Valuation-misstatement penalties require property-by-property analysis

Plain-English summary

An S corporation claimed charitable deductions for many donated items using appraisals that valued each item and then totaled the values. The IRS concluded that the appraiser was not qualified and used random samples of the donated property to calculate gross or substantial valuation-misstatement penalties. Chief Counsel explained that Treasury Regulation section 1.6662-5(f)(1) requires comparing claimed and correct values property by property, rather than only in the aggregate. The memo found no reported case deciding whether the IRS could base the penalty on appraisals of only some of the properties reported on a return. The formal conclusion and most case-development advice were redacted from the public release.

Ruling snapshot

• Question: May the IRS use a random sample of donated items to determine gross or substantial valuation-misstatement penalties for all items?
• Outcome: advice given, with the formal conclusion redacted
• Key authorities: IRC § 6662(b)(3), (e), and (h); Treas. Reg. § 1.6662-5

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201711009
       Release Date: 3/17/2017
       CC:PA:01: GSemasek
       POSTN-125258-16

UILC: 6662.00-00, 6664.03-00

date: November 04, 2016

 to:   Luanne M. Parker
       Appeals Team Case Leader
       (Office of Appeals)

from: Blaise G. Dusenberry
Senior Technical Reviewer
(Procedure & Administration)

subject: Additional Information for Gross and Substantial Valuation Misstatement Penalties

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.


       ISSUE

       Whether ----------------------------------. (taxpayer) is subject to the accuracy-related
       penalty, based on an underpayment attributable to a substantial or gross valuation
       misstatement, for taxable year -------, -------, or both, when the Service calculated the
       penalty by valuing only a limited number of the items of property claimed by taxpayer on
       the returns.

       CONCLUSION




       FACTS

       Taxpayer is an S corporation which operates retail stores in multiple states, selling a
       wide variety of products and supplies related to ------------------------------------------------.
       Taxpayer’s products include -------------------------------------------------------and related
       supplies. The taxpayer also distributes ---------------------, including -----------------------------

POSTN-125258-16 2

--------------------------------------------------. Taxpayer makes charitable donations to certain
----------------------------------------------------------------.

During ------- through -------, taxpayer purchased -------------------------- for $--------------.
Near the end of ------- taxpayer donated the --------- to the -----------------------------. When
the taxpayer filed its tax return for taxable year -------, it claimed an itemized deduction
for a charitable contribution in the amount of $----------------, based on the claimed
combined fair market values of the --------------------. To document the fair market
values, taxpayer included with its ------- return a completed Noncash Charitable
Contributions (Form 8283) and an appraisal, which was earlier prepared by ----------------
---------. ----------------did not create a separate appraisal report for each --------donated
by the taxpayer during -------. Rather, he created one appraisal report for all of the -------
--------- donated during -------. The report listed, appraised and valued each --------
individually and then added the values of the individual items together to calculate the
total fair market value for all of the items contributed to the -----------------------------.

From December ------- through August ------- taxpayer purchased ------------------------and
------------------------------------ for the total purchase price of $----------------. Near the end
of ------- taxpayer donated the ------------------------------------------ to ------------------------------
--------. When the taxpayer filed its tax return for taxable year -------, it claimed an
itemized deduction for a charitable contribution in the amount of $----------------, based on
the claimed combined fair market values of these items. To document the fair market
values, taxpayer included with its return a completed Noncash Charitable Contributions
(Form 8283) and an appraisal, which had been prepared by ---------------. He did not
create a separate appraisal report for each -------------------------------------- donated by the
taxpayer during -------. Rather, ----------------created one appraisal report for all of the
articles of property donated. The report listed, appraised and valued each -----------------
and -----------------individually and then added the values of the individual items together
to calculate the total fair market value for all of the items contributed to the -----------------
-------------.

The Service examined taxpayer’s returns for taxable years ------- and ------- and sought
to determine whether taxpayer complied with the appraisal requirements of Code
section 170 respecting non-cash charitable contributions. Specifically, the Service
examined the taxpayer’s records and those of --------------- in order to determine if the
latter is a not a qualified appraiser because he was regularly used by taxpayer for
appraisal services. To accomplish this, the Service considered the number of reports ---
--------------- prepared for the taxpayer in comparison to the number prepared for all
other individuals and entities during ---------------- and -------. The examination also took
into account the total time --------------- devoted to furnishing appraisals to the taxpayer
and income received from the taxpayer in comparison to those variables for all other
individuals and entities for which --------------- performed appraisals.
POSTN-125258-16 3

The Service determined that --------------- is not a qualified appraiser respecting the
charitable contribution deductions for non-cash donations claimed by the taxpayer and
that, consequently, the deductions should be denied for taxable years ------- and -------.

The Service’s examination also focused on whether taxpayer is liable for accuracy-
related penalties for taxable years ------- and ------- based on underpayments reflected in
the taxpayer’s returns that are attributable to the alternative causes listed in Code
section 6662(b). The Service concluded that because the values of the ---------------------
claimed by the taxpayer when calculating the charitable contribution deduction for
taxable year ------- exceeded the correct values by more than 200 percent, the taxpayer
is liable for the 40% gross valuation misstatement penalty under section 6662(h). The
Service determined that the underpayment reflected on the taxpayer’s ------- return is,
alternatively, due to a substantial valuation misstatement and thus subject to a 20%
penalty pursuant to Code section 6662(b)(3) and (e).

In reaching these conclusions, however, the Service’s Office of Art Appraisal Service
did not perform an appraisal of each of the --------------- the taxpayer donated to the
----------------------------------. Rather, the Service selected --------------, based on a random
statistical sampling, and appraised only these selected ---------. Because the Service’s
appraisal of the --------- randomly selected for review concluded that the values were
overstated by at least 200 percent, the Service concluded that all of the donated ----------
had values overstated by at least 200 percent.

The Service used the same methodology to determine the correct fair market values of
the --------------- the taxpayer donated to the ---------------------------- in taxable year -------.1
The Service selected for review by a random statistical sample ----out of the ---------------
the taxpayer donated to the -----------------------------, which was the foundation for the
charitable contribution deduction claimed by the taxpayer. The Service accordingly
determined the accuracy-related penalty based on a gross valuation misstatement or,
alternatively, a substantial valuation misstatement.

You requested our views on whether the Service may calculate the values of multiple
articles of property through reliance on a random sample of some of the properties in
determining the taxpayer’s liability for the gross valuation or substantial valuation
misstatement penalty under section 6662.

LAW AND ANALYSIS

Section 6662 imposes a penalty of 20% of the portion of an underpayment of tax
reflected in a taxpayer’s return attributable to a substantial valuation misstatement.
I.R.C. § 6662(b)(3). A substantial valuation misstatement exists if the value or adjusted

1
The Service concluded that $----------------, the fair market value the taxpayer used in calculating the
portion of its deduction for the donation of -------------------------------------- to the ------------------------------, was
correct.
POSTN-125258-16 4

basis of property claimed on a return is 150 percent or more of the amount determined
to be the correct value or adjusted basis. I.R.C. § 6662(e). If the reported value or
adjusted basis exceeds the correct amount by at least 200 percent, the valuation
misstatement is considered “gross” and the penalty increases to 40%. I.R.C. § 6662(h);
see e.g. United States v. Woods, 134 S.Ct. 557 (2013); Gustashaw v. Commissioner,
696 F.3d 1124 (11th Cir. 2012). No penalty may be imposed under section 6662(b)(3)
for a taxable year unless the portion of the underpayment attributable to a substantial or
gross valuation misstatement exceeds $5,000. I.R.C. § 6662(e)(2); Treas. Reg.
§ 1.6662-5(b). The determination of whether there is a substantial or gross valuation
misstatement in the case of the return of a pass-through entity is made at the entity
level. Treas. Reg. § 1.6662-5(h). However, the $5,000 limitation is applied at the
taxpayer level. Id.

The regulation implementing the substantial and gross valuation misstatement penalties
under Code section 6662 includes the following rule for determining the penalty in the
case of multiple properties:

***

(f) Multiple valuation misstatements on a return. –(1) Determination of whether
valuation misstatements are substantial or gross.-- The determination of
whether there is a substantial or gross valuation misstatement on a return is
made on a property-by-property basis. Assume, for example, that property A
has a value of 60 but a taxpayer claims a value of 110, and that property B has
a value of 40 but the taxpayer claims a value of 100. Because the claimed and
correct values are compared on a property-by-property basis, there is a
substantial valuation misstatement with respect to property B, but not with
respect to property A, even though the claimed values (210) are 200 percent or
more of the correct values (100) when compared on an aggregate basis. 2

Treas. Reg. § 1.6662-5(f)(1)(emphasis added).

When the Service determines a taxpayer has misstated the value or adjusted basis of
more than one property on his return, Treas. Reg. § 1.6662-5(f)(1) requires the Service
to calculate the correct value or adjusted basis of each property individually. The
example included within Treas. Reg. § 1.6662-5(f)(1) takes into account that when a
taxpayer misstates the values of multiple articles of property on his return, some of the

2
The example under section 1.6662-5(f)(1) is outdated because it reflects the misstatement percentage
threshold for a substantial valuation misstatement under Code section 6662(e)(1)(A) prior to the effective
date of the provision in the Pension Protection Act of 2006, P.L. 109-280, § 1219(a)(1)(A), 120 Stat. 1083
(“PPA 2006”) by which Congress lowered the thresholds for substantial and gross valuation
misstatements to 150 percent and 200 percent, respectively, for tax returns filed after August 17, 2006.
For returns filed before the effective date of PPA 2006, the threshold for a substantial valuation
misstatement was 200 percent and for the gross valuation misstatement penalty to apply, the taxpayer
had to misstate the property’s value or adjusted basis by 400 percent or more.
POSTN-125258-16 5

valuation misstatements may be sufficient to meet the 150 percent threshold under
Code section 6662(e)(1)(A) while other misstatements may not.

There are reported cases in which a taxpayer misstated the value or adjusted basis of
more than one article of property for a single taxable period. Woods (outside basis of
multiple pass-through entities), American Boat Co., LLC v. United States, 583 F.3d 471
(7th Cir. 2009)(in Son-of-Boss transaction, misvaluation of tugboat fleet). Our research
did not, however, disclose a reported case in which a court addressed whether the
Service may determine the substantial or gross valuation misstatement penalty under
Code section 6662 based on an appraisal of some, but not all, of the properties claimed
on the taxpayer’s return. Here, it appears that the Service did not appraise each ---------
-------- individually for taxable year --------or ------- because the large number of ---------
made appraisal of all of them impractical.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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POSTN-125258-16 6

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This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-6845 if you have any further questions.