The U.S. Tax Court recently issued two additional precedential opinions regarding supervisory approval of penalties under I.R.C. section 6571(b), bringing the total to four in 2020. Please see our prior tax alert about the two earlier cases decided by the Tax Court. Section 6751(b) requires that before a penalty can be assessed, the initial determination of the penalty must have written supervisory approval. The purpose of this rule is to prevent an individual IRS employee from using the threat of penalty as a ‘bargaining chip’ to pressure a taxpayer into settlement. Knowledge of the evolving penalty approval case law is essential in determining whether a client can invalidate an asserted or assessed penalty.
In Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. No. 4 (2020), the Court held that the written supervisory approval requirement of section 6571(b)(1) applies to the assessable penalty imposed by section 6707A for failure to disclose reportable transaction information. In this CDP Levy case, the IRS sought to collect the assessed penalty because the taxpayer participated in a benefit plan listed in Notice 2007-83, 2007-2 C.B. 960, but did not disclose its participation on its originally filed Form 1120. The revenue agent proposed section 6707A penalty in the 30-day letter, and obtained supervisor approval a month after the taxpayer submitted a protest to the letter and nearly three months after the letter had been issued to the taxpayer, but prior to the actual assessment.
The taxpayer argued the penalty was invalid as a matter of law because the revenue agent failed to obtain timely written supervisory approval. The Commissioner argued that the approval was obtained before the actual assessment and therefore it had complied with the plain language of section 6751(b)(1). The Commissioner relied on Chai v. Commissioner, 851 F.3d. 190, 218 (2d Cir. 2017), claiming that section 6751(b)(1) does not require supervisory approval any earlier than the act of assessment.
The Court first addressed the issue of whether section 6751 even applied to section 6707A. The Court said that by its terms section 6751(b)(1) applies to the assessment of all penalties under the ‘Internal Revenue Code,’ not just those subject to deficiency proceedings. The Court cited three recent decisions where it stated that 6751(b)(1) applied to specific assessable penalties. ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. 138 (2019) (section 6699, failure-to-file penalty); Kapp v. Commissioner, T.C. Memo. 2019-84 (section 6701, aiding and abetting understatement of tax liability; and Kestin v. Commissioner, 153 T.C. No. 2 (2019) (section 6701(a)(1), fling frivolous return).
The Court next provided the framework for determining whether an asserted penalty does not require supervisory approval under section 6751(b)(1). The Court cited to the two existing statutory exceptions. Supervisory approval is not required for an ‘addition to the tax’ under sections 6651 (failure to pay or file), 6654 (failure to pay estimated income tax), or 6655 (failure by a corporation to pay estimated income tax). (Section 6751(b)(2)(A)) Likewise, supervisory approval is not required for any other penalty automatically calculated through electronic means. (Section 6751(b)(2)(B)) The Court thus concluded that because the penalty imposed under section 6707A does not fit either exception, the written supervisory approval requirement of section 6751(b)(1) applies.
Having concluded section 6707A is subject to 6751(b)(1), the Court applied Clay v. Commissioner, 152 T.C 223 (2019), which set forth the rule for when supervisory approval must occur. In Clay, the penalties were initially proposed to the taxpayer in a 30-day letter, but were approved by a supervisor over a month later. The Court in Clay held that written supervisory approval is required no later than the date the IRS first formally communicates to the taxpayer its determination to assert a penalty and notifies the taxpayer of a right to appeal. Thus, obtaining supervisory approval almost three months after sending its initial determination (30-day letter) to impose the penalty to the taxpayer in Laidlaw’s Harley Davidson Sales, Inc., was too late. Consequently, the Court did not sustain the levy and held for the taxpayer.
In Chadwick v. Commissioner, 154 T.C. No. 5 (2020), the Court held that the written supervisory approval requirement of section 6571(b)(1) also applies to the assessable penalty imposed by section 6672(a) Trust Fund Recovery Penalty (TFRP) for failure to collect and pay over tax. In this CDP Levy case, the IRS sought to collect the assessed TFRPs because the taxpayer was determined to be a responsible person of each of the two LLCs at issue and was therefore required to collect and pay over its employment taxes. The penalties were proposed in two separate Letters 1153 each based upon a revenue officer’s Form 4183 (Recommendation Re: TFRP Assessment) that was approved in writing by a supervisor.
The Court had no difficulty in deciding that the approvals were timely. Under Belair Woods, LLC v. Commissioner, 154 T.C. No. 1 (2020), the initial determination is when the IRS formally notifies the taxpayer it has made a definite decision to assert penalties. The Court reasoned that because the Letters 1153 were the initial determination that formally notified the taxpayer, and the letters had been issued based upon Forms 4183 that had each been approved by a supervisor, it was sufficient to conclude that timely compliance with section 6751(b)(1).
The significance of this case is the issue of whether the TFRP is penalty at all. The Commissioner argued the TFRP penalty (section 6672(a)) was not subject to the section 6751(b)(1) supervisory approval requirement because the TFRP is a tax not a penalty. The Court initially observed that the text of section 6672(a) states it is a penalty and therefore subject to section 6751, which applies to all penalties in the Internal Revenue Code. The text of section 6672(a) imposes a ‘penalty’ against a responsible person who fails to collect or pay over any tax. Accordingly, the Court stated that a plain reading of section 6672(a) shows that it is a penalty under the Internal Revenue Code and subject to section 6751.
The Tax Court has provided significant recent guidance on the meaning and operation of written supervisory approval when an individual makes a determination to assess penalties. The lesson from these latest two cases is that section 6751(b)(1) supervisory approval applies to all penalties in the Internal Revenue Code, unless it fits one of the two listed exceptions in section 6751(b)(2). As such, practitioners should be vigilant when evaluating the timing of supervisory approval and if warranted advocate for invalidity of the penalty.