Tax alert

Eleventh Circuit reverses Tax Court’s penalty approval analysis

Judicial interpretation of initial determination continues to evolve

Sep 20, 2022
Business tax Federal tax Tax controversy

Executive summary

In the recently decided Kroner v. Commissioner, the Eleventh Circuit followed the lead of the Ninth Circuit in disregarding the Tax Court’s developing case law on the supervisory penalty approval requirement under section 6751(b). The Court held that approval at any time prior to assessment satisfies the requirements of the statute. Section 6751(b) provides that no penalty shall be assessed unless the “initial determination” of the assessment is approved in writing by an immediate supervisor. The Tax Court had held that the initial determination was the first formal communication to the taxpayer of the IRS’s determination to assess penalties. The Tax Court invalidated penalties if a supervisor failed to approve the penalty in writing prior to the communication. The Tax Court will now be required to change its analysis of the “initial determination” language in section 6751(b) in two circuits when determining whether the IRS satisfied the supervisory approval requirement before certain penalties can be assessed. 

The Eleventh Circuit considers timing of the penalty approval requirement in section 6751(b)

In Kroner v. Commissioner, the U.S. Court of Appeals for the Eleventh Circuit reversed the U.S. Tax Court, agreeing with the IRS that supervisory approval at any time prior to the assessment of a penalty satisfies the requirement that a supervisor must approve an initial determination of a penalty prior to assessment under section 6751(b). The taxpayer in Kroner failed to report millions of dollars in income. During the examination, the tax examiner provided an initial letter and report proposing changes to his tax liability, asserting section 6662 accuracy-related penalties, and inviting optional responses to discuss further or appeal. After months of discussing the proposals, the IRS sent Kroner a “30-day letter” signed by the examiner’s supervisor. The letter contained the same proposed tax adjustment and penalty and offered appeal rights. The supervisor also signed a penalty approval form on the same day she signed the 30-day letter. The taxpayer did not settle the case at the IRS Appeals Office, and subsequently received a statutory notice of deficiency, or 90-day letter, which he challenged by timely filing a petition to the Tax Court. 

Tax Court precedent requires written supervisory approval prior to the first formal communication evincing a definitive decision to assert penalties

Section 6751(b) provides that no penalty “shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination…” Courts have struggled with defining, “initial determination of … an assessment.” In Chai v. Commissioner, the Second Circuit  turned to the legislative history of the statute, which said penalties, “should only be imposed where appropriate and not as a bargaining chip.” The court in Chai, found the section 6751(b) supervisory approval would only be meaningful if it were secured at a time when the supervisor has discretion whether to give or withhold the approval. The court concluded that this time must at least come prior to the issuance of a notice of deficiency asserting the penalty, rather than prior to assessment.  

Following Chai, the Tax Court, further delineated the meaning of “initial determination”. In Clay v. Commissioner, the Tax Court defined the “initial determination” as the first formal communication that advises the taxpayer of the initial determination to assess penalties. There, the court held that the first formal communication was the 30-day letter and attached revenue agent report, which offered the taxpayer a right to appeal.  In Belair Woods v. Commissioner, the court refined its definition of determination as the point at which the examination is done, and the IRS has made a definite decision to assert penalties. The IRS examiner in Belair Woods first issued the taxpayer a letter inviting them to a conference to discuss proposed adjustments and penalties on an attached summary report. After this initial letter, the examiner secured his manager’s approval for the assertion of penalties and issued the taxpayer a 60-day letter with appeal rights. The court held that the first formal notice of the proposed penalty which notified the taxpayer that the examination division had completed its work and made a definitive decision to assert penalties was the 60-day letter giving the taxpayer the opportunity to appeal.  The dissent argued that the earlier letter inviting the taxpayer to a conference was the initial determination for purposes of section 6751(b). The evolving case law from the Tax Court supports the interpretation that the initial determination of an assessment requiring written supervisory approval occurs well before the literal assessment. 

In Kroner, the taxpayer argued before the Tax Court that the supervisory approval came too late. Following the reasoning of the dissenting judges in Belair Woods, the taxpayer argued the supervisory approval should have come prior to the first letter asserting the penalty and inviting an opportunity to appeal. The Tax Court agreed, relying on its precedent in Clay

The Eleventh Circuit chooses a plain language reading, ignoring the Tax Court’s meticulous definition of initial determination

The Eleventh Circuit disagreed with the Tax Court’s interpretation of section 6751(b), opining that the statute only restricts assessments not IRS communications. The Court held that the IRS satisfies section 6751(b) as long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties. The Eleventh Circuit’s interpretation of section 6751(b) takes a plain language approach, focusing on the text of the statute instead of considering legislative history. The Court found the analysis in Chai and Clay unconvincing and too reliant on the bargaining chip theory as the reason to create a pre-assessment deadline for written approval.  Instead, the Eleventh Circuit reasoned that as long as the supervisory approval comes prior to assessment of the penalties, the legislative purposes of the statute are met. In particular, the court noted that negotiations do not end with assessment. Often, they continue through the collection process where the taxpayer is afforded administrative and judicial remedies that may encourage continued negotiation. 

The Eleventh Circuit followed the reasoning of the Ninth Circuit, which also recently disagreed with the Tax Court’s interpretation of section 6751(b) in  Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner. The Ninth Circuit based its interpretation of section 6751(b) on the plain language of the statute, and the Eleventh Circuit followed that trend, with a concurring opinion warning about the dangers of interpreting statutes by reference to legislative history.  The concurrence singled out the legislative history surrounding section 6751(b) in particular as a “grab-bag” within which any number of legislative intents could be found. 

Tax Court must now take a different approach in analyzing section 6751(b) in the Eleventh and Ninth Circuits 

The Tax Court is bound to follow the precedent of the Circuit to which a case is appealable under Golsen v. Commissioner, also known as the Golsen Rule. After Kroner and Laidlaw’s, Taxpayers in the Eleventh Circuit (Florida, Georgia, and Alabama), as well as the Ninth Circuit (Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington), will no longer be able to argue section 6751(b) is not met where the first formal communication of a penalty came before a supervisory approval, but the approval came before assessment. Meanwhile, taxpayers in states appealable to the other 9 circuits can still argue section 6751(b) requires supervisory approval before the first formal communication of a penalty. Taxpayers contesting a federal tax penalty should consult with their tax counsel.  With two circuits disagreeing with the Tax Court’s section 6751(b) interpretation, the IRS is likely to continue advancing the Ninth and Eleventh Circuit’s plain language interpretation of section 6751(b) in additional circuits. Without a statutory clarification to the language of section 6751(b) or a case going before the Supreme Court, taxpayers will face different outcomes when facing a section 6751(b) issue depending on where they reside.

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