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Chai v. Commissioner

IRS Proposes New Regulations to Settle Supervisory Approval of Penalties Requirements

by Kevin Spencer and Sarah M. Raben | Apr 14, 2023 | Appellate Courts, Court Procedure Matters, IRS Audits, IRS Guidance, Trial Courts

The Internal Revenue Service (IRS) has proposed regulations to clarify the rules regarding supervisory approval of federal civil tax penalties under IRC Section 6751(b). Since Chai v. Commissioner, there has been a substantial number of cases litigating issues involving supervisory approval of federal civil tax penalties. Back in September, we posted about the US Court of Appeals for the Ninth and Eleventh Circuits split in which both Courts departed from long-standing US Tax Court precedence on the timing requirement of supervisor approval. Those two decisions, along with others, prompted this new guidance “to have clear and uniform regulatory standards.”

The proposed regulations address three timing rules: (1) penalties subject to pre-assessment review in the Tax Court; (2) penalties raised in the Tax Court after a petition and (3) penalties assessed without prior opportunity for Tax Court review.

Specifically, the proposed regulations allow supervisors to approve the initial determination of a penalty up until the time the IRS issues a pre-assessment notice, such as a Statutory Notice of Deficiency, which is the notice that provides taxpayers with a ticket to the Tax Court. The proposed regulations explain that “earlier deadlines created by the Tax Court do not ensure that penalties are only imposed where appropriate” and the “bright-line rule relieves supervisors from having to predict whether approval at a certain point will be too early or too late.” Additionally, penalties raised in the Tax Court after a petition is filed, such as an answer or an amended answer, would need supervisory approval any time prior to the penalty being raised. Supervisory approval for penalties not subject to pre-assessment review in the Tax Court may be obtained at any time prior to the assessment.

The proposed regulations require the approval of “the immediate supervisor,” which is defined as “any individual with responsibility to approve another individual’s proposal of penalties without the proposal being subject to an intermediary’s approval.” The term is also not limited to any particular individual.

Comments and requests for a public hearing must be received by July 10, 2023.

Practice Point: Penalties continue to be a hot topic in the tax controversy arena. The updated guidance promises to clarify and standardize the requirements of supervisory approval of IRS penalties, with the hope and expectation of reducing litigation on the issue. From the taxpayer’s perspective, ideally, the new regulations will enable examiners and managers the opportunity to thoroughly review the facts and circumstances of cases before deciding if penalties are warranted. We will continue to follow and report on any new developments.

Please see the links to our prior commentary on Code Section 6751 below:

Courts Split on Supervisory Approval Requirement for Tax Penalties

by Kevin Spencer, Sarah M. Raben and McDermott Will & Emery | Sep 28, 2022 | Appellate Courts, Court Procedure Matters, IRS Audits, Trial Courts

Since Chai v. Commissioner, an opinion by the US Court of Appeals for the Second Circuit subsequently followed by the US Tax Court in several opinions, there has been a substantial number of cases litigating issues involving supervisory approval of federal civil tax penalties. Two recent additions to that list include decisions from the Ninth and Eleventh Circuits, where both Courts departed from the Tax Court’s analysis and ruling on the issue. The disagreement centers on when approval must occur. (Some of our prior discussions on this topic are linked below.)

LAIDLAW’S AND THE NINTH CIRCUIT

In Laidlaw’s Harley-Davidson Sales, Inc. v. Commissioner, the Ninth Circuit, reversing the Tax Court’s ruling, applied a textualist approach and held that approval is required only before the assessment of a tax penalty and not before the Internal Revenue Service (IRS) communicates a proposed penalty to the taxpayer. The Court reasoned that the “language of [Internal Revenue Code (Code) section 6571(b)] provides no reason to conclude that an ‘initial determination’ is transformed into ‘something more like a final determination’ simply because the revenue agent who made the initial determination subsequently mailed a letter to the taxpayer describing it.” While the Court was “troubled” by the manner in which the IRS communicated the potential imposition of the penalty, it explained that a court’s role is to “apply the law as it is written, not to devise alternative language.” In reaching its decision, the Ninth Circuit disagreed with the position developed by the Tax Court in recent years.

KRONER AND THE ELEVENTH CIRCUIT

In Kroner v. Commissioner, the Eleventh Circuit followed Laidlaw’s Harley Davidson Sales and similarly concluded that the IRS satisfies Code Section 6751(b) so long as a supervisor approves the penalty before it is assessed. The Court explained that this was the best reading of the statute because (1) it is more consistent with the meaning of the phrase “initial determination of such assessment,” (2) it reflects the absence of any express timing requirement in the statute, and (3) it is a workable reading in the light of the statute’s purpose. The Court suggested that the IRS may be wise “to have a supervisor approve proposed tax penalties at an early juncture…but the text of the statute does not impose an earlier deadline.”

The Eleventh Circuit was explicit in its departure from Chai and Tax Court precedent, stating that “the Chai court missed an important aspect of the statute’s purpose: it is not just about bargaining, it is also a check on the imposition of erroneous penalties.” The Court also explained that “appropriate penalties should be assessed and collected. Chai’s analysis of these competing interests leaned heavily on the former to the detriment of the latter when justifying its departure from the statutory text.”

Practice Point: It remains to be seen whether this issue will make its way to the Supreme Court of the United States given the apparent circuit split on the issue as [...]

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IRS Failed to Prove Supervisory Approval For Penalty Based Upon Redacted Document

by Kevin Spencer, Le Chen and McDermott Will & Emery | Apr 8, 2020 | Court Procedure Matters, IRS Guidance, Trial Courts, Uncategorized

In a recent order in the The Cannon Corp. v. Commissioner, No. 12466-16, the US Tax Court (Tax Court) held that a redacted email from a revenue agent’s supervisor to the agent regarding a notice of deficiency was not sufficient to satisfy the approval requirement under Internal Revenue Code (IRC) section 6751(b) for the assertion of accuracy-related penalties.

Under IRC section 6751(b), as interpreted by case law, the Internal Revenue Service (IRS) is permitted to assert penalties only if the initial determination to assert the penalty is approved in writing by the supervisor of the individual making such a determination. That provision has been litigated recently in several notable cases, for example, Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), and Graev v. Commissioner, 149 T.C. 485 (2017). Since Graev, the Tax Court has issued a series of decisions on the requirements of IRC section 6751(b). Our recent article discussing these decisions can be found here.

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IRS Required to Obtain Supervisory Approval to Assert Penalties

by McDermott Will & Emery and McDermott Will & Emery | Dec 21, 2017 | Appellate Courts, Court Procedure Matters, IRS Guidance, Trial Courts, Uncategorized

We have written several times about penalty defenses, including substantial authority, issues of first impression and tax reporting disclosures. Additionally, we previously covered the 2016 case of Graev v. Commissioner, where a divided US Tax Court (Tax Court) held that supervisory approval was not necessary before determining a penalty in a deficiency proceeding because the statutory language of Internal Revenue Code (Code) Section 6751(b)(1) couched such approval in terms of a proposed penalty assessment. For those not well-versed in procedural tax lingo, an “assessment” is merely the formal recording of a tax liability in the records of the Internal Revenue Service (IRS). In cases subject to the deficiency procedures—i.e., where taxpayers have a right to contest the IRS’s position in the Tax Court—no assessment can be made until after the Tax Court’s decision is final. (more…)

Graev v. Commissioner: Tax Court Divided on Penalty Procedural Rules

by Jeffrey M. Glassman and McDermott Will & Emery | Dec 12, 2016 | Trial Courts, Uncategorized

In tax litigation, there are often (at least) two important categories of issues to consider: (1) substantive; and (2) procedural. A great deal of tax litigation will be focused on the substance of the Internal Revenue Service’s (IRS) adjustments (e.g., was a taxpayer entitled to a particular deduction?). But the procedural aspects should not be ignored. If the IRS did not abide by its procedural requirements before making a tax adjustment, consideration should be given to whether the IRS’s adjustment is procedurally invalid. Sometimes taxpayers win on these issues; other times they do not. The United States Tax Court’s (Tax Court) recent case, Graev v. Commissioner, is an example of the latter.

In Graev, an IRS Revenue Agent determined that a 40 percent gross valuation misstatement penalty should apply. The Revenue Agent prepared a “Penalty Approval Form” in accordance with Internal Revenue Manual (I.R.M.) procedures and submitted it to his immediate supervisor. The supervisor checked the form’s “Approved” box and initialed the form in its space for “Group Manager Initials.” The Revenue Agent then prepared a proposed notice of deficiency determining the 40 percent penalty and no other penalties.

The proposed notice of deficiency was referred to the IRS Office of Chief Counsel (Chief Counsel) for review, pursuant to I.R.M. procedures. The Chief Counsel attorney assigned to the case prepared a memorandum back to the Revenue Agent’s office with proposed revisions to the notice of deficiency. Specifically, the Chief Counsel attorney instructed the inclusion of an alternative 20 percent accuracy-related penalty. The Chief Counsel attorney signed the memorandum and his immediate supervisor initialed it.

The Revenue Agent revised the notice of deficiency to include the alternative 20 percent penalty, but his immediate supervisor did not approve it in writing. The IRS ultimately issued the revised notice of deficiency, which included a signature by an IRS Technical Services Territory Manager and a page on which the penalties were computed. Under the Internal Revenue Code (Code), the 20 percent and 40 percent penalties cannot be stacked. As a result, the computation for the 40 percent penalty was shown fully, but the computation for the 20 percent penalty was calculated as zero.

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