IRS Sanctions Approval – Tax Authorities
Each year, the Internal Revenue Service assesses billions of dollars in civil penalties against taxpayers. In 1998, Congress passed Section 6751(b) of the Internal Revenue Code, which places a procedural restriction on the IRS’s ability to impose penalties. This article provides that “[n]o Penalty … will be imposed unless the initial decision for such an assessment is personally approved (in writing) by the immediate supervisor of the person making the decision.”
For years, the IRS’ compliance with this legal requirement went largely unchallenged by taxpayers. In Chai c. Commissioner851 F.3d 190 (2d Cir. 2017), however, the United States Court of Appeals for the Second Circuit reversed the Tax Court and held that the onus is on the IRS to establish that the oversight approval was given “on or before the date the IRS issues the notice of deficiency (or files a response or amended response) asserting such penalty.”
While the Tax Court cases decided after Chai adopted and expanded the Second Circuit rule, the Ninth and Eleventh Circuits recently dropped Chai’s reasoning and allowed sanctions to be approved much later in the administrative process. Because the Tax Court applies the law as interpreted by the Court of Appeals in the circuit where the taxpayer lives, differing interpretations of the supervisory approval requirement mean that liability for substantial penalties may apply where the taxpayer resides.
The Internal Revenue Code contains over 150 types of civil penalties. Certain penalties, including accuracy penalties imposed for negligent errors in tax returns and penalties for civil fraud, are subject to “deficiency proceedings” that provide taxpayers with the opportunity to challenge the penalties. in Tax Court before payment is due. In the deficiency regime, if the IRS finds that a taxpayer owes funds and the taxpayer does not appeal the proposed adjustment to the IRS Independent Appeals Office or the taxpayer’s appeal fails, the IRS will issue a “notice of deficiency”. The taxpayer then has 90 days to file a motion with the Tax Court. If the taxpayer fails to file a petition with the Tax Court, or if the Tax Court denies the taxpayer’s petition, the IRS will “evaluate” the failure, in which case the IRS may take steps to collect the amount due.
In contrast, other penalties, including penalties for failing to file information returns, are “taxable penalties” that are payable on notice and demand. See 26 USC §6671. Taxpayers are generally not entitled to judicial review before taxable penalties are paid, except for a limited review of IRS Collections Due Process (CDP) hearings. See id. §§6320, 6330.’Chai‘
Chai arose out of default proceedings following an audit of Jason Chai, a participant in a tax shelter transaction. The auditing revenue officer found that Chai failed to pay self-employment taxes on $2 million in unreported earnings. The IRS issued a notice of deficiency that included an accuracy penalty. At a post-trial briefing in the Tax Court, Chai argued for the first time that the penalty should be waived because the commissioner failed to meet his filing burden regarding the requirement. supervisory approval. The Tax Court concluded that the argument was inappropriate and upheld the penalty.
Among the issues addressed on appeal, the Second Circuit considered Chai’s supervision approval argument. In doing so, the court analyzed the text of Section 6751(b) and found that, although the provision clearly requires approval of the “initial determination of [a penalty] assessment”, the provision was rendered ambiguous by the legal definition of an “assessment”.
After finding an ambiguity in the statute, the Second Circuit proceeded to review the legislative history to determine what Congress had anticipated would constitute an “initial determination.” Based on a Senate committee report expressing the view “that sanctions should only be imposed when appropriate and not as a bargaining chip[,]Chai, 851 F.3d at 219 (citing S. Rep. No. 105-174, at 65 (1998)), the court found that the approval requirement was designed to prevent revenue officers from threatening to unwarranted sanctions to coerce taxpayers into agreeing The court further held that this salutary purpose would be lost if a supervisor could grant approval until such time as a sanction was “assessed” because an unapproved sanction could be used as leverage” through administrative proceedings, settlement negotiations, and possible tax court action,” in which case a review of the matter by a supervisor would become moot.
Ultimately, the Second Circuit concluded that, to substantiate Congress’s intention to enact Section 6751(b), oversight approval must be given prior to the issuance of a Notice of Deficiency, what triggers a taxpayer’s ability to file a petition in the Tax Court, or the date the IRS asserts a penalty in a Response or Amended Response to the Tax Court. Based on this decision, the court then concluded that the commissioner bears both the burden of production and the burden of proof with respect to due process, and that the commissioner failed to discharge of his burden in Chai’s case. Accordingly, the court reversed the portion of the Tax Court’s decision upholding the penalty
In concluding that Section 6751(b) required the approval of the supervisor before issuing a notice of deficiency, the Second Circuit disagreed with the majority of the Tax Court, which had previously held in a different case that written approval could be obtained at any time before the sentence is “assessed” and can be challenged in post-assessment proceedings. See Graev v. Comm’r147 CT 16 (2016) (Graev II). After
Chaihowever, the Tax Court reconsidered graevand chose to follow the conclusion of the Second Circuit, with the agreement explaining that requiring approval before a taxpayer is notified of a penalty is true to Chai’s reading Congress’s objective because it reduces the likelihood that the IRS will use the specter of sanctions as leverage against taxpayers. See Graev v. Comm’r, 149 TC 485 (2017) (adopting the interest in Chai). The Tax Court has since applied this reasoning to further push back the approval deadline. See Clay c. Comm’r, 152 TC 223 (2019), affirmed on other grounds, 990 F.3d 1296 (3d Cir. 2021), cert. refused, 142 S. Ct. 342 (2021); Carter c. Howr, 119 TCM (CCH) 1128, *30 (2020). Recently, however, the Ninth and Eleventh Circuits have cast doubt on
In Laidlaw’s Harley-Davidson Sales vs. Comm’r, 29 F.4th 1066 (9th Cir. Mar. 25, 2022), a revenue officer sent the taxpayer a “30-day letter” advising the company of his intention to impose a penalty. The letter informed the company of its right to request a conference with the IRS appeals office or pay the fine, but also threatened to impose the fine and initiate collection proceedings if it did not take no measurement. The revenue officer sent the letter before obtaining the guardianship’s approval, which was only obtained after the taxpayer filed an administrative appeal.
The administrative appeal was unsuccessful and the IRS imposed the penalty and initiated collection activity. The taxpayer did not pay and requested a hearing at the CDP. After the IRS Appeals Office dismissed the taxpayer’s challenge, the taxpayer filed a petition with the Tax Court and found that failure to obtain supervisory approval before to communicate the penalty to the taxpayer violated section 6751(b), precluding recovery of the penalty.
On appeal, the Ninth Circuit recognized that “a supervisor cannot truly approve a sanction without also having the discretion to withhold approval”, and therefore the supervisor approval requirement cannot always be satisfied. “pending providing written approval just prior to time of assessment.” The court, however, distinguished the taxable penalty at issue in Laidlaw’s penalties that are subject to insufficiency procedures, as in Chai. The court reconciled Chai noting that the issuance of a Notice of Deficiency in this case terminated the manager’s discretion to approve an initial decision and found that, despite the tax agent’s misleading letter, the supervisor retained the discretion to waive the taxable penalty at the time they signed the approval form.
In Kroner vs. Comm’r, 48 F.4th 1272 (11th Cir. Sept. 13, 2022), after a review, a revenue officer released an audit report claiming that Kroner owed back taxes and nearly $2 million in penalties, as well than a letter threatening that the IRS would issue a notice of deficiency if Kroner did not take certain actions. After further discussion, the IRS released an updated audit report with a 30-day letter signed by the tax agent’s supervisor. After a conference with the IRS Appeals Office failed to resolve the case, the IRS issued a Notice of Deficiency.
The Tax Court found that the IRS failed to comply with the surveillance approval requirement, but the Eleventh Circuit backtracked. Citing Laidlaw’s, the court found that “the IRS satisfies section 6751(b) so long as a supervisor approves an initial determination to impose a penalty before assessing those penalties.” Like the Ninth Circuit, the court found that the Tax Court erroneously equated an “initial determination of such assessment” with communications regarding that determination, and that approval may occur until at the time of the assessment. In reaching this decision, the Eleventh Circuit explicitly disagreed with Chaiconcluding that not only is the wording of the law clear, but also that the Second Circuit’s emphasis on the misuse of sanctions as “bargaining chips” ignores that the law “is not just about the negotiation is also a check on the imposition of erroneous sentences.” This other objective was particularly important, according to the Eleventh Circuit, in the case of taxable sentences (such as those at issue in Laidlaw’s) that are not subject to “pre-assessment” review in the Tax Court. Accordingly, in the Eleventh Circuit, approval is not required at any particular time before evaluation.
Despite this recent burst of challenges Chai, the second circuit still offers the most sensible approach to interpreting the surveillance approval requirement of §6751(b). If approval is allowed until appraisal, as the Ninth and Eleventh Circuits ruled, there is a risk that approval will end up being a mere formality. It remains to be seen in the coming years if the growing division of the circuits attracts the attention of the Supreme Court. In the meantime, practitioners should be mindful of precedent in the circuit in which their clients reside in invoking lack of supervisory approval as a defense against sanctions.
Originally published by the New York Law Journal
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