Tax Court in Brief | Colbert v. Commissioner | Accuracy-Related Penalties and IRS Procedural Requirements

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Tax Litigation:  The Week of July 11th, 2022, through July 15th, 2022

Colbert v Commissioner, T.C. Memo. 2022-74 | July 13, 2022 |Wells, J.| Dkt. No. 8395-16.


Short Summary: This case involves the determination of taxpayers’ liability for accuracy-related penalties and IRS compliance with procedural requirements in assessing penalties. Gregory Colbert and Simone Colbert (Colberts) filed joint federal income tax returns for the tax years 2014 to 2016. On January 6, 2016, the IRS issued a notice of deficiency to the Colberts for those tax years. The deficiencies were (1) unreported income, (2) deductions claimed on Schedules A, Itemized Deductions, (3) deductions claimed on Schedules C, Profit or Loss from Business and, (4) unreported state tax refunds. Additionally, IRS assessed the Colberts accuracy-related penalties under Section 26 U.S.C. § 6662 regarding those years. Colberts admitted the deficiencies. However, Colberts argued they should be entitled to waive accrued interest and fees, as they were unaware that the individual that prepared their tax returns submitted and declared certain deductions on their behalf. Simone Colbert filed Form 8857, Request for Innocent Spouse Relief. The IRS granted her the relief. IRS argued Colberts substantially understated income tax on their 2013 and 2014 tax returns. Therefore, they were liable for accurate-related penalties. The date on the Civil Penalty Approval form was illegible. Hence, the Tax Court could not determine if the initial determination of the assessment was made before the mailing of the notice of deficiency. Consequently, the Tax Court determined Colberts were not liable for accuracy-related penalties for understated income tax for the tax years 2013 and 2014. This as IRS did not meet the procedural requirements under Section 26 U.S.C. § 6751(b)(1). The Tax Court determined it have no jurisdiction to redetermine interest pursuant to section 7481(c), as no interest have been assessed in this case.

Key Issues:

  • Whether the assessment of accuracy-related penalties to Colberts pursuant to 26 U.S.C. 6662 was erroneous?

Primary Holdings:

  • The IRS cannot assess any penalty to the taxpayers if the procedural requirements are not met under Section 6751(b)(1). Consequently, the Tax Court determined Colberts were not liable for accuracy-related penalties for understated income tax for the tax years 2013 and 2014.

Key Points of Law:

  • Under Section 26 U.S.C. § 6662(a) and (b) a taxpayer can be assessed with an accuracy-related penalty of 20% of the portion of an underpayment of tax due to (1) negligence or disregard of rules or regulations, or (2) any substantial understatement of income tax, among others.
  • Section 26 U.S.C. § 6662(d)(1)(A) provides that, a substantial understatement is any federal income tax amount greater of (1) 10% of the tax required to be shown on the tax return on the tax year in question, or (2) $5,000 USD.
  • IRS bears the initial burden of proof and of production regarding taxpayer’s liability for Section 6662(a) penalties. See Section 26 U.S.C. § 7491(c).
  • Once the IRS meets its burden of proof and of production, taxpayers should provide sufficient evidence to the Tax Court to demonstrate the determination of the IRS is incorrect.
  • Section 26 U.S.C. § 6751(b)(1) provides that, IRS must comply with the procedural requirements to assess any penalties. See Section 26 U.S.C. § 7491(c). See Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo. 2015-42
  • The IRS shall not assess any penalty unless “the initial determination” of the assessment was approved in writing by the immediate supervisor of the individual making such assessment. See Section 26 U.S.C. § 6751(b)(1)
  • IRS must obtain the approval before the date on which the IRS issues the notice of deficiency assessing the penalty to the taxpayer. See Chai v. Commissioner, 851 F.3d at 221

Insights:  This case is a reminder the IRS is restricted to assess penalties to taxpayers if it does not duly comply with the procedural requirements to determine them. However, we recommend to taxpayers to not rely on the IRS failure to waive their penalties. If the IRS complies with the due process, the taxpayer will have the burden to evidence the IRS is not correct and should provide all relevant evidence to support its arguments in Court to avoid any tax liability. For additional information on 26 U.S.C. §6662 (accuracy-related penalties), see Freeman Law accuracy-related penalty blogs below:

Accuracy-Related Penalties: The Burdens of Proof and Production

What is an Accuracy-Related Penalty?

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