Thursday, May 3, 2018

The Gravity of the Graev III Case Concerning IRS Tax Penalties

When the IRS seeks to impose a penalty against a taxpayer in an income tax case in U.S. Tax Court, typically under section 6662 of the Internal Revenue Code, the asserted penalty must meet the conditions and criteria specified under that provision.  However, before any such penalty can be asserted, there must be an internal "approval" of the penalty being asserted.

Section 6751(b) of the Internal Revenue Code specifies that NO tax penalty can be assessed unless the "initial determination of such assessment" is personally approved, in writing, by the immediate supervisor of the IRS individual making such determination or such higher level official as the Secretary may designate"  The timing of the approval is not specified in that Code section.  This has caused a lot of litigation.

In Graev v. Commissioner, 147 16 (2016) (known as "Graev II") the Tax Court held that a taxpayer's argument about the written approval before the fact of assessment (the mere computer entry on the IRS's ledger that the tax or penalty is owed as a fixed liability of the taxpayer, which can occur only after any tax deficiency proceedings such as U.S. Tax Court cases are final and concluded) was not ripe in the Tax Court and could not be raised in a Tax Court case.  (Note:  "Graev I", or Graev v. Commissioner, 140 T.C. 377 (2013) involved the Tax Court's determination of disallowed cash and non-cash charitable contribution deductions as a ruling in the Graev cases on the substantive tax merits).

Then, however, in Chai v. Commissioner, 851 F. 3d 190 (2d Cir. 2017), decided on March 20, 2017, the Second Circuit Court of Appeals reversed the Tax Court's ruling that the taxpayer's raising of the written approval requirement for tax penalties for the first time on post trial briefing was untimely, and held that the requirement under section 6751(b) for the IRS to obtain a written supervisory approval of the tax penalty kicks in NO LATER THAN the date the IRS issues a statutory notice of defeciency, or files an Answer or Amended Answer asserting the penalty in conjunction with the written approval.  Essentially the Second Circuit held the Tax Court does have jurisdiction to review the written supervisory approval issue if made timely, being no later than the above "trigger" dates.  The Court in Chai FURTHER held that the IRS bears the burden of production and proof to show the supervisory written approval was obtained timely pursuant to section 7491(c) of the Internal Revenue Code.

All of this has set the stage for last December's nationwide ruling in Graev v.Commissioner, ("Graev III"), 149 T.C.No. 23 (12-20-17).  In an 81 page opinion, the Tax Court found the taxpayer's argument that the IRS failed to comply with Section 6751(b) was INDEED properly subject to the Tax Court's pre-assessment jurisdiction and subject to a hearing on the matter.  Moreover, Graev III also held that the Commissioner had the burden of production under section 7491(c) of the Internal Revenue Code to show compliance. Under the specific facts of Graev III, the Tax Court found compliance because the penalty was tied to the IRS officer who "initially proposed" the penalty, being the IRS docket attorney who first proposed an alternative 20% penalty on non-cash charitable contributions as first raised in the statutory notice of deficiency, which had supervisory written approval, as well as a new 40% penalty first raised in the IRS's Amended Answer in that Tax Court case. 

How about a penalty FIRST asserted by an examining revenue agent?  The outside time limit of the Stat. Notice expressed by Chai does not seem to be enough.  In his concurrence in Graev III. Judge Lauber stressed that while written supervisory approval could occur NOT LATER than the time of the statutory notice of deficiency or Tax Court Answer or Amended Answer, the supervisory written approval would be timely only if it were issued no later than the time the FIRST IRS officer FIRST asserts the penalty .  Judge Lauber stated, ..."And by requiring [written] supervisory approval the first time an IRS official introduces the penalty into the conversation, the Court's interpretation is faithful to Congress's purpose by affording maximum protection to taxpayers against the improper wielding of penalties as a bargaining chip."

Since the Graev III decision, there have been numerous motions by the IRS to open the trial record post trial in some cases to introduce written penalty approvals, some of which have been granted and some of which have been denied.  And post trial briefing on this issue has been intensive. 


Wednesday, March 22, 2017

Sixth Circuit Limits Scope of Substance Over Form Doctrine

The U.S. Court of Appeals for the Sixth Circuit recently dealt a significant taxpayer victory in Summa Holdings, Inc. v. Commissioner, No. 16-1712 (Decided February 16, 2017), and limited the government's ability to assert the substance over form doctrine to dismantle the taxpayer's combination plan of providing estate planning wealth shifting benefits to younger generation family members using a domestic international sales corporation (DISC) shelter in tandem with Roth IRA's.

In Summa, the taxpayer father operated an exporting business, and his two sons established their own Roth IRA's, with initial contributions of $3,500 each.  Shortly thereafter, the Roth IRAs as sole shareholders invested $1,500 of capital each in newly formed JC Export, which was established as DISC.  Under the tax law, DISCs can receive up to 10% of an affiliated company's export sales revenue as "sales commissions" as so designated by Congress, which commissions are deductible by the affiliated export company and tax exempt to the DISC.  However, DISC dividends to shareholders are subject to up to 33% income taxes to the DISC as unrelated business taxable income, which was paid by JC Export.  However then the DISC paid the remaining funds to the son's Roth IRA accounts. Over a period of years and by 2008, each Roth IRA had accumulated over $3 million under this plan.

The IRS argued that in substance, Summa Holdings paid a non-deductible dividend to it's shareholders, who were Mr. Benenson and a trust for the benefit of his sons.  The U.S. Tax Court agreed and decided the case in favor of the IRS.

On appeal, the 6th Circuit reversed the Tax Court and held that the substance over form doctrine did not and could not apply to circumstances where the substance of a tax statute enacted by Congress was defined by the IRS through re-characterizing transactions which adhered to the form prescribed by Congress.  The 6th Circuit reasoned that while the substance over form doctrine could be used to prevent a taxpayer from distorting a transaction's true substance by adopting a masquerading transactional form inconsistent with economic reality, here Congress expressly sanctioned using a shell DISC and/or a Roth IRA in form only to achieve an artificial but Congressional permitted tax benefit, as a matter of "congressional design."

The 6th Circuit referred to this type of transaction as "Code compliant" form of tax advantaged transaction that did not follow a devious path in its form but straightforward steps as authorized by Congress.  And quoting Judge Hand in Helverling v. Gregory, 69 F. 2d 809 (2d Cir. 1934), the 6th Circuit reiterated that "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury, " and added that if Congress by design and through the Code authorizes a set of "formal" transactions the taxpayer entered into, "it is of no consequence that it  was all an elaborate scheme to get rid of income taxes."  Consequently, the 6th Circuit refused to adopt the alternative two step narrative of the Commissioner re-characterizing the DISC commissions as constructive dividends follow by excessive Roth IRA contribution.

Our Firm predicts that a huge amount of discussion and debate in the tax scholarship and in the tax press will ensue from this decision.  Stay tuned.

Wednesday, August 12, 2015


The North Carolina Court of Appeals recently decided in Fowler v. North Carolina Department of Revenue, No. COA-14-1302 (August 8, 2015) that the owners of a construction company in Raleigh owed none of the $10.4 million capital gains tax from the sale of their business claimed by the NCDOR, because they changed tax residency to Florida a few weeks before the sale closing.  This has been a very highly contested case and the taxpayers have won for the third time, first at trial before an administrative law judge, then before the NC Superior Court, then before the Court of Appeals.

The Fowler case is significant because of the complex nature of the facts and the trial court's findings that they intended to change their domicile to Florida right before selling their business due to the steps they took to achieve the change (including buying a larger new home in Florida, starting a Florida business, changing their address) even though their steps were less than perfect and even though they had continuing contacts with North Carolina by keeping their old home, and continuing to work for the company's buyer after the sale for a temporary period of time.

Our Firm was handled the taxpayer's administrative appeal in the case and served as co-counsel at trial.  Our view is that the Court of Appeals decision was a just one when all the change of domicile factors are analyzed, and that it is not necessary for a taxpayer to sever every single tie with the prior state of domicile to change to another state, which is consistent with tax residency decisions in other states, most notably of which is the Allen Page case in Minnesota.

For more information, contact Curtis Elliott at 704-372-6322 or

Wednesday, May 27, 2015

Crummey Trusts Continue to Be Approved By Tax Court

The U.S. Tax Court recently held in Mikel v. Commissioner, T.C. Memo 2015-64 that so called "Crummey" gifts of $12,000 each to 60 trust beneficiaries qualified for the annual gift tax exclusion as present interest gifts.  The IRS argued that although the trust beneficiaries had legally enforceable rights of withdrawal over those funds, they were unlikely to assert those rights under the trust's no-contest clause.  The Tax Court disagreed, and found the withdrawal demands could not be legally resisted by the Trustee of the trust and that the in terrorem provisions would not necessarily deter the beneficiaries from pursuing judicial relief as a practical matter.

This favorable view of the trust's Crummey provisions provides further solace to estate planners and their clients that the use of Crummey trust gifts to multiple trust beneficiaries will be accorded present interest status per gift to enable the donor to make larger annual exclusion gifts to family trusts.  This case is a major positive case law development for practitioners and their clients.

Friday, November 7, 2014

IRS Appeals Addresses Estate Tax Case Development (2014)

The IRS Office of Appeals has addressed estate tax case procedures in accordance with its new "judicial approach and culture (AJAC).  One new procedure is a reduction in the number of days remaining on the statute of limitations Appeals will hold the case.

Another feature is that under AJAC, Appeals will not return a case to examinations if the case file is not fully developed factually by exam.

There are only two IRS teams nationwide which handle all E&G appeals, but the staff is dispersed in Chicago, Dallas, Houston, Indianapolis, New York, Philadelphia and Jacksonville, Fla.

Interestingly over 50% of estate and gift tax returns are filed in California.

Saturday, November 9, 2013

Estate and Gift Tax Litigation in the U. S. Tax Court

Curtis Elliott recently spoke as a panelist at a Webinar entitled "Litigating the Valuation of a Business" sponsored by  Mr. Elliott's presentation focused on estate and gift tax litigation in the U.S. Tax Court with particular emphasis on direct and cross examination of expert appraisers in tax cases, and a comparison of the various deposition and discovery rules in various litigation forums. 

For more details, see

For more details about Mr. Elliott's tax controversy practice, see

Saturday, October 12, 2013

Supreme Court Hears Oral Arguments in Woods: TEFRA Penalties and Outside Basis

The Supreme Court recently heard oral arguments in the Woods case.  The issue involved is whether the government can invoke TEFRA jurisdiction in a TEFRA proceeding at the partnership level to determine valuation overstatement penalties related to a partner's outside overstatement of basis in circumstances in which the partnership entity is found to have been a sham.  The issue turns on whether a penalty can be imposed on items such as outside basis, which are not partnership items in a TEFRA proceeding, leaving the taxpayer to present a reasonable cause and good faith defense to the penalty after the TEFRA proceeding is completed and the tax and penalty are paid, in a refund case.

The audio of the oral agruments before the Supreme Court in the Woods case can be found on the SCOTUS web sit.

Supreme Court Web Site