Tax Court Reverses Itself a Year After a Fully Reviewed Opinion Acknowledging a “Graev” Mistake

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Christmas came a little early to at least four Tax Court petitioners, including the estate of Michael Jackson. It also comes early for bloggers who like to write awful titles to our posts. I will discuss the Christmas presents to these petitioners in a companion post but today I focus on the underlying cause which is the reversal by the Tax Court of its decision in Graev v. Commissioner, 147 T.C. No 16 (2016)(sometimes known as Graev II). In that case the Tax Court decided that it did not have the authority in deficiency cases to look at whether the IRS obtained the proper penalty approvals under IRC 6751(b) though the Court split significantly in a fully reviewed decision. We have blogged about this issue more times than deserve links; however, a few links are here and here for those needing background on the issue. I suspect there will be more posts to come before this issue reaches a stable position.

The latest decision in Graev v. Commissioner, 149 T.C. No. 23 (2017)(Graev III) reverses the decision made just last year, adopts the intervening opinion of the Second Circuit in Chai v. Commissioner, 851 F.3d 190 (2nd Cir. 2017) and holds that in deficiency cases the Tax Court does have the ability to review whether the IRS obtained the appropriate signatures prior to the imposition of the penalty. Although, with the exception of Judge Holmes who agreed with the decision solely based on the Golsen rule since Graev’s appeal will go to the Second Circuit, the Court again split rather substantially. This time the split is primarily on the application of IRC 6751(b) and not whether it should apply, though Judge Holmes writes extensively on why he believes the Tax Court should have stuck to its position in Graev II. Mostly because of Judge Holmes’ concurrence (in result only), the opinion is long. This post is no more than a very cursory overview. For those interested in tax procedure, the opinion deserves a careful read.

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Well, it would have been interesting to be in the Tax Court’s conference room on the day(s) it discussed this case. The statute provided lots of room for debate as the Court struggled to fit its language into existing tax procedure norms. Maybe before the case reaches its final resting place, the conference room will be renamed the Graev room for many meetings the case has, and may still, cause. As we have referenced before, kudos go to Frank Agostino for paying attention to a provision in the 1998 act that everyone else seemed to overlook. Frank’s client comes away from the latest opinion in this case a bit empty handed but the split on the Court may provide ample room for Frank to obtain some relief at the next level.

I will discuss the case by looking at each of the four parts: 1) the majority opinion written by Judge Thornton; and then the concurring opinions by 2) Judge Lauber; 3) Judge Holmes, partially dissenting and 4) Judge Buch, partially dissenting.

Majority Opinion

The Court reverses its prior opinion and adopts the Second Circuit’s view of IRC 6751(b) as expressed in Chai. It does this with relatively little fanfare:

Having considered the opinion of the Court of Appeals for the Second Circuit in Chai, and in the interest of repose and uniformity on an issue that touches many cases before us, we reverse those portions of Graev II which held that it was premature to consider section 6751(b) issues in this deficiency proceeding.

The Court then went on to talk about what that means:

In the light of our holding that compliance with section 6751(b) is properly at issue in this deficiency case, we also hold that such compliance is properly a part of respondent’s burden of production under section 7491(c).

Once it decided that it could consider the 6751(b) issue and that the IRS had the burden of production with respect to the issue, the majority then looked at each penalty imposed in order to determine whether the IRS met its burden. Based on its analysis, with which Judge Buch disagrees, the Court sustained the imposition of the penalty.

The majority found that the Chief Counsel docket attorney who reviewed the notice of deficiency initiated part of the penalty and that his supervisor approved his recommendation/determination of the applicability of the penalty. The determination came in the form of a review of the proposed statutory notice of deficiency. When the IRS received his recommendation regarding the penalty to be imposed on the Graevs, it adopted the recommendation in the notice of deficiency sent to the petitioners.

In addition, the Chief Counsel docket attorney assigned to try the case added an additional penalty after the filing of the Tax Court petition. Her supervisor approved this additional penalty. The majority found that the penalties generated by the Chief Counsel attorneys met the requirements of 6751(b). The majority found that the taxpayers’ conduct regarding the unpaid taxes and the claiming of the gift warranted the imposition of the penalty. Since the Chief Counsel attorneys and supervisor’s actions satisfied the approval requirement and since the penalties were otherwise appropriate, the Court determined that the petitioners owed the penalties.

Judge Lauber’s Concurrence

Joined by four other of the eight judges in the majority, Judge Lauber wrote to take issue with the separate opinion written by Judge Buch. He discusses in detail why the approval by Chief Counsel lawyers meet the statutory test as initial recommenders of the penalty. He looks at both delegation orders and the intent of the statute.

Judge Holmes’ concurrence and dissent

Judge Holmes writes at length about the problems and uncertainty that the decision will cause. He has many concerns about the Second Circuit’s opinion and the problems it will cause. His opinion is not a full on dissenting opinion because he agrees that the Tax Court must follow the Second Circuit here pursuant to the Golsen rule; however, he wants to preserve the Tax Court’s approach in Graev II for another day and for a case appealable to a different circuit.

He does not like the Second Circuit’s approach to the case and argues forcefully that compliance with the statute is not ripe for court review in a deficiency case. He notes initially that 6751(b) has existed for almost 20 years. Adopting the Second Circuit’s approach means that many cases during that period have resulted in penalty imposition without appropriate proof by the IRS. He states:

Adopting this reading as our own, and rolling it out nationwide, amounts to saying that we have been imposing penalties unlawfully on the tens of thousands — perhaps hundreds of thousands — of taxpayers who have appeared before us in that time.

This is just the beginning of his concerns about the case. To the extent he is concerned, he might feel better knowing that the IRS does not care when it has hundreds of thousands of improper penalty assessments on its books as it demonstrated following the Rand case. Unlike the Rand case in which most taxpayers could still oppose the penalty if they knew that they had a basis for doing so, the penalty decisions over the past two decades made without the now adopted standards involve a Tax Court decision and cannot, by and large, be undone.

He next engages in a close reading of the Chai opinion and what it says. In doing so he points out the differences in the language of the statute and how taxes work:

And here is where a closer reading of the text and a broader understanding of tax litigation ought to make a difference. As the majority and Chai implicitly acknowledge, liability for penalties — indeed, liability for tax of any kind — is fixed by the Code sections imposing penalties and tax. See Chai, 851 F.3d at 217 (explaining that penalty “aris[es] under [section] 6662(a)”). “Assessment” is just a recording of the liability. See Hibbs v. Winn, 542 U.S. 88, 100 (2004); United States v. Galletti, 541 U.S. 114, 122 (2004) (assessment is “little more than the calculation or recording of a tax liability”). Liability “arises and persists whether vel non that tax is assessed.” Principal Life Ins. Co. v. United States, 95 Fed. Cl. 786, 790-91 (2010); see also Kelley, 539 F.2d at 1203 (“liability is imposed by statute independent of any administrative assessment”).

He points out that Chai conflates liability and assessment and that in doing so it will play havoc with the burden of proof rules. The Second Circuit looked to the purpose of a statute that did not make good sense rather than pay close attention to the technical language. He thinks that it is possible to achieve a correct result based on a technical reading of the statute and that the correct technical reading takes the Tax Court out of 6751 since the statute refers to assessment. He produces numerous examples to show how difficult it will be to make the statute work. His portion of the opinion cogently explains many aspects of tax procedure but he is left alone among the judges deciding this case because of his desire to adhere to the result in Graev II.

Judge Buch’s concurrence and dissent

Judge Buch, joined by five other judges, three of whom who like him had worked at Chief Counsel’s office prior to joining the Court and the other two having worked in the Tax Division of the Department of Justice, agreed that the Tax Court should apply Section 6751(b) in a deficiency proceeding but disagreed with the application of the new rule to penalty determinations by Chief Counsel lawyers. His opinion focuses on the role that Chief Counsel attorneys play in the process. He characterized this role as one of advisor rather than the person making the determination.

I agree that the Chief Counsel attorney’s role in reviewing the notice of deficiency is that of advisor. The IRS does not have to agree with the Chief Counsel attorney in this situation. If the Chief Counsel attorney’s advice is something different than a determination then it provides another example of something that does not fit the language of the statute. This segment of the opinion does a good job of showing the problems with the statute raised by Judge Holmes in the preceding section.

Two Chief Counsel attorneys made penalty recommendations/determinations in this case. The attorney who reviewed the notice of deficiency prior to it issuance made one which fits the description in the prior paragraph and then another attorney was assigned to the case once the petitioners filed in Tax Court. The second attorney made another penalty determination. Once the case is petitioned, Chief Counsel’s office can make a decision on adding or removing penalties without getting the opinion of the IRS. The opinion here does not distinguish between the two situations in which the penalty determinations were made by the Chief Counsel attorneys and their managers but it would be possible to split hairs here continuing to demonstrate the potential problems with the statute.

Conclusion

For the reasons detailed by Judge Holmes in the many examples he provided, the Tax Court has not seen the last of the many variations of how 6751(b) can cause mischief. Anyone defending a penalty will want to read Judge Holmes’ concurrence carefully in order to gather ideas on how to challenge the approval process chosen by the IRS. The IRS also needs to read that section carefully in order to create procedures that will withstand attack. Of course, the Second Circuit may still have more to say on how to interpret 6751 as it applies to the Graevs.

 

Comments

  1. Congress made two changes to penalty administration in 1998 — enacting section 7491(c) (placing the burden of production on penalties in any court proceeding on the IRS) and section 6751(b) (requiring written supervisory approval of certain penalties).

    Without any prompting, the Tax Court began enforcing 7491(c), starting with Higbee v. Commissioner, 116 T.C. 438 (2001), any time a taxpayer contested the penalties. But, in Swain v. Commissioner, 118 T.C. 358, 364-365 (2002), the court put in a caveat — that if the taxpayer never mentioned contesting penalties, the IRS had no burden of production under 7491(c) (a ruling that I consider a major mistake, since pro se taxpayers usually assume that any contest to a deficiency includes the penalties, as well, so there is no need to mention penalties). I have blogged before how the Tax Court judges selectively use Swain mostly against tax protestors — still insisting on the IRS showing 7491(c) compliance in non-tax protestor cases where the taxpayer never even put the word “penalty” into the petition or any other filing.

    Thanks to Frank Agostino, the Tax Court woke up to the existence of section 6751(b) a few years ago. But, its first reaction was to say that the Tax Court could enforce section 6751(b) only in CDP cases, not deficiency cases. That’s Graev II.

    Most CDP cases are decided in unpublished orders on motions for summary judgment filed by the IRS. Since the Tax Court finally started enforcing 6751(b) in CDP, however, judges have been divided (mostly in their orders) over whether taxpayers have to affirmatively mention 6751(b) to get that section considered. It seems to me that the first big issue post Graev III is going to be whether taxpayers have to mention 6751(b) to get the court to force the IRS to come forward to prove supervisory approval compliance. Since Frank did raise 6751(b) by name in Graev, Graev III gives no guidance on this question. But, guidance may be had in the Higbee line of cases that eventually resulted in the Tax Court enforcing the burden of production on the IRS on all sorts of subsidiary penalty issues (such as whether a substitute for return was filed; Wheeler v. Commissioner, 127 T.C. 200 (2006), affd. 521 F.3d 1289 (10th Cir. 2008)) when a taxpayer merely wrote in the petition: “The petitioner is not liable for a penalty.” If Swain stays, I would hope that 6751(b) compliance is just one more thing the IRS must prove — without the taxpayer specifically having to mention that Code section.

    Judge Holmes spins out a parade of horribles of issues that will have to be decided as progeny of Graev III. With all due respect to Judge Holmes, if one starts from the premise (with which I agree) that Congress, though it drafted section 6751(b) badly, really intended for the Tax Court to enforce this provision in deficiency cases, this parade of horribles would be the same, even if Congress had been clearer in the language it chose. Those horribles are simply issues that will be decided in the normal course of litigation when particular cases present those fact situations. The opinions deciding those fact situations will merely be progeny of Graev III, like Wheeler and Swain were progeny of Higbee.

    But, will Swain continue to be good law? Swain was adopted with no briefing from the tax protestor taxpayer and should be discarded as not in conformity with what Congress no doubt expected — that anyone petitioning a notice of deficiency containing penalties has the right to put the IRS to come forward with evidence of penalty appropriateness.

    Also, I am not sure that appellate courts will agree with the Tax Court Graev III majority that IRS attorneys can add penalties to either a notice of deficiency or to a Tax Court case (through pleadings citing section 6214(a)). In trying to harmonize Congress’ desire not to have penalties used as bargaining chips, it is my view that any penalty added by an attorney is really just a bargaining chip — often traded away in a settlement. Most cases settle, so the Tax Court rarely rules on such attorney-added penalties. In my view, there should be an exception to section 6214(a)’s usual rule that the IRS can seek a greater deficiency through its pleadings for situations where IRS attorneys seek to add or increase penalties that are covered by the rules of section 6751(b). That is how I would harmonize section 6751(b) and section 6214(a).

  2. Norman Diamond says:

    ‘Liability “arises and persists whether vel non that tax is assessed.” Principal Life Ins. Co. v. United States, 95 Fed. Cl. 786, 790-91 (2010); see also Kelley, 539 F.2d at 1203 (“liability is imposed by statute independent of any administrative assessment”).’

    Those cases should help clarify that when a taxpayer figures out that liability is alleged (by combination of statutes and IRS administrative records) and the taxpayer demands a Notice of Deficiency, the IRS must obey the Internal Revenue Manual and issue a Notice of Deficiency. I wish I’d known those cases a few months ago.

    ‘He points out that Chai conflates liability and assessment and that in doing so it will play havoc with the burden of proof rules.’

    Right, it does not seem possible that a court would make such a mistake. It seems more likely that the court’s misstatement was intentional. In my experience the Department of Justice makes greater efforts than the IRS in persuading courts to misstate both statues and facts. We’d be better off if the IRS represented itself in all tax cases.

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