In yet another precedential opinion involving the interpretation of IRC 6751(b) Tax Court Judge Greaves decides a Graev issue in favor of the IRS. In Thompson v. Commissioner, 155 T.C. No. 5 (2020) the issue turns on the impact of a settlement offer made to the taxpayer prior to supervisory approval of the penalty proposed by the IRS. The Tax Court determines that proposing to settle a penalty does not equal an initial determination under the statute. Because the settlement proposal did not equal an initial determination, the IRS does not lose the penalty for making the settlement offer before obtaining permission of the revenue agent’s immediate supervisor.
read more...The taxpayer invested in a distressed asset trust transaction (DAT transaction) which the IRS had targeted for special treatment as an abusive transaction. For these types of targeted transactions, the IRS sometimes develops special settlement initiatives to try to run multiple cases through the same procedure, avoiding as much time and trouble as possible. A revenue agent sent the taxpayer a letter at the beginning of the examination laying out the terms of the settlement, including the amount of the penalty the taxpayer would need to pay for the IRS to accept a deal. The court described the letter as the revenue agent stating he was: “aware that * * * [petitioners] participated in an abusive transaction” and offered them “the opportunity to resolve * * * [their] tax liabilities associated with that transaction in accordance with the terms set forth in * * * [Announcement 2005-80 (Oct. 28, 2005)].”
The court further stated that this initial “letter did not identify a tax period or tax form to which it related, provide an underpayment amount, or request petitioners’ consent to assessment and collection. Petitioners did not accept the settlement offer in the 2007 letter.”
The Revenue Agent mailed a second letter 20 months later in 2009 when the taxpayers did not respond to the initial letter. Similar to the first letter, the 2009 letter did not identify a tax period, form number, or underpayment amount and did not request petitioners’ consent to assessment and collection. The letter explained that if petitioners did not accept the settlement terms, the IRS would “complete its examination and fully develop the facts” of petitioners’ case and “impose applicable penalties under the Internal Revenue Code.”
Both letters went out prior to the determination by the agent’s immediate supervisor regarding the penalty as part of a larger determination by the IRS on how to treat penalties in this situation. The agent and the manager’s hands were bound by the overall agency decision on how to treat these cases. (In that regard this case has some similarities to the recent decision in Minemyer v. Commissioner that ended up with a different result.)
Because the taxpayers did not respond to the second letter, the revenue agent proceeded to examine their return. In doing so he determined that they owed tax and both an accuracy related penalty under IRC 6662(h) as well as a penalty under 6662A. He obtained the approval of his immediate supervisor who was acting in the position in December 2009. A notice of deficiency was sent in 2012. This case has been in the Tax Court since March of 2013. Here is a link to the docket sheet if you want to follow along the slow path this case has taken to decision for liabilities on the years 2003 to 2007.
The court describes three arguments raised by the Thompsons. First, they argued that the settlement letter served as an initial determination and required the approval of the revenue agent’s supervisor, since it raised the issue of penalties. Second, they argued that the approval was signed by an acting immediate supervisor who would not have provided meaningful review. Third, they argued that to the extent of any ambiguity, because this is a penalty situation, the ambiguity should be resolved in their favor. The court addressed and rejected each argument.
With respect to the need for the IRS to obtain supervisory approval prior to sending out the settlement letter, the court provided a very reasoned basis for explaining why the statute did not require the IRS to do so prior to sending this type of letter:
The offer letters in this case do not reflect an “initial determination” because they do not notify petitioners that Exam had completed its work. Rather than determining that petitioners are liable for penalties of specific dollar amounts, subject to review by Appeals or the Tax Court, each letter offers to settle penalties arising from the DAT transaction on certain terms, including substatutory penalty rates, which are based not on an audit but on Announcement 2005-80. When petitioners failed to accept the offers, RA Damasiewicz still had work to do — the 2009 letter explicitly says the IRS had not completed its examination or fully developed the facts of petitioners’ case. Furthermore, the 2009 letter warns that declining the settlement offer would result in “applicable penalties,” without stating which penalties, if any, might end up being “applicable” to petitioners’ facts. An offer letter like the ones at issue does not require supervisory approval because it is not a “determination” at all, but a preliminary proposal of the revenue agent within an ongoing examination.
The court’s reasoning makes good sense to me. The opposite result would create quite a shakeup at the IRS in the way it processes tax shelter settlement offers. Just because it would shake up the long-standing practice does not make the practice one that requires preserving, but the letters sent in cases such as this do not tell the taxpayer exactly what the IRS has decided in their case, other than that their case is one the IRS has identified as a tax shelter. The taxpayers probably already knew that when they invested in the shelter and signed numerous documents acknowledging the risk. The initial letter lets the taxpayer know the risk has increased significantly but provides few specifics.
The second issue regarding the significance of having the supervisory approval form signed by an acting supervisory rather than a permanent supervisor gets very little comment from the court. If the IRS had to get penalty forms signed by permanent supervisors rather than actors, probably half of the agents could not move forward with their cases. Acting supervisors are everywhere. While they may or may not offer the same level of review as permanent supervisors, the statute does not prohibit acting supervisors from being the ones to approve the penalty form. The court’s short treatment of this argument makes sense to me.
The third issue concerns the rule of lenity and the court cites the Rand case where Andy Roberson argued for the application of this rule. The court finds that the situation in this case does not operate as one where the rule of lenity can stop the application of the penalty. The decision provides no surprises in this regard. Tax shelter investors will have a hard time invoking this rule. The level of sympathy they evoke does not equal that of the low income taxpayers involved in the Rand case, who saw the IRS impose a penalty upon them for claiming the earned income tax credit in a way they could not support.
The Thompson case adds another interpretation to the Graev situation and receives precedential status as a result. We now know that general letters offering a broad settlement initiative that includes penalties do not require the type of supervisory approval described in 6751(b). I understand why petitioners would want to make this argument. The case presents a situation like the Minemyer case, where hanging around in the Tax Court for long enough can allow a taxpayer to benefit from creative arguments that come out long after the filing of the petition. Here, the taxpayers do not benefit from the creative argument but testing out the possibility certainly made sense.
The post says, “Just because it would shake up the long-standing practice does not make the practice one that requires preserving,” and then invokes arguments like “If the IRS had to . . . .” Somebody has to get to the bottom of why a supervisor’s approval is required. The fact that acting supervisors are all over the place is an argument that they should not be in the loop at all. The fact that procedures that the law requires would make it difficult for half the IRS agents to proceed with their cases is something that should be taken up with Congress, not a burden for taxpayers under audit to bear. If the requirement is based on a congressional judgment that the penalties are so enormous and disruptive that they should not be used to threaten taxpayers in the absence of supervisory sign-off, then, that argument applies equally to the situation here. Allowing an agent to tell taxpayers in pretty certain terms that they are going to be subject to penalties if they do not agree to a settlement is a pretty potent threat. The same way that this post argues that taxpayers are aware that they invested in a tax shelter, one could equally conclude that any taxpayer getting a letter like this from the agent can pretty easily figure out to within an order of magnitude what penalties are being threatened.
This Thompson case is one being litigated by Joe DiRuzzo. It is one of several cases in which Joe, following the argument Frank Agostino, Prof. Tuan Samahon of Villanova, and I made in Kuretski, argued that the President’s removal power over Tax Court judges at section 7443(f) violates the Separation of Powers. The Tax Court rejected the argument in one of Joe’s cases, in an opinion in Battat. Then, other judges followed Battat in unpublished opinions, including in Thompson. Joe tried to bring a series of these cases up to the courts of appeal on a writ of mandamus. The courts declined to issue the writs, and told Joe he should raise the argument on a final appeal in the cases, if he then wanted to. The 9th Cir. so ruled in the Thompson case on Nov. 14, 2018 at 9th Cir. Docket No. 17-71027. This side visit to the 9th Cir. no doubt explains part of why this 2013 case is still being litigated. I would not be surprised if Joe appeals Thompson (assuming he loses on the merits in the case) and argues both the 6751(b) and 7443(f) issues in the 9th Cir.
As a reminder, Kuretski was decided by the D.C. Cir., but Congress changed 7441 to make it clear that the Tax Court is not part of the Executive Branch after the D.C. Cir. held that the Tax Court is part of the Executive Branch. No other Circuit has yet ruled on the 7443(f) issue, let alone ruled after Congress changed the statute. The Tax Court’s position in Battat is that the Tax Court is not part of the Executive Branch, but the Tax Court won’t identify the Branch in which it thinks the Tax Court resides. Expect Joe to pursue the 7443(f) issue in eventual appeals of Battat, Thompson, and several other cases appealable to other Circuits.
Distressingly, another outcome based more on IRS convenience (“If the IRS had to get penalty forms signed by permanent supervisors rather than actors, probably half of the agents could not move forward with their cases,” and “Acting supervisors are everywhere. While they may or may not offer the same level of review as permanent supervisors . . . .”) than on fairness to taxpayers or congressional intent as expressed — “The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.”
The revenue agent “sent the taxpayer a letter at the beginning of the examination laying out the terms of the settlement, including the amount of the penalty the taxpayer would need to pay for the IRS to accept a deal.” Although the “letter did not identify a tax period or tax form to which it related [or] provide an underpayment amount,” can there be any doubt that a taxpayer who has invested in a transaction referred to in such a letter is in a position to calculate the exposure to within an order of magnitude and may well have done so before investing, as part of the diligence process? And in case there was any doubt, Announcement 2005-80, cited in the letter, spells out how to calculate the penalty. The revenue agent’s letter is a threat to impose a penalty; there is no other way to construe it. That is a procedure of Congress specifically disapproved, whether in one case or for the government’s administrative convenience of processing masses of similar cases.
This case should be appealed and reversed.