After an exception to a penalty has been eliminated from the tax code, will it apply if the penalty results from carryover deductions from years prior to the elimination?
Taxpayer Says: The reasonable cause exception is available to him because congress did not intend to eliminate it for underpayments resulting from carryover deductions arising in years before the statute was amended.
Internal Revenue Service Says: The statute as amended eliminates the reasonable cause exception to the gross valuation misstatement penalty, and the taxpayer cannot claim the exception.
From Internal Revenue Code Section 6662(h)(1): Imposes a 40% penalty on the portion of an underpayment of tax that is attributable to a gross valuation misstatement. For returns filed after August 17, 2006, a gross valuation misstatement exists if the value of any property claimed on the return is 200% or more of the amount determined to be the correct value.
From Internal Revenue Code Section 6664(c)(1): Provides that, generally, no penalty shall be imposed under section 6662 with respect to any portion of an underpayment if it is shown there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.
From Internal Revenue Code Section 6664(c)(3): Provides that “[i]n the case of any underpayment attributable to a * * * gross valuation overstatement under chapter 1 with respect to charitable deduction property, paragraph (1) [section 6664(c)(1)] shall not apply.” In the case of facade easement contributions, the elimination by the Pension Protection Act of 2006 of the reasonable cause exception for underpayments attributable to gross valuation overstatements applies “to returns filed after July 25, 2006.”
From Internal Revenue Code Regulation 1.6662-5(c)(1): The penalty “applies to any portion of an underpayment for a year to which a * * * deduction * * * is carried that is attributable to a * * * gross valuation misstatement for the year in which the carryback or carryover of the * * * deduction * * * arises.”
THE CAUSE OF THE DISPUTE
If you file your tax return and understate the amount of tax you owe, the IRS can assess an accuracy related penalty (section 6662). Generally, if you have “reasonable cause” for the understatement, you can request abatement of the penalty (section 6664). Reasonable cause is not defined in the tax code, and penalty relief is decided on a case-by-case basis.
In this case, the taxpayer claimed a $190,000 noncash charitable contribution deduction for a facade easement. The deduction was limited on his 2004 return, and the taxpayer carried the excess over to tax years 2005 and 2006. The 2006 tax return was filed timely on April 16, 2007.
The IRS disallowed the deduction, saying the easement had no value.
The taxpayer and the IRS eventually agreed the deduction was valueless, and that the underpayments on the returns for 2004, 2005, and 2006 were attributable to the overstated value.
The taxpayer and the IRS also agreed the reasonable cause exception applied to the 2004 and 2005 tax return.
However, the IRS says the reasonable cause exception does not apply to the 2006 tax return because the exception was eliminated entirely for underpayments attributable to gross valuation overstatements of charitable deduction property by the Pension Protection Act of 2006 (PPA). The amendment applied to returns filed after July 25, 2006.
The taxpayer says the reasonable cause exception is available to him because congress did not intend to eliminate it for underpayments resulting from carryover deductions arising in years before the statute was amended.
The taxpayer says denying the reasonable cause exception would be a retroactive imposition of a penalty on conduct that occurred before enactment of the PPA.
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The taxpayer’s argument cannot be reconciled with the statute’s clear terms. The provision eliminating the reasonable cause exception for underpayments attributable to gross valuation overstatements of easement donations was made effective for “returns filed after July 25, 2006.”
Thus, congress clearly intended the effective date for the amendment to be applicable to returns filed after that date.
As to the taxpayer’s contention that the impact is retroactive, the PPA amendment eliminating the reasonable cause exception was in effect when he filed his return for 2006. The taxpayer thus “reaffirmed” his gross valuation overstatement when he filed the return after enactment of the PPA amendment. He could have chosen not to claim the carryover for 2006 in view of the change in the statute but did not do so.