When imposing certain penalties, the IRS is required to comply with Code section 6751(b)(1), which provides:
No penalty under this title 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 or such higher local official as the Secretary may designate. IRC § 6751(b).
The Tax Court Renders Code Section 6751(b) a Nullity.
In Graev, the meaning of “initial determination of such assessment” was hotly contested by the taxpayers and the IRS. The taxpayers argued that an initial determination is made before a deficiency notice is sent out. The IRS argued that the determination does not occur until the penalty is about to be assessed, which in the case of several deficiency penalties, does not occur until after trial and an opinion is issued by a Tax Court judge.
An en banc opinion from the Tax Court held that the written approval under Code section 6751(b) could be validly obtained at any time before the penalty is assessed—including after trial. See Graev v. Comm'r, 174 T.C. No. 16, 2016 WL 6996640, at *10, n.13 (2016). The holding in Graev is troubling because it essentially renders Code section 6751(b) a nullity in deficiency cases, as the IRS would have up until the very moment of assessment (i.e., the end of trial) to get the managerial approval—even after the Tax Court had determined that the penalty applies.
If managerial approval is not necessary until after an assessment is required (because, for example, the Tax Court judge decides penalties should be imposed), then the managerial approval requirement becomes a mere bureaucratic formality rather than a measure to prevent the abuses that Code section 6751(b) was designed to prevent.
The Second Circuit Disagreed with the Tax Court's Opinion in Graev.
Six months after the Tax Court issued Graev, the Second Circuit analyzed Code section 6751(b) and its legislative history, and rejected the Tax Court's interpretation of the statute in Graev. In doing so, the Second Circuit strengthened the managerial approval mandate set forth by Code section 6751(b)(1). See Chai v. Comm'r, 851 F.3d 190, 215-23 (2d Cir. 2017).
In Chai, the court held that Code section 6751(b) “requires written [supervisory] approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.” Id. at 221. The Second Circuit explained that allowing “an unapproved initial determination of the penalty to proceed through administrative proceedings, settlement negotiations, and potential tax court proceedings, only to be approved sometime prior to assessment would do nothing to stem the abuses § 6751(b) was meant to prevent.” Id. at 219.
The Second Circuit clarified that the IRS obligation, imposed by Code section 6751(b)(1), to have the initial penalty determination “personally approved (in writing) by the immediate supervisor of the individual making such determination” requires something more than a general bureaucratic, rubber-stamped forwarding of an initial assessment. In so doing, the court observed that “the IRS's current administrative practice requires a supervisor's approval to be noted on the form reflecting the examining agent's penalty determination or otherwise be documented in the applicable workpapers.” Id. at 220.
The Second Circuit cited other IRS administrative practices requiring that the “managerial review and approval must be documented in writing in the case file.” Chai, 851 F.3d at 220 (quoting IRM 188.8.131.52.3(7) (Aug. 5, 2014)). The Second Circuit found these procedures, issued by the IRS, were “a persuasive signal of the IRS's reading of § 6751 to require, as Congress intended, supervisory approval prior to the issuance of a notice of deficiency.” Id.
With respect to Congressional intent for Code section 6751(b), the Chai court explained that Congress enacted Code section 6751(b) to ensure penalties are imposed fairly and to preclude the IRS from threating the imposition of penalties as a tactic to strong-arm settlements. See S. Rep. No. 105-174, at 65 (1998) (“The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.”) The Tax Court's interpretation of Code section 6751(b) in Graev appears to thwart Congressional intent.
Whether the Graev or Chai approach is correct will be a contentious debate in the Tax Court and the other U.S. Circuit Courts of Appeal. While the Chai decision is binding on the Tax Court for cases appealable to the Second Circuit, any cases not appealable to the Second Circuit Court of Appeals would not be controlled by Chai. See Golsen Rule. Interestingly, Graev is also appealable to the Second Circuit, so the Tax Court may be forced to reconsider its holding in that case.