Burden of Production in Section 6751(b)

A. An Overview

On January 7, 2020, the United States Tax Court issued its division opinion in Frost v. Commissioner, 152 T.C. No. 2. For tax professionals who practice in the Tax Court, the decision in Frost is worth a quick read as it discusses the proper allocation (and shifting) of the burden of production in Section 6751(b) penalty cases, the latter of which is currently a hot issue.

B. Background

Mr. Frost was a former IRS collections officer. After his employment with the IRS, he set off on his own to become a self-employed salesman and consultant. He also prepared federal income tax returns. On his 2010 through 2012 returns, he reported his business income and expenses on Schedule C. He also reported a partnership loss on Schedule E of his 2011 return.

The IRS selected Mr. Frost’s returns for examination, resulting in the IRS Office of Appeals issuing a notice of deficiency (“NOD”) for the years at issue. The NOD disallowed many of Mr. Frost’s Schedule C deductions and his loss on Schedule E. In addition, the NOD determined that Mr. Frost was liable for accuracy-related penalties under Section 6662 for negligence and/or substantial understatements of income tax.

Mr. Frost timely filed a petition with the Tax Court. During those proceedings, the IRS produced a Civil Penalty Approval Form (“Approval Form”). The Approval Form was necessary to support the IRS’ burden of production on the penalties issue. See also Section 7491(c). However, the Approval Form indicated the accuracy-related penalty had been approved only for substantial understatement of income tax (and not negligence) for 2012. Thus, the Approval Form did not address the 2010 and 2011 penalties.

Because many of the deductions claimed by Mr. Frost required strict substantiation under Section 274(d), the Tax Court wasted little time in disallowing Mr. Frost’s Schedule C deductions. Moreover, because Mr. Frost was unable to substantiate his basis in the partnership, the Tax Court similarly disallowed his loss claimed on Schedule E.
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