United States

Corporation's negligence penalty upheld, lack of reasonable cause

TAX ALERT  | 

A federal district court decided that a sophisticated corporate taxpayer would not be able to overcome a negligence penalty because it could not prove that it had either a reasonable basis for its tax return position or reasonable cause and good faith for the position. The IRS assessed additional taxes and a 20% accuracy-related penalty for negligence for which the corporation brought a refund suit challenging both the addition to tax and the penalty. In Blue Mountain Energy, Inc. v. United States, 118 AFTR 2d 2016-5405 (D. Utah Aug. 5, 2016), the court granted the government’s motion for summary judgment as to the additional tax, but said there was an issue of fact with respect to the negligence penalty. The IRS brought this second motion for summary judgement alleging that Blue Mountain Energy could not successfully meet its burden of proof to challenge the accuracy related penalty. (No. 2:14-cv-418-DN), 124 AFTR 2d 2019-XXXX (D. Utah Sept. 27, 2019).)

Background

Blue Mountain Energy is a wholly owned subsidiary of Deseret Generation & Transmission Cooperative (“Deseret Generation”), an electric generation and transmission company. Blue Mountain Energy owns and operates an underground coalmine that sells coal exclusively to a Deseret Generation plant. Blue Mountain Energy remits and pays the Black Lung Excise Tax (“the tax”) imposed under section 4121 on these sales. The tax is assessed based on the tonnage of coal sold by the producer with a maximum cap based on a percentage of the sale price. When Blue Mountain Energy calculated its excise tax liability it used an artificial constructive sale price, as described under section 4216(b), instead of the actual amount paid from Deseret. The IRS audited Blue Mountain Energy and assessed additional amounts of excise tax after determining that the non-arm’s length transfer amount between Deseret and Blue Mountain Energy was the amount that the tax should have been based on.

The constructive sale price rules of section 4216(b) allow for taxpayers to use a taxable item’s fair market value when determining their liability if the sale of the item is either made at retail, on consignment, or in a non-arm’s length transfer for less than its fair market price. Blue Mountain Energy argued that the coal was sold at retail and therefore the constructive sale price rules were applicable to them. The IRS contended that the constructive sale price rules did not apply because the coal was sold in a non-arm’s length transaction at an above market price. The court determined, in its original summary judgement order and decision, there was no ambiguity in the language of the statute, and even if there was, the IRS interpretation of the statute receives deference. The court denied the government’s motion for summary judgment on the negligence penalty, determining that whether Blue Mountain Energy was aware of, and relied upon, a cited revenue ruling when it filed its tax returns and, if so, whether such reliance could mitigate the negligence penalty, was still at issue. The government brought this second motion for summary judgment on the penalty issue. 

Accuracy-related penalty

Section 6662(b)(1) applies an accuracy-related penalty on an underpayment of tax attributed to negligence or a disregard of rules or regulations. A taxpayer can defeat a negligence penalty by proving that it had a reasonable basis for its return position under reg. section 1.6662-3(b)(3) or that the negligence was due to reasonable cause and good faith as described under reg. section 1.6664-4.

Blue Mountain Energy maintained that it relied on Rev. Rul. 81-188 (a constructive sale price related revenue ruling applicable to the trucking industry) in concluding that it could use a constructive sale price to determine its tax liability. The government argued that the revenue ruling was inapplicable and that Blue Mountain Energy could not rely on it. Blue Mountain Energy argued that it was reasonable to rely on the revenue ruling “even if there was no actual knowledge of the ruling.” Further, Blue Mountain Energy argued that it demonstrated reasonable cause and good faith and should not be subject to the negligence penalty.

Reasonable basis

Blue Mountain Energy argued that it was not negligent in basing its excise tax liability on a constructed sale price because it had the reasonable basis of relying on its own reasonable interpretation of the constructive sale price rules and because it relied on the guidance of a revenue ruling. First, the court determined that Blue Mountain Energy could not assert that its own interpretation of the statutes could serve as a reasonable basis. The court then determined that because the prior summary judgment order and decision concluded that the wording of the statute was unambiguous and not applicable to Blue Mountain Energy, continued reliance on such discredited interpretation was an attempt to relitigate the issue and would not serve as a reasonable basis for the taxpayer’s return position. 

The court next addressed Blue Mountain Energy’s argument that it relied on Rev. Rul. 81-188 and whether that could provide a reasonable basis for Blue Mountain Energy’s position. Revenue rulings are recognized as authority that can provide a reasonable basis for taxpayers’ positions. Reg. section 1.6662-4(d)(3)(ii) explains this reliance as it relates to its relevance and persuasiveness. The regulations specify that a “revenue ruling having some facts in common with the tax treatment at issue is not particularly relevant if the authority is materially distinguishable on its facts, or is otherwise inapplicable to the tax treatment at issue.” Further, the regulations say that a revenue ruling that is more than 10 years old should be accorded little weight.

The court analyzed the revenue ruling and determined that it did not address the facts or issues that are applicable to Blue Mountain Energy’s facts, industry, or type of tax. Further, the revenue ruling was issued in 1980 relating to a tax that was later repealed. Using the above regulation and its analysis of the ruling, the court determined that Rev. Rul. 81-188 was not relevant, is unpersuasive, and is only accorded little weight due to its age. Thus, Blue Mountain Energy could not rely on the revenue ruling as an authority for which would give it a reasonable basis for its return position.

Reasonable cause and good faith

Blue Mountain Energy’s second argument is that even if it was negligent, the penalty should be waived because it had reasonable cause and acted in good faith. Blue Mountain Energy argued that its reasonable cause and good faith is demonstrated because it had an honest misunderstanding of the law. The court rejected this argument. 

Although the regulations do indicate that reasonable cause and good faith can include an honest misunderstanding of law, the regulations continue to specify that this honest misunderstanding of law must be “reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer.” Reg. section 1.6664-4(b)(1). In support of its position that that Blue Mountain Energy’s honest misunderstanding of the law should sufficiently demonstrate reasonable cause and good faith, it cited two prior tax court cases. In the first case, the taxpayer at issue misunderstood the law because it relied on a regulation for which there was a subsequently issued conflicting regulation. In the second case, the taxpayer was not sophisticated and used a common definition for a term that was otherwise defined in the tax code.

The court quickly dismissed the argument that these cases supported Blue Mountain Energy’s argument for reasonable cause, contrasting the unambiguous law and sophisticated taxpayer in the present case. Further, the court determined that Blue Mountain Energy’s reliance on its own interpretation of the law and an irrelevant revenue ruling could not be interpreted as acting with reasonable cause and with good faith.

For these reasons, the court determined that the 20% underpayment penalty for negligence was appropriately imposed. 

Takeaways

The taxpayer has the burden to prove a reasonable basis for its position on a tax return when faced with an underpayment penalty for negligence. The taxpayer also has the burden to prove it had reasonable cause and acted in good faith, if it cannot establish a reasonable basis for the position. When making one of these defenses it is important for the taxpayer to remember it will be held to its level of experience, knowledge, and education. Sophisticated taxpayers are expected to make sophisticated decisions. Taxpayers who interpret a statute cannot interpret it in a way that is inconsistent with its unambiguous interpretation. When taking a return position that may result in an underpayment of tax, taxpayers should consult their tax advisors to ensure that they have a reasonable basis for the position.

AUTHORS


Subscribe to Tax Alerts



How can we help you with your tax planning & compliance?