Automatically Generated Penalties Do not Require Managerial Approval

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This is the first of several posts on precedential cases decided by the Tax Court earlier this year regarding the IRC 6751 provision requiring preapproval by a manager before the assertion of certain penalties. The case of Walquist v. Commissioner, 152 T.C. No. 3 (February 25, 2019) represents the type of case that one might wish had been litigated by a petitioner other than a pro se petitioner that did not engage in the process; however, the outcome would almost certainly have been the same with a more robust litigation participant. In the Walquist case the Tax Court addresses the imposition of a penalty in a setting in which the IRS argues that automation removes the need for prior managerial approval. The court agreed.

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The IRS sent the Walquists a statutory notice of deficiency for 2014 determining a liability over $13,000 and a related accuracy penalty. Although petitioners earned almost $100,000 in 2014, on their return they claimed a deduction for almost the same amount based upon a “Remand for Lawful Money Reduction,” a tax protestor type claim. The IRS disallowed this claimed deduction resulting in the deficiency determined. The IRS handled the case through its Automated Exam Correspondence Unit designed to minimize the amount of human involvement in the audit.

The Automated Exam process generated a 30-day letter to petitioners. Because the amount of the liability determined through the process exceeded $5,000, the program automatically placed on the notice an accuracy related penalty of 20% of the liability. Petitioners did not respond to the 30-day letter, resulting in the issuance of the SNOD. Petitioners timely filed a petition with the Tax Court in which they continued to assert tax protestor type arguments. The tax protestor activity did not stop and the court gives a detailed accounting of the time wasting efforts of petitioners before it ultimately imposes the IRC 6673 penalty because of their post-petition actions. I will not describe this aspect of the case as it is relatively boring.

The ultimate finding of the court with respect to the requirement for managerial approval is that:

Because the penalty was determined mathematically by a computer software program without the involvement of a human IRS examiner, we conclude that the penalty was ‘automatically calculated through electronic means,’ sec. 6751(b)(2)(B), as the plain text of the statutory exception requires.

The court goes on to say that this conclusion is consistent with the description of the imposition of a penalty in this situation as described in the Internal Revenue Manual and the context in which the statutory exception appears in IRC 6751. Computer generated penalties do not raise the concerns that caused Congress to enact IRC 6751 because no one is imposing them in order to influence to taxpayer to accept the liability or otherwise to coerce an outcome. The court stated that if the penalty imposed under these circumstances fails to meet the statutory exception it is difficult to imagine a penalty that would meet the exception.

The court noted that its conclusion in this precedential opinion was consistent with unpublished orders that it had issued in recent years. Another reason for paying attention to those orders.

The result here makes perfect sense. The IRS did not impose this penalty as a bargaining chip. The court provides a detailed analysis for its decision. Perhaps the only thing surprising about the opinion is that a precedential opinion on this issue did not previously exist. Although petitioners did nothing to advance their argument that the exception should not apply, their failure did not create the result in this case.

The decision here was the first of several precedential IRC 6751 opinions issues in the first few months of the year as the court continues to answer the questions raised by this unusual statute. We will cover all of the opinions in the coming days.

Comments

  1. bryan camp says

    Nice post, Keith and I look forward to the series. I am not sure, however, that the result here “makes perfect sense.” I have a bit darker take on this case that I explained in a “Lesson” post here: https://taxprof.typepad.com/taxprof_blog/2019/03/lesson-from-the-tax-court-no-human-review-needed-for-automated-penalties.html.

  2. Norman Diamond says

    It would be better to discuss a case that didn’t really involve tax protesters, but since this is what we have, this is what I have to ask about.

    “The IRS handled the case through its Automated Exam Correspondence Unit designed to minimize the amount of human involvement in the audit.”

    To minimize human involvement, is there a bot available for taxpayers who don’t know why they’re being penalized?

    “Computer generated penalties do not raise the concerns that caused Congress to enact IRC 6751 because no one is imposing them in order to influence to taxpayer to accept the liability or otherwise to coerce an outcome.”

    That is most definitely not true. IRS employees (and DOJ employees) who know how to game the system do not directly write assertions that a penalty should be imposed. They create allegations of supposed underlying facts, whereupon the penalty is automatically imposed based on the supposed underlying facts. Though Tax Court is less hostile to pro se’s than other courts, even Tax Court blocked rebuttal evidence when the IRS asked it to.

  3. The Manual at 4.19.20.2 has a list of “Project Codes” that are currently processed through ACE (Automated Correspondence Examination). Many of them are related to EIC disallowance. However, some are not.

    For examples, there is “employee business expenses.” This is perhaps the line where the Walquists entered their bogus deduction. There are “Schedule A Deductions” and “Schedule A Contributions,” although we know this is not where their problems started because the opinion tells us they claimed the standard deduction. And there is “non-filer,” which would not apply here either.

    ACE is not AUR (Automated Underreporter) which is covered by a different section of the Manual, 4.19.3. That’s the source of many of the computer-generated notices seen by practitioners. These cases are all reviewed by IRS employees:

    “Potential AUR cases are systemically identified through computer matching of tax returns with corresponding Information Returns Master File (IRMF) payer information documents. Cases are selected for inventory in a manner determined to provide overall compliance coverage. Selected cases undergo an in-depth review by a tax examiner to identify underreported and/or over-deducted issues which require further explanation to resolve the discrepancy.” IRM 4.19.3.1.1

    The missing $1,215 unemployment compensation income in Walquist seems to be a red herring. The Walquists were in a 25% tax bracket, so it’s possible IRS criteria for AUR allow initiation of cases to collect small amounts of $300 or so. But we know that this is not an AUR case because the Tax Court tells us it was an ACE case.

    There may be a section in the Manual that explains how cases move from AUR to ACE without enough human intervention to require managerial approval of a Section 6662 penalty. I can’t find it this morning, and the Tax Court should have clerks for that. Or, the judges could have sent the case back to IRS for further explanation. They might have done so, for petitioners who are not tax protesters.

  4. Did anyone else notice that the IRS Letter 525 was not mailed until July 25, 2017 – nearly two years after the return would have been filed, even if an extension was requested? My experience with the ACE and AUR systems is that the first contact is made before the end of the next year after the return is filed. Was the Letter 525 really the first contact with the Walquists? They are not in court to tell us. If the first contact came earlier, how much human input did it involve?

    But it was not the first contact between them and IRS. An earlier case, Docket No 13684-12S, was settled by stipulation signed by Judge Holmes. It contained an unusual provision:

    “ORDERED AND DECIDED:

    “That there is a deficiency in income tax due from petitioners for the taxable year 2010 in the amount of $2,520.00.

    “It is further stipulated that, if petitioners pay the unpaid portion of their 2010 income tax deficiency, with interest, within 30 days of the filing of this decision, then Respondent may not reopen petitioners’ Offer-in-Compromise, which Respondent accepted on April 18, 2011, for any reason derived from petitioners’ 2010 income taxes.”

    The Tax Court case involving 2014 taxes was not decided until February 2019, but Walquist had apparently conceded he owed the tax by November 2017, about the same time he answered the Tax Court petition, when he filed a case in District Court in Minneapolis:

    “Craig Steven Walquist brought a petition for garnishment of U.S. Treasury Secretary Steven Mnuchin’s salary in the amount of $13,401 to satisfy Walquist’s debt to the IRS, because he claims to have disclaimed all obligations to pay federal taxes. (See Garnishment Pet., Nov. 27, 2017, Docket No. 1.) Magistrate Judge David T. Schultz issued a report and recommendation (“R&R”) recommending that Walquist’s petition be denied and the action dismissed as frivolous. (R&R, Dec. 8, 2017, Docket No. 6.)”

    (Or perhaps this case involved another year.)

    It’s also interesting that the “automated” Notice of Deficiency proposed an assessment of $13,832 with penalty of $2,766, but the IRS answer to the petition reduced the amount to $12,220 and $2,444. A footnote explained,

    “Respondent explained that the CEAS program had determined the deficiency and penalty by calculating the tax due on petitioners’ income as shown by third-party reports, without accounting for the income actually reported on their return. Because petitioners’ offsetting “Remand for Lawful Money Reduction” was less than their reported income, they in fact reported $6,466 of gross income. Our decision in this case will reflect the reduced deficiency and penalty as alleged in respondent’s answer.”

    Had they not asserted their tax-protester arguments, petitioners could have saved themselves a couple thousand dollars just by paying $60 for a Tax Court petition to get a Chief Counsel review of the automated miscalculation. Elderly widows who speak English as a second language probably don’t avail themselves of this opportunity.

    For those doing research into the psychology of tax protesters, there is a person with the same name as petitioner who resides in a lovely $300K home (photos online) in suburban Wayzata, and has worked since 2015 as a real estate appraiser for the City of Minneapolis.

  5. Excuse my obsession with this case, but it’s fascinating when the facts of a reviewed opinion don’t match what can be found in the public record elsewhere. When Petitioner Walquist filed his District Court case, he attached a copy of a Letter 525 received from IRS. It’s not the one dated July 26, 2017, to which the Tax Court opinion refers. It’s dated June 30, 2017, and it has an IRS “Employee ID” of 1000099771. The letter states, “We reviewed your 2014 federal income tax return, ANY INFORMATION YOU GAVE US, and made proposed changes …” (Emphasis added.) It continues, “Review the enclosed Form 4549 . . . and attached Form 886 and let us know by July 30, 2017 if you agree or disagree with our proposed changes.”

    Walquist’s District Court case also attaches a two-page response dated July 26, 2017, with some gibberish about Federal Reserve Notes along with some Biblical quotes including Hebrews 10:4 (“For it is not possible that the blood of bulls and of goats should take away sins.”)

    What happened here, then, is that IRS allowed 30 days on June 30 for a response; then pulled the trigger on July 26. Was this a decision made by a computer? Was the Tax Court even told about the June 30 Letter 525? Or perhaps the July 26 response was faxed to IRS in Ogden, and provoked a same-day response. Would a computer do that?

    What might have started this case was likely not the $1,215 unemployment compensation, but $14,159 of petitioners’ income that was reported on a 1099-MISC. No self-employment tax was paid. The IRS computation correctly includes $2,001 of self-employment tax.

    For further reading, see petitioner Walquist’s book “Gentile,” available in paperback on Amazon. “In 1996, with a King James Bible in one hand and a Black’s Law Dictionary in the other, Craig began a journey of intrigue that demanded his discoveries be made available to the public. In his first book, “GENTILE: Deception in the Last Days,” Craig offers insights into Eschatology not found in the most popular titles in the genre. In the words of an American Justice, America is welcomed to it’s ‘Evil Day’!” (Coincidentally, 1996 was the year he filed his first bankruptcy.)

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