IRS chief counsel: continue applying valuation misstatement penalties.

• Author: Nevius, Alistair M.

The IRS Office of Chief Counsel in October issued an action on decision (AOD-2011-02) and a chief counsel notice (CC-2012-001) that both address the application of the valuation misstatement penalties contained in Secs. 6662(b)(3) and 6662(h). The AOD announces the IRS's decision that it will not acquiesce to the Ninth Circuit Court of Appeals decision in Keller, 556 F.3d 1056 (9th Cir. 2009), rev'g T.C. Memo. 2006-131. In addition, the chief counsel notice provides direction to chief counsel attorneys for handling Tax Court cases in which a taxpayer concession on the merits of a tax dispute could preclude the application of a valuation misstatement penalty.

Sec. 6662 imposes a variety of accuracy-related penalties for tax underpayments. Under Sec. 6662(b)(3), a 20% accuracy-related penalty is imposed on any underpayment of tax attributable to a "substantial valuation misstatement." A substantial valuation misstatement occurs when the value or the adjusted basis of any property claimed on a return is 150% or more of the amount ultimately determined to be the correct value or adjusted basis (Sec. 6662(e)(1)(A)). Under Sec. 6662(e)(1)(B), a substantial valuation misstatement also occurs in connection with certain transactions between persons described in Sec. 482.

Sec. 6662(h)(1) increases the accuracy-related penalty from 20% to 40% if the underpayment is attributable to one or more "gross valuation misstatements." A gross valuation misstatement occurs when the value or adjusted basis of any property claimed on a return is 200% or more of the amount determined to be the correct value or adjusted basis (Sec. 6662(h)(2)(A)(i)). Under Secs. 6662(h) (2)(A)(ii) and (iii), a gross valuation misstatement can also occur in connection with certain transactions between persons described in Sec. 482. This item focuses on the valuation penalties imposed under Secs. 6662(e)(1)(A) and 6662(h)(1).

The IRS's recent releases highlight one area of disagreement in the application of the valuation misstatement penalties. The circuits are currently split over whether these penalties apply when the underlying deduction or credit is disallowed on grounds unrelated to overvaluation. The Fifth and Ninth Circuits have held that a valuation misstatement penalty is not applicable when the entire deduction is disallowed on grounds unrelated to an overvaluation.

In Todd, 862 F.2d 540 (5th Cir. 1988), aff'g 89 T.C. 912 (1987), the Fifth Circuit affirmed a Tax Court...