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IRS Did Not Formally Communicate a Penalty Determination Before Issuing a Notice of Deficiency

(Parker Tax Publishing January 2020)

The Tax Court held that the IRS did not formally communicate its initial determination of penalties, for which written supervisory approval was required under Code Sec. 6751(b)(1), until it issued a notice of deficiency to a corporate taxpayer and a final partnership administrative adjustment to a partnership formed by the corporation. The Tax Court found that conversations during the taxpayer's examination in which the potential assertion of penalties were discussed were not the initial determination of a penalty in part because the IRS did not send the taxpayers any document that conferred the opportunity for administrative appeal. Tribune Media Company v. Comm'r, T.C. Memo. 2020-2.


In 2009, Tribune Media Co. (Tribune) formed Chicago Baseball Holdings, LLC (CBH), in a transaction that the IRS characterized as a disguised sale. The IRS determined a tax deficiency for Tribune and adjustments for CBH. Additionally, the IRS determined that a 40 percent gross valuation misstatement penalty applied under Code Sec. 6662 or, in the alternative, that one of the 20 percent penalties applied for negligence, disregard of rules or regulations, a substantial understatement of income tax, or a substantial valuation misstatement.

Various IRS or Office of Chief Counsel employees were involved in the audits of Tribune and CBH. Revenue Agent H. Paul Unger was the examination team coordinator. His immediate supervisor was Lisa Valdez. They were advised by Daniel Trevino, an attorney with the Office of Chief Counsel, and his immediate supervisor was Naseem Khan.


During Tribune's audit, Unger first recommended determining a 20 percent penalty orally to Valdez in December 2014. Tribune first became aware that the IRS was considering imposing penalties during a meeting in January 2016. At this meeting, the parties discussed adjustments to Tribune's return, and Trevino informed Tribune's representatives that the IRS would apply a penalty to any underpayment determined for 2009. Trevino's notes about the meeting stated: "Applying penalties. Have not ruled any out."

Penalties were first proposed in writing in a draft Form 5701, Notice of Proposed Adjustment (NOPA). In early 2016, Unger drafted a NOPA for Tribune asserting various 20 percent penalties. He sent the draft to IRS Counsel for review. In February 2016, after reviewing the NOPA, Trevino orally recommended to Khan also asserting the 40 percent penalty. Unger ultimately adopted this recommendation when he prepared the final NOPA. In March 2016, the NOPA was sent to Tribune, proposing the 40 percent gross valuation misstatement penalty or, alternatively, the various 20 percent penalties. The IRS did not send a 30-day letter granting Tribune the opportunity to appeal the determinations in the NOPA.

Valdez signed a Form 3198, Special Handling Notice for Examination Case Processing, in April 2016, showing the 40 percent penalty. The form did not show any alternative penalties but was accompanied by the case file. Valdez said that Unger prepared the Form 3198 and she reviewed and signed it. A notice of deficiency was sent to IRS Counsel for review and, in June 2016, Khan approved it. The notice included the 40 percent penalty and, alternatively, the various 20 percent penalties. The IRS sent the final notice of deficiency to Tribune on the same day as Khan's approval.


Unger first recommended that a 20 percent penalty be applied to the adjustments for CBH in writing in December 2015 to Valdez, his immediate supervisor. CBH first became aware of the IRS's intent to impose a penalty during a February 2016 conference call. As with Tribune, Unger sent a draft NOPA asserting in the alternative the various 20 percent penalties to Trevino for review in February 2016. Trevino orally recommended to Khan that a 40 percent gross valuation misstatement penalty also be applied. Unger did not adopt Trevino's suggestion when he prepared the NOPA for CBH. A NOPA was sent to CBH in March 2016. It proposed a 20 percent penalty but did not mention the 40 percent penalty. The IRS did not send CBH a letter granting the opportunity to appeal the NOPA.

The final partnership administrative adjustment (FPAA) was then prepared for issuance to CBH. Valdez signed a Form 3198 in June 2016 closing the case out to technical services. The form did not list any penalties but was accompanied by the case file. Before the FPAA was issued, a draft FPAA that included all of the alternative penalties at issue was forwarded to the Office of Chief Counsel for review. In a June 2016 memo, Khan stated her approval of the proposed FPAA, which included the 40 percent penalty in addition to the various 20 percent penalties in the alternative. Finally, the Letter 1830-F, TMP Notice of Final Partnership Administrative Adjustment, informed CBH that the IRS had determined that a 40 percent penalty applied to the adjustments. The notice also assessed the various 20 percent penalties in the alternative.

Tribune and CBH challenged the deficiencies and penalties in the Tax Court. They argued that under Code Sec. 6751(b)(1), written approval was required before the first time the IRS communicated the penalties. They argued that the NOPA, the January 2016 meeting, and the February 2016 call were communications of penalty determinations before which approval was required. They also argued that an NOPA is an initial determination because it grants appeal rights. The IRS contended that formal communication offering the opportunity for administrative appeal with respect to the penalties was not included in the NOPAs and that, therefore, the notice of deficiency and the FPAA were not the first formal communications of the penalty determinations.

Tax Court's Analysis

The Tax Court held that the first formal communications of the initial determinations of the penalties to which Code Sec. 6751(b)(1) applied were the notice of deficiency and the FPAA. The court found that the IRS did not send Tribune or CBH any document that conferred the opportunity for an administrative appeal, which the court said can be one of the important indicia of formality. Nor did the IRS, in the court's view, send any other written communication purporting to determine a penalty with any sense of finality.

The Tax Court said that Tribune and CBH were arguing for a rule that would require written supervisory approval of the IRS's first proposal of a penalty rather than its initial determination of one. According to the court, this approach ignored the sense of formality implied by the word "determination" in the statute and would render the examination of penalty issues unworkable. The court said that clearly, "determination" is not a synonym for a mere suggestion, proposal, or initial information mention of the possibility of the assertion of a penalty. Rather, citing Belair Woods, LLC v. Comm'r, 154 T.C. No. 1 (2020), the court found that a "determination" is embodied in a written communication to the taxpayer that notifies him or her of a final IRS decision. The Tax Court rejected the taxpayers' assertion that an NOPA grants appeal rights. The court found that an NOPA is a proposed adjustment that falls short of a determination requiring approval. Further, the court found that while a taxpayer may request during an audit that an unresolved issue be referred to Appeals, such a request is not a right. The court concluded that, standing alone, an NOPA is not a determination of a penalty.

Turning to the facts of this case, the Tax Court concluded that the initial penalty determinations were first communicated to Tribune and CBH in the notice of deficiency and the FPAA. The court observed that these notices were not signed by Valdez. The court found that while Valdez did sign the Forms 3198, manifesting her intent to approve the adjustments included with those forms, it was unclear to the court what was included with the Forms 3198. As a result, there was a question of fact as to what Valdez approved. As to the 40 percent penalties, the court found that Khan satisfied Code Sec. 6751(b)(1) when she approved in writing Trevino's initial determination to assert those penalties. The court therefore granted summary judgment for the IRS as to the 40 percent penalties. However, the court noted, those notices included the 40 percent penalties and, alternatively, the various 20 percent penalties. Because Khan was not Unger's immediate supervisor, the court found that her approval did not satisfy Code Sec. 6751(b)(1) with respect to the 20 percent penalties.

For a discussion of procedural requirements for computing penalties, see Parker Tax ¶262,195.

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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