Penalties against LLC approved by IRS supervisor, Tax Court holds

Editor: Mark G. Cook, CPA, CGMA

In Salacoa Stone Quarry, LLC, T.C. Memo. 2023-68, the Tax Court held that penalties for misstatement of a charitable conservation easement’s value were properly approved by an IRS supervisor, despite a discrepancy in dates on the penalty approval documents. The court also ruled that the taxpayer, a limited liability company (LLC), was not entitled to discovery regarding the date discrepancy.

Factual background

The Tax Court found the following facts solely for purposes of deciding the IRS’s motion for partial summary judgment: Salacoa Stone Quarry LLC was established in Georgia in December 2016 and classified as a partnership for federal income tax purposes and subject to audit and litigation procedures under the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, P.L. 97-248. Its tax matters partner was a Georgia LLC, and its principal place of business was in Georgia when the petition was filed.

In December 2016, Salacoa acquired a 106-acre tract for $304,000 in Pickens County, Ga. A year later, after soliciting investors desiring large tax deductions, it converted a significant portion of the property to an openspace conservation easement. Salacoa claimed a $24.8 million deduction for donating the easement on its partnership tax return for the 2017 tax year.

In December 2019, the IRS decided to audit Salacoa’s 2017 tax return and assigned the case to Revenue Agent Richard Skinner. As the investigation approached its conclusion in November 2020, Skinner proposed assessing a 40% penalty on Salacoa for a gross valuation misstatement under Sec. 6662(h). Alternatively, based on Secs. 6662(b) (1)–(3), (c)–(e), and 6662A(b), Skinner recommended assessing a 20% penalty on Salacoa for a substantial valuation misstatement, understatement of income tax related to reportable transactions, negligence, and/or substantial understatement of income tax.

Skinner’s recommendations were set forth in a civil penalty lead sheet and approval form. Margaret McCarter, Skinner’s team manager, personally approved the evaluated penalties, digitally signed the documented lead sheet on Nov. 10, 2020, and confirmed that she was the immediate supervisor of Skinner, who initially determined the penalties.

On Feb. 2, 2021, Skinner sent Salacoa a package of documents, including Form 4605-A Examination Changes, and Form 886-A, Explanation of Items. These documents were the first formal notification to the LLC that the IRS intended to assert the penalties recommended by Skinner against it. On June 17, 2021, the IRS issued Salacoa a final partnership administrative adjustment (FPAA) disallowing Salacoa’s $24.8 million deduction and determining the penalties. In response, Salacoa timely filed a petition with the court seeking a readjustment of the LLC’s partnership items.

Legal background

The point of summary judgment is to expedite litigation and avoid costly and unnecessary trials. Partial summary judgment may be granted on an issue when there is no genuine dispute of material fact and a decision can be rendered as a matter of law. If the moving party provides a properly supported motion for summary judgment, the nonmoving party may not solely rely on pleadings. Rather, it must set forth specific facts, by affidavit or otherwise, demonstrating a genuine dispute that should proceed to trial.

According to Sec. 6751(b)(1), no penalty under the Code can be determined unless the immediate supervisor of the individual who determined the initial assessment of the penalty personally approved the evaluation in writing. In Kroner, 48 F.4th 1272 (11th Cir. 2022), rev’g in part T.C. Memo. 2020-73, the Eleventh Circuit (the circuit to which an appeal of the Tax Court’s decision in Salacoa would lie) stated that the IRS satisfies the Sec. 6751(b)(1) requirements as long as a relevant supervisor approves the initial determination of a penalty assessment before the IRS assesses the penalties.

Even though Kroner held that supervisory approval for estimated penalties must occur before the actual assessment of the tax, the Eleventh Circuit left open the possibility that supervisory approval may need to be obtained sooner in some cases — before the supervisor has lost discretion whether to approve or reject the penalty assessment. Similarly, in Laidlaw’s Harley Davidson Sales, Inc., 29 F.4th 1066 (9th Cir. 2022), and Chai, 851 F.3d 190 (2d Cir. 2017), the Ninth Circuit and the Second Circuit, respectively, held that supervisory approval must be obtained before the supervisor loses discretion to approve or reject the penalty assessment.

Here, there was no dispute that McCarter timely approved the penalties in November 2020 and signed the documents as Skinner’s immediate supervisor. However, Salacoa argued that there was a discrepancy between McCarter’s digital signature date (Nov. 10, 2020) and the date shown on the form (Nov. 20, 2020). Therefore, Salacoa requested discovery to determine whether the IRS had in fact complied with Sec. 6751(b)(1). Salacoa issued informal discovery and Freedom of Information Act requests seeking to inspect any relevant communications among Skinner, McCarter, and the IRS examination team.

Tax Court’s analysis

The Tax Court stated that it was mindful that summary judgment should not be granted unless the nonmoving party has had sufficient opportunity for discovery but that the discovery must be relevant to the subject matter of the pending case. In this case, however, the court held that Salacoa’s requests for discovery were irrelevant to the question presented in its motion for summary judgment: whether the penalties had been properly approved.

The Tax Court found that the record included documents that showed the required written supervisory approval was obtained. Citing its own precedent in Sparta Pink Property, LLC, T.C. Memo. 2022-88, and Patel, T.C. Memo. 2020-133, the court determined that by asking for discovery of communications among the IRS exam team, Salacoa was improperly seeking to look beyond the signature appearing on the form. Therefore, the court limited its consideration to whether there was evidence of timely written supervisory approval.

The Tax Court explained that the relevant forms and documents were mailed to Salacoa on Feb. 2, 2021, and the IRS issued the FPAA on June 17, 2021. Thus, when McCarter signed the approval form in November 2020, she still had the discretion to approve or reject the recommended penalty. Whether she signed the documents on Nov. 10 or Nov. 20 would not affect the timeliness. Either way, she provided written approval while still having discretion to approve or reject the penalty, so the IRS satisfied Sec. 6751(b)(1), and further discovery regarding McCarter’s signature’s date would be irrelevant, the court held. Accordingly, the court granted the IRS’s motion for partial summary judgment.

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Cook at mcook@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.