IRS Issues Proposed Regulations on Supervisory Approval Of Penalty Assessments

(Parker Tax Publishing April 2023)

The IRS issued proposed regulations under Code Sec. 6751(b) regarding supervisory approval of certain penalties assessed by the IRS. The IRS stated that the proposed regulations are necessary to address uncertainty regarding various aspects of supervisory approval of penalties that have arisen due to recent judicial decisions, including the timing of supervisory approval, the definition of immediate supervisor, and what constitutes personal, written approval. REG-121709-19.

Background

Under Code Sec. 6751(b)(1), the IRS may not assess a penalty unless "the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate."

In Belair Woods, LLC v. Commissioner, 154 T.C. 1 (2020), the Tax Court held that supervisory approval must be obtained before the IRS sends a notice that "formally communicates to the taxpayer, the Examination Division's unequivocal decision to assert a penalty." In subsequent cases, the Tax Court has held that supervisory approval must be obtained before the first communication to the taxpayer that demonstrates that an initial determination has been made. The Tax Court has applied this timing rule to penalties subject to pre-assessment review in the Tax Court, as well as to assessable penalties.

Recently the Ninth Circuit, the Circuit, and the Eleventh Circuit reversed the Tax Court's "formal communication" timing rule, noting that it has no basis in the text of the statute. In Laidlaw's Harley Davidson Sales, Inc. v. Comm'r, 2022 PTC 83 (9th Cir. 2020), the Ninth Circuit held that the statute requires approval before the assessment of a penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment, and noted that the statute does not make any reference to the communication of a proposed penalty to the taxpayer, much less a formal communication. In Minemyer v. Comm'r, 2023 PTC 15 (10th Cir. 2023), the Tenth Circuit held that the statute requires approval before the IRS issues a notice of deficiency asserting a penalty. In Kroner v. Comm'r, 2022 PTC 281 (11th Cir. 2022), the Eleventh Circuit held that the statute only requires approval before assessment, finding that a deadline of assessment is "consistent with the meaning of the phrase "initial determination of such assessment." The Tax Court has continued to use its "formal communication" timing rule in recent decisions, including Simpson v. Comm'r, T.C. Memo. 2023-4, and Castro v. Comm'r, T.C. Memo. 2022-120.

Recent cases have also addressed other issues under Code Sec. 6751(b)(1), including (but not limited to) clarification as to who is an immediate supervisor (Sand Investment Co. v. Comm'r, 157 T.C. 136 (2021)); what constitutes personal, written approval (PBBM-Rose Hill, Ltd. v. Comm'r, 2018 PTC 269 (5th Cir. 2018)); whether particular Code sections impose a "penalty" subject to Code Sec. 6751(b)(1) (Grajales v. Comm'r, 156 T.C. 55 (2021), aff'd 2022 PTC 254 (2d Cir. 2022)); and what constitutes a penalty "automatically calculated through electronic means" (Walquist v. Comm'r, 152 T.C. 61 (2019)).

Proposed Regulations

On April 11, the IRS issued proposed regulations in order to provide clear and uniform standards regarding the penalty approval requirements under Code Sec. 6751(b). The proposed regulations are intended to clarify the application of Code Sec. 6751(b) in a manner that is consistent with the statute and its legislative history, has nationwide uniformity, is administrable for the IRS, and is easily understood by taxpayers.

Timing Issues

The proposed regulations provide three rules regarding the timing of supervisory approval of penalties under Code Sec. 6751(b). One rule addresses penalties that are included in a pre-assessment notice that is subject to the Tax Court's review, such as a statutory notice of deficiency. One rule is for penalties that the IRS raises in an answer, amended answer, or amendment to the answer to a Tax Court petition. And one rule is for penalties assessed without prior opportunity for review by the Tax Court.

For penalties that are included in a pre-assessment notice issued to a taxpayer that provides the basis for jurisdiction in the Tax Court upon timely petition, Prop. Reg. Sec. 301.6751(b)-1(c) provides that supervisory approval may be obtained at any time before the notice is issued by the IRS. The IRS observed that Code Sec. 6751(b) clearly provides that there be supervisory approval before the assessment of a penalty and contains no express requirement that the written approval be obtained at any particular time prior to assessment.

For penalties raised in the Tax Court after a petition, Prop. Reg. Sec. 301.6751(b)-1(d) provides that supervisory approval may be obtained at any time prior to the IRS requesting that the court determine the penalty. The IRS said that this rule gives full effect to the language in both Code Sec. 6214 and Code Sec. 6751(b)(1) because once a penalty is raised, the Tax Court decision will control whether it is assessed. Code Sec. 6214(a) permits the IRS to raise penalties in an answer or amended answer that were not included in a notice that provides the basis for Tax Court jurisdiction upon timely petition.

Prop. Reg. Sec. 301.6751(b)-1(b) provides that supervisory approval for penalties that are not subject to pre-assessment review in the Tax Court may be obtained at any time prior to assessment. This includes penalties that could have been included in a preassessment notice that provides the basis for Tax Court jurisdiction upon timely petition, but which were not included in such a notice because the taxpayer agreed to their immediate assessment. The IRS explained that, unlike penalties subject to deficiency procedures before assessment, there is no Tax Court or potential Tax Court decision that would make approval of an immediately assessable penalty by an IRS supervisor meaningless. Instead, consistent with the language of Code Sec. 6751(b), supervisory approval can be made at any time before assessment without causing any tension in the statutory scheme for assessing penalties. The IRS also observed that this proposed rule is consistent with congressional intent that penalties not be used as a bargaining chip. Most penalties not subject to pre-assessment review in the Tax Court cannot be used as a bargaining chip, the IRS explained, because they are not in addition to a tax liability.

Exceptions to the Rule Requiring Supervisory Approval of Penalties

Prop. Reg. Sec. 301.6751(b)-1(a)(2) provides a list of penalties excepted from the requirements of Code Sec. 6751(b). Prop. Reg. Sec. 301.6751(b)-1(a)(2) excepts those penalties listed in Code Sec. 6751(b)(2)(A), along with penalties imposed under Code Sec. 6673. Penalties under Code Sec. 6673 are imposed at the discretion of the court and are designed to deter bad behavior in litigation and conserve judicial resources. The proposed rule excepts penalties under Code Sec. 6673 from the requirements of Code Sec. 6751(b)(1) because Code Sec. 6751(b)(1) was not intended as a mechanism to restrain federal courts.

Definitions

Prop. Reg. Sec. 301.6751(b)-1(a)(3)(iii) defines the term "immediate supervisor" as any individual with responsibility to approve another individual's proposal of penalties without the proposal being subject to an intermediary's approval. The proposed rule does not limit the term immediate supervisor to a single individual. According to the IRS, limiting the term to a single individual within the IRS would restrict Code Sec. 6751(b)(1) in a way that does not reflect how the IRS operates and would invite unwarranted disputes about which specific individual was most appropriate in situations where multiple individuals could fairly be considered an "immediate supervisor." Instead, the IRS said that the term is better understood to refer to any person who, as part of their job, directly approves a penalty proposed by another.

Prop. Reg. Sec. 301.6751(b)-1(a)(3)(v) provides that "personally approved (in writing)" means any writing, including in electronic form, that is made by the writer to signify the writer's assent and that reflects that it was intended as approval. The IRS noted that this rule reflects a straightforward, plain language interpretation of the term, and is consistent with the legislative history's requirement that "specific approval" be given.

Prop. Reg. Sec. 301.6751(b)-1(a)(3)(vi) provides that a penalty is "automatically calculated through electronic means" if it is proposed by an IRS computer program without human involvement. Prop. Reg. Sec. 301.6751(b)-1(a)(3)(vi) provides that a penalty is no longer considered "automatically calculated through electronic means" if a taxpayer responds to a computer generated notice proposing a penalty and challenges the penalty or the amount of tax to which the penalty is attributable, and an IRS employee works the case.

For a discussion of the rules relating to IRS supervisory approval of penalty assessments, 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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