Today we welcome guest blogger Professor Monica Gianni. Professor Gianni serves as an Associate Professor in the Department of Accounting of the David Nazarian College of Business and Economics at California State University, Northridge. She is the successor author to Volume 6, Tax Practice and Procedure, of the Bittker & Lokken treatise on Federal Taxation of Income, Estate and Gifts and Of Counsel at Davis Wright Tremaine LLP. She wrote to me and asked if I could mention her article forthcoming in The Tax Lawyer – a publication of the ABA Tax Section. I suggested that she might do a better job of describing her article than me and persuaded her to write a description herself. She writes on the penalty litigation that has consumed the Court – and this blog – for the past few years. Keith
As a reader of this blog, you have undoubtedly read numerous posts on Section 6751(b). Section 6751(b) requires supervisory approval in writing prior to assessment of certain penalties. Enacted in 1998 as part of the IRS Restructuring and Reform Act, the statute’s purpose was to prevent IRS agents from using penalties as bargaining chips. The section remained essentially dormant for over 20 years, with both the IRS and taxpayers accepting the position that approval needed to be obtained only prior to assessment. The trilogy of Graev cases and the decision of the Second Circuit Court of Appeals in Chai v. Commissioner changed the Section 6751(b) landscape completely, opening a Pandora’s box of taxpayers using Section 6751(b) to avoid penalties on the technicality of no-written-supervisory approval. Hundreds of court cases have followed, resulting in cases inconsistently interpreting Section 6751(b) and well-counseled taxpayers avoiding tax penalties.
I’ve written an article on this subject, which is due to be published in the next volume of The Tax Lawyer—Supervisory Approval of Penalties: The Opening of a Graev Pandora’s Box. The article tries to bring some order into the case law that has resulted from a badly drafted statute. (You can download the article here). After examining the current state of case law, the article concludes by recommending that the statute be repealed. Internal IRS procedures can address issues with the conduct of IRS employees while not opening the door to taxpayers using a technicality to avoid penalties and IRS employees potentially imposing penalties overbroadly in their attempts to comply with Section 6751(b). While others argue that repeal is not the answer, there seems to be agreement that something needs to be done. As Keith Fogg has pointed out, if the statute isn’t repealed, “maybe we will still be litigating Graev cases into the next decade helping to provide a never-ending source of blog posts.”
read more…The bulk of the litigation on this section has addressed when supervisory approval must be given to comply with Section 6751(b). The Tax Court has taken an expansive interpretation of the statute in favor of taxpayers, generally requiring that supervisory approval be obtained prior to the first formal communication to the taxpayer advising that a penalty will be imposed. The Circuit Courts of Appeals have started to disagree with the Tax Court. The Ninth Circuit, in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, held that approval is required at the earlier of the assessment of the penalty or before the supervisor “loses discretion whether to approve the penalty assessment.” More recently, the Eleventh Circuit in Kroner v. Commissioner and Carter v. Commissioner reversed the Tax Court, holding that approval is required only before the assessment of penalties.
Rather than examine those decisions one more time, this post looks at procedural requirements of supervisory approval that have resulted from numerous Tax Court decisions in actions brought by taxpayers for penalty relief based on inadequate supervisory approval. First, what is required of a supervisor to fulfill the penalty-approval requirement? The simple answer is nothing but the approval itself. No cross-examination of the supervisor by the taxpayer is required, no reasonable-cause defense by the taxpayer has to be presented first, and there is no requirement that the “thought process” of the supervisor be analyzed or that her review of the penalty have been “meaningful.” The supervisor does not have to consider the merits of the penalty determination, does not have to have real estate expertise for a valuation penalty, and can even approve a valuation penalty before receiving the appraisal report. As summarized in Belair Woods, LLC v. Commissioner, the penalty approval form itself does not have to “demonstrate the depth or comprehensiveness of the supervisor’s review.”
The next question is—how is approval shown? The approval, by the express language of the statute, must be in writing. That being said, an actual signature is not required, and approval can be shown by an electronic signature or even by e-mail. If the approval form, however, shows no date of approval or the date is illegible, the taxpayer will prevail under Section 6751(b). The reason for the penalty on the approval form must be the same as contained in the Notice of Deficiency, and the specific penalty must be listed and not just a general statement that penalties are approved.
A further question is—who is the supervisor that must approve the penalty? Section 6751(b) requires that the taxpayer’s “immediate supervisor” approve the penalty, and this connection must be shown on the approval form. “Immediate supervisor” is not defined in the statute, and there are no regulations under this section. When faced with the issue, the Tax Court in Sand Investment Co. v. Commissioner determined that such supervisor “is most logically viewed as the person who supervises the agent’s substantive work on an examination, even if the examiner’s direct supervisor is someone else.” The IRS considers an acting supervisor to be the agent’s immediate supervisor if he has an approved Designation to Act or a Notification of Personnel Action on file.
If a taxpayer wants to challenge a penalty in court based on lack of IRS supervisory approval, are there any limitations? A taxpayer cannot raise the Section 6751(b) issue for the first time on appeal when the issue could have been raised in the Tax Court. Nor can the issue be raised for the first time at the district court level if it was not raised in administrative proceedings. For a TEFRA partnership action, Section 6751(b) must be raised at the partnership level and is not a partner-level defense. And, if a taxpayer enters into a closing agreement agreeing to the assessment of penalties rather than going to court, he waives any subsequent Section 6751(b) challenge.
The above describes just some of the procedural rules that have developed from numerous court cases post-Graev. Although there is more certainty now than there was prior to these cases, different results for taxpayers can occur depending on which circuit has venue over any ensuing appeal. Whether the statute has succeeded in preventing penalties from being used as bargaining chips seems to have become an irrelevant consideration, as taxpayers have used the statute to escape often well-deserved penalties.
All well said. Repeal is the answer. The morass of Chai (a horribly incorrect and fairy tale decision) will otherwise never end.
Seems to me that the idea is for someone a wee bit more objective than the agent consider the merits. Some of the fact patterns you describe, particularly BelAir Woods, show that there was minimal if any consideration of the merits. I think the provision serves an important purpose and believe it should be given more teeth.