is a well-settled principle that the Internal Revenue Manual does not have the force of law, is not binding on the IRS, and confers no rights on taxpayers.’” On the issue of section 6751(b) compliance, the court found that the IRS’s use of a form other than the one prescribed by internal administrative regulations does not preclude a finding that the supervisory approval requirement has been satisfied. The court held that section 6751(b) does not require written supervisory approval on any particular form. The court found that while it is true that Agent Wozek’s name does not appear on the Form 5701 by which he solicited Mr. Lynch’s approval, this fact was immaterial because Agent Wozek’s declaration stated that, the Commissioner showed (and Palmolive did not dispute) that Agent Wozek “prepared the Forms 5701 * * * and 886A, * * * and gave it to * * * [his] immediate supervisor, Michael Lynch, for approval”. What must be “in writing” to satisfy section 6751(b)(1) “is the supervisor’s approval. The statute does not require any particular writing by the individual making the penalty determination, nor any signature or written name of that individual.

Lastly, Palmolive argued that the substantial valuation misstatement penalty and the substantial understatement penalty, omitted from the July 2008 Form 5701 but asserted in the July 2014 FPAA, cannot be sustained because “[t]he FPAA represents the Commissioner’s ‘final determination’ of penalties, not the ‘initial determination.’” But the court concluded that Palmolive’s argument conflated the “initial determination” (in Appeals Officer Holliday’s submission of the Form 5402-c) with the supervisory approval (by Mr. Lee’s signing it and directing issuance of the FPAA). The court rejected Palmolive’s argument because it reflected an imprecision: “Supervisory approval of these two penalties was reflected not by the issuance of the FPAA by ‘CTF-OSC’ (which took place on July 28, 2014) but rather six weeks earlier by Mr. Lee’s June 13, 2014, signing of the Form 5402-c, by which he directed that the FPAA be issued.” Nevertheless, the court concluded that even if one views the FPAA itself as the act by which the supervisor approved the penalties reflected therein, it would satisfy section 6751(b)(1) as to any penalties that had first been “initial[ly] determin[ed]” in the then-recent Form 5701 proposing the FPAA. In such a circumstance, the written supervisory approval of the penalty would have been made “no later than the date the IRS issues the notice of deficiency * * * [or as here, the FPAA] asserting such penalty,” and both the initial determination and the supervisory approval would have occurred before the FPAA was issued.

Accordingly, the Court concluded that the IRS complied with section 6751(b)(1), because each penalty at issue was “initial[ly] determin[ed]” and then approved in writing by a supervisor before being communicated to Palmolive.