Tax Court Vacates Summary Judgment Order Due to Backdated Penalty Approval Form

(Parker Tax Publishing September 2023)

The Tax Court vacated its order granting partial summary judgment for the IRS on the issue of whether the IRS complied with the written supervisory approval requirements in Code Sec. 6751(b)(1) for penalties asserted against a taxpayer, after finding that an IRS supervisor amended a penalty consideration lead sheet to include additional penalties in February 2017 and backdated her signature on the sheet by writing in a date of July 16, 2016. The court also granted in part the taxpayer's motion for sanctions under Code Sec. 6673(a)(2) due to the IRS counsel's failure to timely advise the court of the supervisor's erroneous declaration. LakePoint Land II, LLC v. Comm'r, T.C. Memo. 2023-111.

Background

LakePoint Land II, LLC (LakePoint), is a limited liability company (LLC) treated as a partnership for federal income tax purposes. LakePoint Land Group, LLC, is its tax matters partner.

The IRS assigned Revenue Agent (RA) Pamela Stafford to examine LakePoint's Forms 1065, U.S. Return of Partnership Income, for its 2013 and 2014 tax years. RA Catherine Brooks was the immediate supervisor of RA Stafford in connection with the examination. Between May 9 and 20, 2016, RA Stafford corresponded with a representative of LakePoint. The objective of the correspondence was to review proposed adjustments and penalties and to potentially reach a resolution of the audit. In the correspondence, LakePoint's representative requested that RA Stafford provide the IRS's "determination" of penalties. RA Stafford responded by providing a list of "proposed adjustments," including penalties, to LakePoint's representative. No settlement was ever reached.

On July 15, 2016, RA Stafford prepared a penalty consideration lead sheet (July Lead Sheet). Initially, in a motion for partial summary judgment, the Tax Court was led to believe that RA Brooks personally approved RA Stafford's initial determination of the penalties in writing by electronically signing the July Lead Sheet on July 16, 2016, and that this July Lead Sheet asserted all of the penalties that were eventually determined in LakePoint's final partnership administrative adjustment (FPAA).

However, the Tax Court later learned from the parties that there existed different versions of the July Lead Sheet, including a version signed by RA Brooks on November 29, 2016 (November Lead Sheet). A Form 5701, Notice of Proposed Adjustment (NOPA), was also signed by RA Brooks on July 21, 2016. The parties agreed that the July Lead Sheet was amended by RA Stafford in February 2017 to include additional penalties (which were recommended by IRS counsel) and was in fact signed by RA Brooks on February 10, 2017 - although RA Brooks backdated her signature by writing in a date of July 16, 2016.

In March 2017, the IRS issued the FPAA to LakePoint. The FPAA determined for the 2013 tax year a Code Sec. 6662(a) underpayment penalty based on (1) negligence or disregard of rules or regulations under Code Sec. 6662(b)(1), (2) a substantial understatement of income tax under Code Sec. 6662(b)(2), (3) a substantial valuation misstatement under Code Sec. 6662(b)(3), and (4) an increase to the Code Sec. 6662(a) penalty from 20 percent to 40 percent for a gross valuation misstatement under Code Sec. 6662(h). The FPAA determined for the 2014 tax year a Code Sec. 6662(a) underpayment penalty based on (1) negligence or disregard of rules or regulations under Code Sec. 6662(b)(1), and (2) a substantial understatement of income tax under Code Sec. 6662(b)(2).

In June 2017, LakePoint filed a petition with the Tax Court, disputing the FPAA and seeking readjustments of partnership items under Code Sec. 6226. The IRS filed a Motion for Partial Summary Judgment seeking favorable adjudication on the issue of whether it complied with the written supervisory approval requirement of Code Sec. 6751(b)(1) for the penalties asserted against LakePoint. On December 19, 2022, the IRS filed a First Supplement to Motion for Partial Summary Judgment in which it argued that "complaints [LakePoint] asserts with respect to the Penalty Consideration Lead Sheets signed on July 16 and November 29, 2016, are absent from the penalty-approval NOPA." In the IRS's supplemental filing, there was no indication that the July Lead Sheet was in fact signed by RA Brooks on February 10, 2017. Rather, the IRS's counsel continued to represent to the Tax Court that RA Brooks had in fact signed the document in question on July 16, 2016. By order dated March 24, 2023, the Tax Court granted the IRS's Motion for Partial Summary Judgment.

LakePoint filed a Motion for Reconsideration of the order granting the IRS's Motion for Partial Summary Judgment. LakePoint also filed a Motion to Impose Sanctions under Code Sec. 6673(a)(2), the Tax Court's rules, and the court's inherent authority to supervise its proceedings. Under Code Sec. 6673(a)(2)(B), when an attorney representing the IRS has committed a fraud on the Tax Court, the Tax Court has power to assess attorneys' fees against the IRS. LakePoint contended that sanctions were appropriate because the IRS's counsel knew or should have known that RA Brooks submitted a false Declaration to the Tax Court. LakePoint requested that the Tax Court decide the Code Sec. 6751(b) penalty approval issue against the IRS and award reasonable expenses including attorney's fees it incurred as a result of the IRS's misconduct.

The IRS acknowledged its counsel's shortcomings and indicated that it "should have exercised more candor to the Court by explicitly identifying the issue with the date of the Penalty Lead Sheet referenced in the First Brooks Declaration." The IRS also acknowledged that its First Supplement to Motion for Partial Summary Judgment "fall[s] short of the level of excellence and professionalism that the Court has a right to expect"; however, the IRS argued that its counsel's actions did not rise to the level of fraud or bad faith. The IRS asserted that its counsel was unaware of the issues related to the July Lead Sheet when the original Motion for Partial Summary Judgment was filed. The IRS also said that that its counsel took remedial actions to correct the error.

Analysis

The Tax Court found that its March 23, 2023 order granting the IRS's Motion for Partial Summary Judgment was predicated on facts that were not true and therefore granted LakePoint's Motion for Reconsideration. After determining that genuine issues of material fact existed precluding a finding that the IRS complied with the requirements of Code Sec. 6751(b)(1), the court vacated its March 24, 2023, order.

The Tax Court also granted in part LakePoint's Motion to Impose Sanctions. The court found that the month before filing its First Supplement to Motion for Partial Summary Judgment on December 19, 2022, the IRS denied a request from LakePoint for admissions seeking to confirm that RA Brooks executed the July Lead Sheet on July 16, 2016. Then on March 3, 2023, the IRS's counsel produced emails between RA Brooks and RA Stafford reflecting that RA Brooks signed the July Lead Sheet on February 10, 2017 (not July 16, 2016). At the same time, however, the court found that the IRS's counsel continued to represent to the court in the First Supplement to Motion for Partial Summary Judgment that RA Brooks signed the July Lead Sheet on July 16, 2016.

The court observed that it was the IRS's counsel who previously recommended, in a February 2017 internal memorandum to RA Stafford, that she include both the substantial valuation and gross valuation misstatement penalties. The court reasoned that even if the IRS's counsel did not initially recall the sequence of penalty approvals, at a minimum he had a duty to the court to timely correct these erroneous factual representations in November 2022. The court noted that RA Brooks informed the IRS's counsel by email on November 2, 2022, that she had noticed a discrepancy between the July and November Lead Sheets. Based on these facts, the court concluded that the IRS's counsel knew or should have known, no later than November 2, 2022, that its representations made to the Tax Court were less than accurate and lacked candor and that RA Brooks's Declaration was false. Rather than correcting the material misrepresentation found in the IRS's Motion for Partial Summary Judgment, the court found that the IRS's counsel sought to pivot and present additional evidence on an alternative legal theory without withdrawing or conceding the original legal theory for why summary adjudication was appropriate. The court noted that no other remedial action was taken to correct the error until April 10, 2023, which was after the court had issued its Order granted the IRS's Motion.

In sum, the court found the IRS's counsel failed to timely advise the court of RA Brooks's erroneous Declaration. Accordingly, the court found the actions of the IRS's counsel to be in bad faith and to have multiplied the proceedings in this case unreasonably and vexatiously under Code Sec. 6673(a)(2). The court found that the actions of the IRS's counsel resulted in LakePoint's retaining additional counsel to elicit the truth regarding the Code Sec. 6751(b) issues in this case and substantially increased the discovery and motion practice required. However, the court found that it was premature to award costs and fees to LakePoint since no evidence of the excess costs and fees incurred had been submitted. Rather, the court said it was appropriate to make such determination in the future. The court therefore granted in part LakePoint's Motion to Impose Sanctions under Code Sec. 6673(a)(2) and reserved ruling on the IRS's liability for excess costs until after trial. The court otherwise denied the relief sought in LakePoint's Motion to Impose Sanctions.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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