Section Affected
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Edition page numbers
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Ch. 8. Penalties.
III. Civil Penalties. L. Penalty Administration. 1. Authority to Assess; Notice. |
Practitioner Ed. pp. 414-419
Student Ed. pp. 287-289
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This week, the Tax Court issued two T.C. opinions (one of which was a reviewed opinion) and a T.C. Memo Opinion dealing with the ongoing refinement, through interpretation, of the meaning of § 6751(b), here, which is:
No penalty under this title shall be assessed 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.There are some exceptions, but the focus in most of the cases (including the ones decided this week) has been the text quoted above.
The opinions are: Belair Woods, LLC v. Commissioner, 154 T.C. ___, No. 1 (2020) (reviewed), here; Frost v. Commissioner, 154 T.C. ___, No. 2 (2020), here; and Tribune Media Company v. Commissioner, T.C. Memo. 2020-2, here. An excellent discussion of the opinions are presented in Bryan Camp's offering Lesson From The Tax Court: A Practical Interpretation Of The Penalty Approval Statute § 6751 (Tax Prof Blog 1/13/20), here. (Note: I added this link to Bryan's article on 1/13/20.)
Rather than discussing those opinions, I offer an overview of the current state of play on the interpretation of § 6751(b) from my Federal Tax Procedure book as I now have it in the working draft for the 2019 editions (which will be published in August 2020). The key holdings of the cases are incorporated in this overview. The overview in the blog below does not include footnotes; for those wanting the footnotes, I offer the text and footnotes in pdf format here. Here is a cut and paste of the overview without footnotes. I do not indent to show that this is quoted text.
Second, § 6751(b)(1) prohibits the assessment of a penalty “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.” The purpose of the requirement was to prevent agents from improperly using the threat of a penalty as inappropriate leverage–a “bargaining chip”–to extract concessions when the IRS institutionally had not made a determination to assert a penalty. This wording of statute, however, is facially nonsensical because there is no such thing in the tax law as the determination of an assessment and, in any event, the assessment comes long after the threat of penalties could have been made to bully taxpayers. In statutory interpretation lingo, the statutory text is “ambiguous,” a characterization which has spawned many opinions as the courts try to deal with the deficiencies in the statutory text through purposive interpretation strategies to apply the text as the courts think or speculate Congress intended but did not say in the statutory text. I attempt to bullet-point key features of the statutory prohibition under the current state of play. I state the current state of play in general overview, but do not develop many of the nuances, some of which are yet to come. There undoubtedly will be further refinements as the courts address various unique fact patterns, so stay tuned. With those caveats, here is my summary:
• The most significant issue has been the timing of the written approval. Once the courts accepted that timing must be before the assessment despite the statutory text, the issue is to identify the timing of the initial determination required for the written approval. The statutory text provides no guide for determining that earlier timing, but by focusing on the requirement for an “initial determination” and the legislative history, courts have looked to some event indicating more than a communication to the taxpayer that the agent was considering penalties. The initial determination is “the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.” In the context of an audit, the initial determination is the 30-day letter (or equivalent such as the 60-day letter in a TEFRA audit) sent to the taxpayer stating Examination’s determination to assert one or more penalties and offering the taxpayer a right to contest the determination in Appeals. Mere notice that to the taxpayer the agent is considering asserting penalties and asking the taxpayer to discuss the penalties is not the determination requiring written approval. However, if the RAR is prepared asserting the penalty and delivered to the taxpayer, written approval must be before or contemporaneous with the RAR. And, even a notice that the IRS has preliminarily determined to assert a penalty that the taxpayer can avoid by action on his part is not the initial determination requiring written approval.
• Where § 7491(c) applies to impose the production burden on the IRS to prove written approval before communicating a decision to assert penalties and the taxpayer challenges the penalties, the IRS must meet the production burden that the written approval was obtained and timely. If the IRS meets that production burden to show written approval before communication to the taxpayer of the determination of the penalty, the taxpayer then has the burden of production to show an earlier communication of the determination of the penalty before written approval was obtained. If the taxpayer meets that burden of production, the trier of fact will decide based upon the allocation of the persuasion burden. There is an open issue of whether, if the IRS meets its production burden that written approval was obtained before the communication of the penalty determination and the taxpayer meets his resulting production burden showing an earlier communication before the written approval, the IRS or the taxpayer then bears the ultimate burden of persuasion on the issue.
• Where § 7491(c) does not impose the production burden on the IRS (such as in proceedings not involving individuals), the taxpayer must raise and prove the absence of § 6751(b) written approval as a defense.
• There is no requirement that the supervisor’s written approval either reflect or be predicated on meaningful review of the determination.
• No particular IRS form is required for the written approval so long as it is clear that the written approval does in fact approve the penalty. Even the manager’s signature on the cover letter forwarding the penalty determination has been held to suffice.
• Where in the administrative process including Appeals, initial determinations as to alternative penalties may be made by different persons (e.g., Examination agent, Appeals Officer or in a Tax Court case by the attorney), providing that the required immediate supervisor approval is made for each such determination. For example, if the IRS attorney in a Tax Court case asserts a new penalty by answer or amended answer, which the IRS is entitled to do (§ 6214(a)), does the “approval” of the attorney and the attorney’s manager meet the requirement? The IRS’s answer is that that approval suffices.
• The exceptions to the written approval requirement are for penalties under §§ 6651, 6654, or 6655 and for ““any other penalty automatically calculated through electronic means.” In addition to the specific exceptions from this supervisor written approval requirement some IRS liabilities nominated penalties may not in fact be penalties subject to the requirement. For example, the § 6673(a)(1) penalty that the Tax court may impose for proceedings for delay or for frivolous or groundless positions are not subject to the requirement. An open issue is whether the Trust Fund Recovery Penalty (“TFRP”), § 6672 is subject to this requirement. Although the Code labels the TFRP a penalty, courts often called the liability simply a collection method for the underlying employment withholding tax not paid over by the employer. One court of appeals, in a nonprecedential decision, suggested that the TFRP was not a penalty subject to the manager approval requirement. The IRS position is that the TFRP is not subject to the written approval requirement. [UPDATE 1/23/20: The Tax Court held in Chadwick v. Commissioner, 154 T.C. ___, No. 5 (1/21/20), here, that the TFRP is subject to § 6751(b) immediate supervisor written approval requirement; I discuss Chadwick in Tax Court Holds the TFRP is a Penalty Subject to § 6751(b) Written Approval Requirement (1/23/20), here.]
• Finally, if the taxpayer agrees to a penalty by executing a closing agreement with the IRS, § 7121(b)’s finality requirement will foreclose a taxpayer from contesting the issue of whether the § 6751(b) written approval requirement was met.
JAT Comments:
1. I do note in one footnote that there needs to be a solution to the mess other than sporadic and anecdotal case resolutions. Here is that footnote:
This appears to me to be a classic case where a well-considered statutory amendments or, failing that, a comprehensive interpretive regulation could clean up the mess. The courts have already found the statute ambiguous, the condition required for “reasonable” interpretive regulations. Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). By adopting well-considered interpretive regulations, the IRS could essentially moot out the plethora of prior and future court machinations to deal with the problem. See National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 981 (2005) (permitting the agency to adopt interpretive regulations contrary to prior judicial interpretations so long as the prior judicial interpretations are not compelled by the text of the statute, which would not be true here because the statute is ambiguous). I don’t think reversal of the court interpretations of § 6751(b) would be foreclosed under Brand X by prior judicial precedent that foreclose the agency new interpretation as occurred in United States v. Home Concrete & Supply, LLC, 566 U.S. 478 (2012). An interpretive regulation, with notice and comment, by Treasury, the expert on IRS processes and the big picture, would likely produce a more holistic set of interpretations than courts can do anecdotally as unique cases arise. The problem with the regulations approach is that final regulations could take a very long time, perhaps a couple of years. But, since the regulations would be interpretive, Treasury could adopt Temporary Regulations and, provided that the final Regulations are adopted within three years, the Temporary Regulations could be effective immediately (§ 7805(e)) and the final regulations could be effective from the date of the Temporary Regulations (§ 7805(b)).2. For those interested in statutory interpretation, § 6751(b) is a classic example showing the folly of textualism in statutory interpretation. Literal interpretation of the statutory text of § 6751(b) is meaningless. Accordingly, the courts have looked to the legislative history in order to make meaning of the text and apply purposive interpretations to effect what the courts believe (or speculate) Congress must have intended. I am not a fan of textualism except in those cases where the text really, really is plain and unambiguous (like the Chevron Step One test). When, as frequently, text is not plain and unambiguous, the statute should be holistically interpreted drawing on whatever interpretive tools are available to make the statute work in the context in which it applies. If legislative history is helpful or persuasive, in that endeavor then courts and agencies should use legislative history. And of course all of those tools could be brought to bear in comprehensive regulations and even in judicial decisions. The problem with judicial decisions is that they tend to be more episodic than comprehensive, and decided by courts without the expertise to see how all the gears in administrative mechanism fit together.
Addendum 1/14/20 12:30pm:
3. I recommend for those digging into the proper interpretation and application of § 6751(b) to read Lew Taishoff's ruminations. Can We Talk - Part Deux (Taishoff Law Blog 1/6/20), here.
4. Nobody asked (yet) what my view of the point of "determination" by which the supervisor written approval must be obtained. Certainly, I agree that it must be obtained by the 30-day or 60-day letters in deficiency and TEFRA proceedings, respectively. But, must it be obtained when the agent merely mentions (or threatens) that he is considering asserting a penalty and is seeking taxpayer input on whether the penalty should apply? That makes no sense to me. Certainly for the more egregious conduct (i.e., drawing the 40% accuracy related penalty and the civil fraud penalty (generally the bullshit tax shelter genre oft discussed in this blog)), the taxpayers know at the inception of the audit that penalties will be considered although they may not know for sure whether the penalties will be "determined." So, the mere consideration of the penalty by an agent with no individual authority to assert the penalty would not seem to be a determination (if determination means anything). On the other hand, by the agent's mere mention that he or she is considering penalties, the agent can be attempting to extract agreements that he or she might not otherwise be able to obtain on the merits. So, I probably could argue the issue both ways, but if determination means anything, I don't think it is agent level ruminations that have not yet been approved in any way by the structure within the IRS that requires approval at least at some level (setting aside whether the approval is the type and in the format required by § 6751(b)).
Addendum 1/17/20 10:40 am.:
5. Yesterday, the Tax Court issued an opinion in Laidlaw's Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. ___, No. 4 (2020), here. The key holding for present purposes (for the opening synopsis) is: "The written supervisory approval requirement of I.R.C. sec. 6751(b)(1) applies to the assessable penalty imposed by I.R.C. sec. 6707A for failure to disclose reportable transaction information." The analysis in the opinion applies to other assessable penalties as well.
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