Ninth Circuit Reverses Tax Court; Agrees with IRS's Position on Penalty Approval

(Parker Tax Publishing April 2022)

A panel of the Ninth Circuit reversed a decision of the Tax Court, in which the Tax Court sided with the taxpayer and against the IRS in determining that the IRS had not complied with the written supervisory approval requirement in Code Sec. 6751(b) in a case involving the penalty under Code Sec. 6707A for failing to report a listed transaction. The panel concluded that the IRS satisfied Code Sec. 6751(b) where the supervisor gave written approval of the initial penalty determination before the penalty was assessed and while she still had discretion to withhold approval. Laidlaw's Harley Davidson Sales, Inc. v. Comm'r, 2022 PTC 83 (9th Cir. 2022).

Background

Laidlaw's Harley Davidson Sales, Inc. (LHDS) participated in the Sterling Benefit Plan, an employee benefit plan that the IRS determined was a listed transaction. Under Code Sec. 6011, taxpayers that fail to timely disclose their participation in such a transaction are subject to a penalty under Code Sec. 6707A. LHDS filed a tax return for its 2008 tax year that did not report its participation in the plan. LHDS later amended its 2008 return to disclose its participation.

Sandra Czora was the IRS agent assigned to examine LHDS's return for potential liability for a penalty because of LHDS's failure to include reportable transaction information with its original return. Czora first notified LHDS of the proposed Code Sec. 6707A penalty in a 30-day letter issued in May 2011. The 30-day letter notified LHDS of its right to request a conference with the IRS Office of Appeals (Appeals) and emphasized that if LHDS took no action, the IRS would assess the penalty and begin collection procedures. Enclosed with the 30-day letter was a revenue agent's report and other documents detailing Czora's calculation of the proposed penalty. The 30-day letter and its attachments were signed only by Czora and not by any supervisor.

LHDS requested a conference with Appeals in order to dispute Czora's imposition of the Code Sec. 6707A penalty. In August 2011 - more than a month after the submission of LHDS's written protest, and nearly three months after the date on the 30-day letter - Group Manager Virginia Korzec, Czora's immediate supervisor, approved Czora's assertion of the Code Sec. 6707A penalty by signing a Civil Penalty Approval Form. LHDS's administrative appeal was unsuccessful and, in August 2013, Appeals recommended assessment of the Code Sec. 6707A penalty. The IRS assessed the penalty in September 2013.

LHDS did not pay the penalty, and the IRS issued a notice of intent to levy. LHDS responded by requesting a collection due process (CDP) hearing, which was held in May 2014. After the CDP hearing, Appeals sustained the proposed levy, stating that it verified IRS compliance with the requirements of any applicable law, regulation, or administrative procedure with respect to the penalty assessment and the levy notice. That verification statement, however, did not specifically address the IRS's compliance with Code Sec. 6751(b)(1), which requires the immediate supervisor of the individual making the initial penalty determination to approve the initial determination in writing.

LHDS petitioned the Tax Court and argued in a motion for summary judgment that the IRS had not complied with Code Sec. 6751(b)(1) and therefore, Appeals abused its discretion in sustaining the proposed levy.

Tax Court's Decision and IRS Appeal

In Laidlaw's Harley Davidson Sales Inc. v. Comm'r, 154 T.C. 68 (2020), the Tax Court granted summary judgment for LHDS. The Tax Court rejected the IRS's argument that Code Sec. 6751(b)(1) requires that the IRS secure supervisory approval only before the assessment of a penalty. The court quoted the Second Circuit's reasoning in Chai v. Comm'r, 2017 PTC 124 (2d Cir. 2017), that 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. Relying on its previous decision in Clay v. Commissioner, 152 T.C. 223 (2019), and other Tax Court precedent, the Tax Court ruled that supervisory approval of an assessable penalty is required before the IRS "formally communicates" to the taxpayer its determination that the taxpayer is liable for the penalty. After finding that Czora's 30-day letter "embodied the initial determination" to assert the Code Sec. 6707A penalty because it was "the first formal communication by the IRS of the conclusion" that the Code Sec. 6707A penalty applied to LHDS, the court ruled that Korzec's written approval of the penalty after that communication to LHDS was untimely, thus invalidating the penalty assessment.

The IRS appealed to the Ninth Circuit, again asserting that Code Sec. 6751(b)(1) allows written supervisory approval to occur at any time before the assessment of the penalty. However, the IRS acknowledged 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. In this case, the IRS said that Korzec retained such discretion even after the IRS "formally communicated" its determination of liability to LHDS.

Ninth Circuit's Analysis

The Ninth Circuit agreed with the IRS and reversed the Tax Court's grant of LHDS's motion for summary judgment. The court held that Code Sec. 6751(b)(1) requires written supervisory approval before the assessment of the penalty or, if earlier, before the relevant supervisor loses discretion to withhold approval of the penalty assessment. Since in this case, Korzec gave written approval of the initial penalty determination before the penalty was assessed and while she still had discretion to withhold approval, the court concluded that the IRS satisfied Code Sec. 6751(b)(1).

The problem with the Tax Court's interpretation of Code Sec. 6751(b)(1), the Ninth Circuit said, was that the statute contains no express requirement that the written approval be obtained at any particular time prior to assessment, nor does it make any reference to the communication of a proposed penalty to the taxpayer - much less a "formal" communication. The Ninth Circuit found that the language of Code Sec. 6751(b)(1) provides no reason to conclude that an "initial determination" is transformed into "something more like a final determination," as the Tax Court concluded, simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it. According to the Ninth Circuit, the word "initial" as used in Code Sec. 6751(b)(1) 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. The court also observed that this case did not involve a notice of deficiency, which it said could limit a supervisor's discretion to prevent the assessment of a penalty (since under Code Sec. 6213(c), a deficiency "shall be" assessed if a notice of deficiency is sent and the taxpayer fails to file a petition with the Tax Court within 90 days).

The Ninth Circuit said that it was troubled by the language of the letter and attachments LHDS received, because a natural interpretation was that in the absence of action from LHDS, the IRS would inevitably assess the penalty - a threat which the court pointed out was premature because a supervisor had not yet approved the initial determination. The court agreed with LHDS that a law that prevented a non-supervisor revenue agent from formally communicating a proposed penalty to the taxpayer without first receiving supervisory approval would probably reduce the likelihood of a revenue agent threatening an unjustified penalty to secure a settlement. However, the court found that it had to apply Code Sec. 6751(b)(1) as written, and the language of the statute did not support LHDS's interpretation.

Observation: In a dissenting opinion, one judge emphasized that Code Sec. 6751(b)(1) requires supervisory approval of the "initial" determination of an assessment and that under the majority's interpretation, approval is not required until the moment before the penalty is finally assessed, i.e., the final penalty determination. Thus, in the view of the dissenting judge, the majority's reading of the statute rendered the approval requirement a mere formality that contradicted Congress's purpose in enacting the requirement.

For a discussion of the written supervisor approval requirement for the initial determination of a penalty, see Parker Tax ¶262,195.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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