IRS Office of Chief Counsel Gives Direction on Graev Compliance in Litigation

IRS asserts supervisory approval is not required before imposition of a Trust Fund Recovery Penalty 

Section 6751(b) begins, “No penalty under this title shall be assessed unless…” In a brief paragraph, Chief Counsel Notice 2018-006 directs IRS attorneys to argue that the trust fund recovery penalty (TFRP) under section 6672 is a tax, rather than a penalty. Therefore, the argument goes, supervisory approval for assertion of a TFRP is not required by section 6751. The Notice also flags this issue generally, noting “there may be other taxes that taxpayers will contend are penalties.”  

In support of the IRS position the Notice cites United States v. Rozbruch, 28 F. Supp. 3d 256 (S.D.N.Y. 2014), aff’d on other grounds, 621 Fed. Appx. 77 (2d Cir. 2015). In Rozbruch the government had filed suit under section 7403 to reduce its tax assessments to judgment and to foreclose on property owned by the Rozbruchs. The taxpayers defended in part by arguing that the TFRP assessments were invalid for failure to comply with section 6751’s supervisory approval requirement.  

The Rozbruchs pointed out that section 6672 explicitly calls the TFRP a penalty. Penalties may not be imposed on top of the TFRP. (I have not read the case documents apart from the court’s decision; the taxpayers may have made additional points not mentioned in the decision.) On the other side, the government pointed out that individuals who make payments towards a TFRP are really paying the underlying trust fund taxes; liability for a TFRP is co-extensive with the employment taxes that remain to be paid over. The district court in Rozbruch agreed with the government, citing an Eighth Circuit decision and several Second Circuit district court cases finding the TFRP to be a tax.  

However, the government’s position is not yet established in the Tax Court. The court declined to decide the issue in its April 2018 decision in the CDP case of Blackburn v. Commissioner, 150 T.C. No. 9. (The case was first noted on PT in a Designated Order post by Professor Caleb Smith.) In Blackburn Judge Goeke found that it was unnecessary to decide whether supervisory approval is required for TFRPs because the IRS had satisfied the requirement in any event. The IRS had a Form 4183, Recommendation re: Trust Fund Recovery Penalty Assessment, bearing the approval of the recommending Revenue Officer’s immediate supervisor, the Acting Group Manager. This was enough to support the Settlement Officer’s finding under section 6330(c)(1) that IRS had complied with administrative procedures in making the assessment. Judge Goeke rejected the taxpayer’s argument that the Settlement Officer should have looked beyond the form to investigate whether the supervisor’s review was “meaningful.” As the opinion points out, Tax Court “caselaw acknowledges that reliance upon standard administrative records is acceptable to verify assessments.” Blackburn, slip op. at 10 (citing Nestor v. Commissioner, 118 T.C. 162, 266 (2002); Davis v. Commissioner, 115 T.C. 35, 41 (2000)).  

Judge Holmes also raised the issue in a TFRP CDP case, Humiston v. Commissioner, Docket No. 25787-16 L. In Humiston, no Form 4183 was mentioned in the Settlement Officer’s determination or apparent from the record before the court. In a May 24 order denying the IRS’s motion for summary judgment, Judge Holmes notes that the TFRPs “are called penalties under the Code,” and determines that the novelty of the legal issue weighs in favor of permitting petitioner to raise it at calendar call. I do not know whether petitioner did so, but he now has counsel so perhaps the case will result in a decision on the issue. It appears that case would be appealable to the 2d Circuit Court of Appeals, which of course started all this with Chai.  

Next up, Judge Lauber may have the intersection of 6751 and the TFRP before him in the Florida case of Kane v. Commissioner, Docket No. 10988-17 L (hat tip: Lew Taishoff). Under a recent order, the IRS has until June 28 to file “a Form 4183 or any other relevant documentation concerning supervisory approval of the TFRPs in question.”  

The way a provision is titled or described does not trump its function for constitutional purposes, but it does provide evidence of Congressional intent for purposes of statutory construction. See National Federation of Independent Business v. Sibelius, 567 U.S. 519, 543-546, slip op. at 12-13 (2012) (finding the individual shared responsibility provision a penalty for purposes of the Anti-Injunction Act but a tax for purposes of constitutional validity). Taxpayers arguing this issue before the Tax Court will need to address both form and function of the TFRP.  

Uncertainty continues around penalties “automatically calculated through electronic means” 

Readers of this blog know that penalties which are “automatically calculated through electronic means” do not require supervisory approval under section 6751(b)(2). For background, see my previous post on the issue. Chief Counsel Notice 2018-006 largely repeats the position taken in prior IRS guidance (linked in the prior post). The 2018 Notice says, in part:  

Penalties appearing in a statutory notice of deficiency as a result of programs such as the Automated Underreporter (AUR) and the Combined Annual Wage Reporting Automated programs will fall within the exception for penalties automatically calculated through electronic means if no one submits any response to the notice, such as a CP2000, proposing a penalty. However, if the taxpayer submits a response, written or otherwise, that challenges a proposed penalty, or the amount of tax to which a proposed penalty is attributable, then the immediate supervisor of the Service employee considering the response should provide written supervisory approval prior to the issuance of any statutory notice of deficiency that includes the penalty. A penalty is no longer automated once a Service employee makes an independent determination to pursue a penalty or to pursue adjustments to tax to which a penalty is attributable.  

This is in line with prior IRS guidance but it does not do a whole lot to clear up unresolved issues. For one thing, the notice does not mention correspondence examinations. It is unclear whether we should read anything into that. Perhaps the IRS is not ready to publicly take a consistent position on correspondence examinations, but it is a shame the issue was not explicitly addressed in Notice 2018-006. The Notice also fails to clarify the issue of timing, and when precisely a taxpayer’s response arrives too late take a penalty out of section 6751(b)(2)’s ambit.   

The prior post on section 6751(b)(2) examined a nondesignated order in Triggs v. Commissioner. Triggs involves a correspondence examination where the taxpayer did not respond during the audit. The IRS argued that the correspondence exam function had automatically asserted the penalties according to its computer programming without the independent intervention of any human IRS employee, and therefore no supervisory approval was required for either the negligence penalty or the substantial understatement penalty. Although penalty assertion in correspondence examinations may be fully automated in practice, several IRM provisions appear to conflict with this view and require examiners to exercise responsibility for penalty assertions. On April 5, 2018 Judge Leyden ordered further submissions to address these IRM provisions.  

The Triggs case is still pending. The IRS filed its supplement in response to the April 5 order, and subsequently Judge Leyden gave the petitioner until June 29 to respond. The court also provided him with a list of local low-income taxpayer clinics. Unfortunately, to date Mr. Triggs remains pro se. 

IRM provisions also muddy the waters for Judge Lauber in the case of Bowse v. Commissioner. Bowse has a fact pattern similar to Triggs but in it arises from the AUR program rather than correspondence exam. It also deals solely with the substantial understatement penalty rather than both negligence and understatement. Like Triggs, the Bowse case was brought to my attention by Carl Smith.  

In Bowse, Judge Lauber highlights the timing problems that muddle the application of section 6751(b)(2) to a deficiency case in the Tax Court. Remember, it is the “initial determination” of a penalty “assessment” that requires supervisory approval under section 6751. Professor Bryan Camp has an excellent post explaining why the statutory language does not make much sense and inevitably causes courts to engage in interpretive gymnastics. We can clearly see this in Bowse.  

Mr. Bowse and his wife Ms. Vaes were picked up by the AUR program, but they did not respond to the IRS’s letters until after the AUR program issued them a statutory notice of deficiency (SNOD). The SNOD included a 20% substantial understatement penalty. At that point, the taxpayers submitted an amended return, and in response the Office of Appeals reduced the proposed deficiency and understatement penalty amounts. The penalty was still 20% of the proposed deficiency; it was reduced in proportion to the deficiency amount. The taxpayer then appealed the SNOD to the Tax Court.  

On those facts, what constitutes the “initial determination” of the penalty “assessment”? Was it the automated proposal by AUR in the SNOD? Or did the individualized review by Appeals take the case out of 6751(b)(2) territory? Does it matter that the proposed penalty amount changed? To answer this question, one needs to consider both what “initial determination” means and what qualifies as the “assessment” under section 6751.  

As Professor Camp explains, in Graev III the Tax Court interpreted the word “assessment” to essentially mean “penalty assertion.” And so Graev III examines whether certain IRS employees had “authority to make the initial determination of a penalty,” among other issues. 149 T.C. No. 23, slip op. at 17. But before Graev III the word “assessment” in section 6751 was taken at its ordinary meaning in the tax context – the official recording of a liability. Because of this, pre-Graev IRS guidance and IRMs are not wholly consistent with the IRS’s current litigating position. The IRMs in particular raise questions for Judge Lauber, as they did for Judge Leyden in Triggs. 

In Bowse, the IRS argued that no supervisory approval was required because the AUR program had automatically proposed the penalty in its SNOD without any human employee review. However, Judge Lauber is not sure it’s that simple and requests further briefing from the parties on several points.  

In his order Judge Lauber quotes several IRM sections, including this one: 

‘…However, if a taxpayer responds either to the initial letter proposing a penalty or to the notice of deficiency that the program automatically issues, an IRS employee will have to consider the taxpayer’s response. Therefore, the IRS employee will have to make an independent determination as to whether the response provides a basis upon which the taxpayer may avoid the penalty. The employee’s independent determination of whether the penalty is appropriate means the penalty is not automatically calculated through electronic means. Accordingly, IRC 6751(b)(1) requires managerial written approval of an employee’s determination to assert the penalty.’ IRM pt. 20.1.5.1.6(9) (Jan. 24, 2012); see also IRM pt. 4.19.3.2.1.4(2) and (3) (Sept. 1, 2012).  

(Emphasis added.) The IRM clearly suggests that the taxpayer can escape automatic penalty calculation by responding to the AUR program’s SNOD. Judge Lauber asks for briefing to address the following five questions: 

(1) By filing a Form 1040X for 2014 after receiving the notice of deficiency, did petitioners “respond * * * to the notice of deficiency that the [AUR] program automatically issue[d],” within the meaning of the IRM provision quoted above?

(2) If so, after considering petitioners’ response, did an IRS employee “make an independent determination as to whether the response provides a basis upon which the taxpayer may avoid the penalty,” within the meaning of the IRM provision quoted above?

(3) By accepting petitioners’ amended return and reducing the deficiency and penalty amounts, did the IRS made a new “initial determination” of the assessment of the penalty?

(4) If so, was that new initial determination of the penalty “automatically calculated through electronic means”?

(5) If not, what IRS officer made the “initial determination” of the reduced penalty, and who was the immediate supervisor of that individual? 

This order is interesting coming from Judge Lauber, whose concurrence in Graev III suggests a straightforward approach. He describes the majority opinion as “requiring supervisory approval the first time an IRS official introduces the penalty into the conversation.” Graev III, Lauber, J., concurring, slip op. at 27. That reading of “initial determination” appears narrower than the IRM’s, since under the IRM a taxpayer’s response to a SNOD can take a penalty out of section 6751(b)(2)’s ambit.  

I suspect the conflict between the IRS’s litigating position and the IRM is temporary. The IRMs cited by Judges Lauber and Leyden (like the 2002 Service Center Advice) reflect the IRS’s pre-Graev III understanding of what “assessment” means in section 6751. If assessment meant the official recording of the liability, then naturally a taxpayer’s response after an AUR SNOD but prior to assessment could take the final penalty decision out of the computer’s hands. Now that penalty “assessment” means penalty “proposal,” though, I would expect to see the IRMs on section 6751(b)(2) changing to remove references to taxpayers responding to the SNOD. It is somewhat puzzling, however, that Chief Counsel Notice 2018-006 does not explicitly mention this change or clarify whether, in the IRS’s view, the SNOD is the cut-off point for taxpayers to respond to an automated penalty proposal in order to trigger supervisory review.