Chai not Gaining Traction with Tax Court or IRS

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Back in March, Steve blogged about the 2nd Circuit’s decision in Chai v. Commissioner reversing the Tax Court and finding that the IRS had a duty to prove that the immediate supervisor of the employee imposing a penalty met the requirements of the previously long forgotten IRC 6751.  The Chai decision came shortly after a fully reviewed Tax Court opinion in which the Court, in Graev v. Commissioner, held that the IRS did not have a duty to prove that the immediate supervisor had signed.  See my blog post here.  The 2nd Circuit essentially adopted the views of the dissent in Graev.  Because appellate venue for Graev lies in the 2nd Circuit, the decision in that case will unlikely stand; however, the opinion can still provide precedent for Tax Court cases appealable to other circuits as the Tax Court applies its Golsen rule.  This post will focus on what is happening post-Chai and how that might impact your clients who are unable to move to New York City or other fine locations in the 2nd Circuit.

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The first matter to discuss is Graev.  The IRS has chosen not to roll over and accept Chai as applying in a way that resolves the Graev case.  The IRS filed a motion with the Tax Court asking it to reconsider its opinion in Graev in light of the Chai decision.  The critical paragraph of the motion states:

“Respondent requests that the Court vacate its decision in this case and order additional briefing on what steps the Court should take in this case in light of the Chai opinion. Respondent has views which it believes will benefit the Court to consider in the changed circumstances of this case.”

The Tax Court granted this motion and issued an order vacating the decision and requiring the parties to file simultaneous briefs by June 1, 2017.  The petitioner and respondent timely filed these briefs.  The Court ordered the parties to file responsive briefs by June 20; however, petitioner filed a motion requesting until June 30 to file responsive briefs and permission to file a response to the responsive briefs by July 31.  The Court granted petitioner’s request so it will be at least a month before this case becomes fully at issue again.

The vacation of the decision raises an interesting question with respect to the Golsen rule.  Does the Graev opinion control future decisions of the Tax Court if the decision in the case is vacated at the request of the government?  The answer to that question appears to be yes as discussed further below.

While you might have expected that the IRS requested the vacation of the decision in Graev so that it could concede the IRC 6751 issue, the IRS has taken the fight to a new level, and in fact, in the first post-Chai brief filed in the Graev case, the IRS did not even cite to Golsen.  The brief filed by Frank Agostino’s firm cited Golsen four times and devoted the first of six sections of the brief to this issue.  In the statement of the case, petitioner’s brief states:

The issue is whether the rule in Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), and the United States Court of Appeals for the Second Circuit’s opinion in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), aff’a in part and rev’a in part, T.C. Memo. 2015-42, 109 T.C.M. (CCH) 1206 (2015), require this Court to vacate its decision determining the Graevs liable for 20% accuracy-related penalties under section 6662(a) and instead enter a decision for the Graevs adjudging them not liable for the penalties because the Commissioner failed to comply with the written-approval requirements of section 6751(b)(1).

So, the next opinion by the Tax Court in this case will have the opportunity to decide a number of issues concerning the application of the 2nd Circuit’s decision on the these types of cases.  Petitioner frames the issues in this manner:

The Second Circuit’s opinion in Chai requires this Court to vacate the March 7th Decision for five reasons. First, Chai is controlling in this case pursuant to the rule in Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), because this case is appealable to the Second Circuit, because the holdings in Chai are squarely on point and the facts are indistinguishable, and because the failure to follow Chai would result in inevitable reversal upon appeal.

Next, in rejecting the majority’s holding and reasoning in Graev II that the 6751(b)(1) issue was not ripe in a deficiency proceeding (i.e., it was premature), the Second Circuit in Chai held that the issue of the Commissioner’s compliance with the requirements of section 6751(b)(1) is ripe for review in a deficiency proceeding.

Third, by rejecting the concurrence’s holding and reasoning in Graev II that the Commissioner’s failure to comply with the written-approval requirements of section 6751(b)(1) is excusable as harmless error, the Chai Court held that the written-approval requirement in section 6751(b)(1) is a “mandatory, statutory element of a penalty claim” that is not subject to harmless error analysis.

Fourth, the facts of this case, as found in Graev I and Graev II, require a holding that the Commissioner did not comply with the requirements of section 6751(b)(1) in determining the 20% accuracy-related penalties at issue.

Fifth, the Chai Court rejected the Commissioner’s contention that an amended answer filed by his attorneys can cure his failure to comply with the written-approval requirement of section 6751(b)(1) because compliance at the time of the initial determination is a “mandatory, statutory element.” Thus, the Court must vacate the March 7th Decision and its determination that the 20% accuracy related penalties may be assessed.

In contrast, the IRS frames the issues as follows:

Because this case is appealable to the Second Circuit, this Court’s holding in Graev v. Commissioner, 147 T.C. No. 16 (2016), regarding the timing of the supervisory approval of the initial determination of a penalty assessment cannot stand on appeal. Therefore, this Court must face additional issues regarding whether there was adequate supervisory approval of the initial determination of a penalty assessment in this case.

Those issues are: (1) whether the timely supervisory approval of a 40 percent accuracy-related penalty was, in effect, approval of the alternative position of the 20 percent penalty; (2) whether an attorney’s recommendation to include the 20 percent penalty in the statutory notice of deficiency, which recommendation was approved and adopted, can constitute the initial determination of the penalty assessment in this case; and (3) if a penalty assessment arises from an assertion raised in the amendment to answer in this case, whether the initial determination of that penalty assessment was made by the attorney who asserted the penalty in the amendment to answer. To avoid the potential for piecemeal litigation of these issues, respondent requests a ruling on each one even if the Court decides more than one issue in respondent’s favor.

So, the next phase of Graev could focus on the ability of the Chief Counsel attorney and the supervisor of that attorney to initiate and provide the appropriate supervisory approval.  If the IRS wins this argument, it will win the case and it will avoid the problem that occurs in cases in which Chief Counsel attorneys in the answer or subsequent pleadings change the penalty from the penalty imposed by the Commissioner in the notice of deficiency.  We will closely watch the case and keep you informed.

Meanwhile, there are many other cases in which petitioners have suddenly decided to raise the failure of the IRS to obtain the proper supervisory approval for a penalty.  We blogged about such a case decided almost immediately after Chai.  A more recent case shows another side.  On June 12, 2017, Judge Lauber issued an order in the case of Zolghadr v. Commissioner in which he rejected their Chai argument for two reasons.  First, petitioners did not raise the argument in time in a deficiency case.  Remember that both Chai and Graev were also deficiency cases where  the timing of raising the argument was also a concern.  Second, and more important for this discussion, he addressed the merits and the current viability of Graev stating:

“Alternatively, even if petitioners’ argument were timely, their reliance on Chai is misplaced because this case is appealable to the U.S. Court of Appeals for the fourth Circuit, not to the U.S. Court of Appeals for the second circuit, which decided the chai case.  For cases in which the appellate venue is a court of appeals other than the second Circuit, the applicable Tax Court rule is that enunciated in Graev v. Commissioner, 147 T.C. (slip. Op. at 42 n.25).  Under that case respondent has no burden of production to demonstrate compliance with section 6751(b).”

While we are waiting for the “final answer” in Graev, you should not wait to raise the IRC 6751 argument in your case.  In addition, you now know that at least one judge on the Tax Court views Graev as controlling which means you may have to move your case into the applicable circuit court if your client lives outside the Second Circuit.  I think Judge Lauber’s view of the current applicability of the Golsen rule as it applies to Graev is a view shared by other judges on the Tax Court.  Do not expect to roll into Tax Court citing Chai and automatically winning.

Comments

  1. On June 12, 2017, Judge Lauber issued an order in the case of Zolghadr v. Commissioner in which he rejected their Chai argument for two reasons. First, petitioners did not raise the argument in time in a deficiency case. Remember that both Chai and Graev were also deficiency cases where the timing of raising the argument was also a concern. Second, and more important for this discussion, he addressed the merits and the current viability of Graev.

    The Zolghadrs, are representing themselves, and most likely will be appealing their case to the 4th Circuit Court of Appeals and would appreciate any comments or concerns of the procedurallytaxing community. Please provide your thoughts.

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