The question of when a supervisor must give approval for imposition of a penalty has created much litigation in the Tax Court as taxpayers try to remove a penalty proposal by using the failure of the IRS to comply with the IRC 6751(b) approval process. In Laidlaw’s Harley Davidson Sales v. Commissioner, No. 20-73420 (9th Cir. 2022) the court reversed the decision of the Tax Court in a precedential opinion reported at 154 T.C. 68 (2020) (knocking out the penalty for failing to follow the approval process required by the statute.) We discussed the Tax Court decision here.
The Ninth Circuit decision casts into doubt the approach the Tax Court has developed through litigation over the past several years. It remains to be seen whether the Tax Court will reverse its approach based on the Ninth Circuit opinion, an outcome I view as unlikely, or stay the course creating an exception and perhaps a split that will require resolution in the Supreme Court. Of course, all of this is against a backdrop of Congress seriously considering eliminating IRC 6751(b) reported here and here.
Laidlaw involves the reportable transaction penalty imposed under IRC 6707A. This penalty can be quite large. As mentioned in the earlier post, the year at issue is 2008 before petitioners and the IRS began focusing on IRC 6751(b). Bryan Camp has written an excellent post on the Ninth Circuit’s opinion which you can read here. His post provides good background on the issue of approval timing in general and discusses two recent TC Memo opinions on the topic.
Laidlaw participated in a listed transaction but failed to alert the IRS about its participation. The Revenue Agent auditing Laidlaw’s return issued a 30 day letter notifying Laidlaw of the intention to impose the IRC 6707A penalty. The Agent did not obtain a supervisor’s signature prior to the issuance of the 30 day letter but the supervisor did sign off on the penalty thereafter once Laidlaw filed its protest to the letter. The administrative appeals did not succeed and the IRS assessed the penalty which led to collection action.
Laidlaw submitted a Collection Due Process (CDP) request and petitioned the Tax Court after receiving a determination upholding the proposed levy action. The Tax Court held that the IRS had not met the requirement of IRC 6751(b) that the supervisor approve the penalty prior to the 30-day letter. The Ninth Circuit described the Tax Court decision as follows:
The Tax Court rejected the Commissioner’s argument that § 6751(b)(1) requires that the IRS secure supervisory approval only before the assessment of a penalty. The Tax Court reasoned that the statute’s legislative history, as analyzed in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), “strongly rebuts” the Commissioner’s argument because the statute “would make little sense if it permitted approval of an ‘initial’ penalty determination up until and even contemporaneously with the IRS’s final determination.” The Tax Court also rejected the Commissioner’s argument that under Chai the timeliness of written supervisory approval hinges on whether the supervisor retained authority to give approval because “[t]o so suggest would be to ignore the paramount role that the legislative history of section 6751(b)(1) played in Chai’s analysis.”
The fact that the IRS appealed the decision speaks to the importance of the issue to the IRS and to the government’s deeply held disagreement with the Tax Court’s approach to the timing of supervisory approval. In addition to disagreeing with the Tax Court’s legal conclusion, the issue has significant administrative importance because of the amount of money at stake and the impact of letting so many taxpayers who committed inappropriate actions with respect to their taxes off of the hook.
Before the Ninth Circuit the IRS argued:
The Commissioner argues that in this case § 6751(b)(1) permitted written supervisory approval at any time before the assessment of the penalty. However, the Commissioner acknowledges that because the initial determination must be “approved” by a supervisor, a penalty cannot be assessed unless supervisory approval occurs at a time when the supervisor still has discretion whether to approve the subordinate IRS official’s initial penalty determination.
As we have discussed in many posts, IRC 6751(b) fails to provide clear guidance. The Tax Court and the Ninth Circuit struggle to interpret the meaning of adjective “initial” which describes the determination by which the supervisor must provide a signed approval. In rejecting the Tax Court’s interpretation of initial, the Ninth Circuit states:
the language of the statute provides no reason to conclude that an “initial determination” is transformed into “something more like a final determination” simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it. We think “initial,” as used in § 6751(b)(1)’s phrase “initial determination,” more naturally indicates that a subordinate’s determination to assert a penalty lacks the imprimatur of having received supervisory approval, rather than that the determination has not yet been formally communicated to the taxpayer. Moreover, Taxpayer does not argue that the “determination” that Supervisor Korzec approved differed in any way from RA Czora’s initial determination to assert the § 6707A penalty. Finally, this case does not involve a notice of deficiency, which, as discussed above, could limit a supervisor’s discretion to prevent the assessment of a penalty.
The Ninth Circuit acknowledges that its interpretation allows a revenue agent to signal penalty imposition without first obtaining approval – the concern expressed by Congress in enacting the provision but it falls back on its conclusion that the law as written does not require approval before the matter procedurally moves out of the supervisors hands. Here, the supervisor had the authority to approve or deny the penalty prior to assessment.
The IRS has more administrative leeway in imposing an assessable penalty than a liability handled by the deficiency process. Up until the moment of assessment, the IRS can make decisions that impact the assessment. By holding that the approval just needs to occur before assessment, the Ninth Circuit gives the IRS the approval it needs not only to save the penalty in the Laidlaw case but also numerous other cases involving assessable penalties.
What impact will Laidlaw’s approach to interpreting when an “initial” determination arises in cases that are subject to deficiency procedures? In a deficiency case the IRS loses control long before the assessment occurs. Once the notice of deficiency is sent, the taxpayer can file a Tax Court petition and the IRS has no more ability to control the assessment. So, this decision makes a clear distinction between cases based on the procedural path they take toward assessment. The Tax Court’s approach focuses on the 30-day letter as the initial determination moving the timing of the approval to a stage that can be well before assessment but at a point that could impact the discussion/negotiation of the outcome. The Ninth Circuit, by focusing on assessment or the point at which the IRS has lost control of assessment provides a greater cushion for the IRS to come into compliance.
Assuming this taxpayer does not take the case to the Supreme Court or does not obtain certiorari, the possibility remains that on this legal issue of the interpretation of “initial” a future case may go up to the Supreme Court because of a split in the circuits.