Penalty defenses and the supervisory-approval requirement.

AuthorRoberts, Matthew L.
PositionPROCEDURE & ADMINISTRATION

Sec. 6751(b)(1) provides that the IRS may not assess certain penalties (1) "unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate." Although the provision was added to the Internal Revenue Code in 1998, (2) few taxpayers asserted noncompliance with Sec. 6751(b)(1) as a penalty defense until nearly 20 years later, after the decisions in Graev II, (3) Chai, (4) and Graev III. (5)

In Graev II, the taxpayers argued that the imposition of an accuracy-related penalty was improper because the IRS had failed to obtain managerial approval of the penalty prior to issuance of the notice of deficiency. In a sharply divided reported opinion, (6) the Tax Court disagreed and concluded that the taxpayers' argument was "premature." Specifically, the Tax Court held that Sec. 6751(b) (1) permitted the IRS to obtain written managerial approval at any time prior to the actual assessment of the penalty, which had not yet occurred as part of the deficiency proceeding. However, the dissenting opinion, authored by Judge David Gustafson, concluded otherwise, based on the ambiguity of the statutory term "initial determination of ... [the penalty] assessment" and the relevant legislative history. According to Gustafson, the legislative history strongly supported a position that the IRS must obtain written managerial approval of the penalty prior to issuance of a notice of deficiency.

Shortly after Graev II, the Second Circuit was similarly confronted with whether the IRS was required to obtain written managerial approval of an accuracy-related penalty prior to issuance of a notice of deficiency. In Chat, the Second Circuit agreed with Gustafson's dissent in Graev II and held that the IRS was required to obtain written managerial approval "no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty."The Chat court also concluded that compliance with Sec. 6751(b)(1) was part of the IRS's burden of production in court proceedings under Sec. 7491(c). (7) After Chat, the Tax Court vacated its decision in Graev II and concluded in Graev III that the IRS was required to provide evidence of compliance with Sec. 6751(b)(1) as part of its burden of production under Sec. 7491(c).

Chat and Graev III were decided in 2017. Since that time, the Tax Court and other federal courts have clarified the scope of Sec. 6751(b)(1) and its applicability to taxpayers in various factual contexts. These recent decisions and their significance to tax practitioners are discussed more fully below.

The 'initial determination'

Perhaps no other statutory language has resulted in more interpretative headaches than the requirement under Sec. 6751(b)(1) that the IRS obtain written managerial approval of the "initial determination of ... [the penalty] assessment." Because the term is not found in any other part of the Code and, in fact, is anomalous when juxtaposed with other statutory provisions governing the assessment process, this is not surprising. (8)

The Code defines an "assessment" as the formal recording by the IRS of the taxpayer's tax liability, which is "essentially a bookkeeping notation." (9) Generally, if the IRS asserts additional taxes are due, the Code requires it to "determine" the taxpayer's "deficiency." (10) If the IRS determines a deficiency, it must then issue a notice of deficiency, which permits the taxpayer to file a petition with the Tax Court within 90 days. (11) Once a petition is timely filed, the IRS is precluded from assessing the deficiency "until the decision of the Tax Court has become final." (12) Accordingly, the statutory scheme contemplates that "one can determine a deficiency ... and whether to make an assessment, but one cannot 'determine' an 'assessment.'" (13)

Because of this ambiguity, federal courts have placed more reliance on the legislative history surrounding Sec. 6751(b)(1). Specifically, that legislative history indicates that Congress enacted Sec. 6751(b)(1) based on its belief that "penalties should only be imposed where appropriate and not as a bargaining chip." (14) Moreover, Congress believed written managerial approval would "prevent IRS employees from arbitrarily using penalties as leverage against taxpayers[.]" (15) Thus, much of the federal courts' recent jurisprudence in interpreting the term "initial determination" has focused on furthering these legislative goals. (16)

Deficiency procedure penalties

The Code generally divides penalties into two groups. Under the first group of penalties, located in Subchapter A of Chapter 68 of the Code, (17) the IRS must follow the deficiency procedures prior to making a penalty assessment. (18) That is, the IRS must issue a notice of deficiency to the taxpayer proposing the penalties before initiating a collection action. These penalties generally include the penalties for failure to file and failure to pay under Sec. 6651 in addition to those related to failure to pay estimated taxes under Secs. 6654 and 6665. (19) In addition, such penalties include the accuracy-related and fraud penalties under Secs. 6662-6664.

As discussed previously, the Second Circuit in Chai held that the IRS is required to obtain written managerial approval of deficiency procedure penalties no later than the date the IRS issues the notice of deficiency or files an answer or amended answer asserting such penalties. But the decision in Chai left open the issue of whether the IRS must obtain written managerial approval at any time prior to the issuance of the notice of deficiency.

The Tax Court's decision in Clay (20) answered this issue. Specifically, in Clay, the Tax Court held that an IRS Revenue Agent Report (RAR), coupled with a 30-day Appeals letter, (21) constituted the "initial determination" under Sec. 6751(b)(1). The Tax Court reasoned that when the "proposed adjustments are communicated to the taxpayer formally as part of a communication that advises the taxpayer that penalties will be proposed and giving the taxpayer the right to appeal them with Appeals (via a 30-day letter), the issue of penalties is officially on the table." Because the IRS penalty approval form had been signed by an IRS manager after the taxpayer received the RAR and 30-day letter, the Tax Court concluded that the IRS was prohibited from assessing the penalty.

In Belair Woods, LLC, (22) the Tax Court similarly concluded that the "initial determination" of the penalty assessment at issue occurred when the IRS issued a "TMP 60-Day Letter" (23) to the tax matters partner of a TEFRA partnership. On the basis of Clay, the Tax Court reasoned that the 60-day letter was the "initial determination" because it provided Appeals rights and "formally notified [the taxpayer] that the Examination Division had completed its work and ... had made a definite decision to assert penalties."

The federal courts have also held that the "initial determination" of penalties can occur during a Tax Court proceeding. (24) For example, in Rotb, (25) the Tenth Circuit held that the "initial determination" of a gross-valuation accuracy-related penalty was properly approved in writing when IRS counsel filed an answer asserting the penalty and that counsel's immediate supervisor also signed the answer.

But the Tax Court has cautioned taxpayers that written managerial approval is not required prior to the first IRS informal communication of the penalties to the taxpayer. For example, in Tribune Media Co., (26) the Tax Court concluded that written managerial approval of the penalties at issue was not required prior to the taxpayer's first informal meeting with the IRS to discuss the penalties. Moreover, the Tax Court held in that decision that written managerial approval was not required prior to issuance of a Notice of Proposed Adjustment (NOPA). The Tax Court noted that neither the informal meeting nor the NOPA provided the taxpayer the opportunity for IRS Appeals rights, which the Tax Court determined was "one of the important indicia of formality." The Tax Court further reasoned that the term "determination" in Sec. 6751(b)(1)...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT