Your client,(HHC), engaged in a transaction that resulted in the formation of a new entity. The IRS

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Question:

Your client,(HHC), engaged in a transaction that resulted in the formation of a new entity. The IRS audited HHC's 2009 tax return, re-characterized the transaction as a disguised sale, and determined a deficiency of $170,001,240 for HHC. Along with the deficiency the IRS assessed a 40% gross valuation misstatement penalty of $68,000,496, or, in the alternative, one of the 20% accuracy-related penalties for negligence and disregard of rules or regulations, substantial understatement of income tax, or substantial valuation misstatement. HHC wants to file a petition with the Tax Court challenging the Notice of Deficiency (NOD), on the grounds that the IRS did not comply with section 6751(b)(1) requirement for supervisory approval of penalties.

There were four principal IRS employees involved in the examination of HHC: Revenue Agent Mr. Ferro; his immediate supervisor, supervisory Revenue Agent Ms. Cortez; IRS Office of Chief Counsel attorney Mr. Lobo, who counseled the revenue agents; and his immediate supervisor Associate Area Counsel Ms. Kazan.

During the examination of HHC's return, Mr. Ferro first recommended determining a 20% penalty against HHC alternatively for negligence, disregard of rules or regulations, a substantial understatement of income tax, or a substantial valuation misstatement. He made this recommendation orally to Ms. Cortez in December 2014.

HHC first became aware that the IRS was considering imposing penalties during a meeting in January 2016. At this meeting the parties discussed adjustments to HHC's return, and Mr. Lobo informed representatives of HHC that the IRS would apply a penalty to any underpayment determined for 2009. Mr. Lobo's notes about topics discussed at the meeting state: "Applying penalties. Have not ruled any out."

Penalties were first proposed in writing in a draft Form 5701, Notice of Proposed Adjustment (NOPA). In January 2016, Mr. Ferro drafted a NOPA asserting the various 20% penalties. He sent the draft to IRS Counsel Mr. Lobo for review and advice. Mr. Lobo recommended also asserting the 40% gross valuation misstatement penalty. Lobo made this recommendation orally to his immediate supervisor, Ms. Kazan, in February 2016. Mr. Ferro ultimately adopted this recommendation when he prepared the final NOPA. On March 31, 2016, the IRS sent that NOPA with an attached Form 886-A, Explanations of Items, to HHC proposing the 40% gross valuation misstatement penalty or, alternatively, the various 20% penalties. The IRS did not send a 30-day letter granting HHC the opportunity to appeal the determinations in the NOPA.

The NOPA identifies the taxpayer, tax year, and date; contains the typed text "Cortez, Liliana E" in the box for Team Manager; and states: "See attached 886/Amount to be finalized on RAR after all adjustments." Ms. Cortez's name is typewritten on the bottom of the HHC NOPA. The NOPA states:

"Based on the information we now have available and our discussions with you, we believe the proposed adjustment listed below should be included in the revenue agent's report. However, if you have additional information that would alter or reverse this proposal, please furnish this information as soon as possible."

Ms. Cortez signed a Form 3198, Special Handling Notice for Examination Case Processing, on April 21, 2016. The purpose of a Form 3198 is to close a case out from the examination perspective and transmit the case files and all of the adjustments to technical services, who will prepare the notices sent to taxpayers. A signed Form 3198 therefore serves to show Ms. Cortez's intent to approve any adjustments included with those forms. Ms. Cortez can testify that Mr. Ferro prepared the Form 3198 for HHC, and that she reviewed and signed it. The form she signed showed a section 6662(h) penalty (the 40% gross valuation misstatement penalty) but did not show any alternative penalties. The form was accompanied by the case file, but it is now impossible for anyone to tell what exactly what was included in the file.

Next, the notice of deficiency was sent to IRS Counsel for review. On June 28, 2016, Ms. Kazan electronically signed a memorandum approving the proposed notice of deficiency for HHC. The notice included the 40% penalty and, alternatively, the various 20% penalties. The IRS sent the final notice of deficiency to HHC on June 28, 2016, the same day as Ms. Kazan's approval. The notice of deficiency bears an unidentifiable signature.

Required:
List the different penalties that the IRS is asserting against HHS and the tax code sections where those penalties come from.