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 to when supervisory approval is required. Since Chai, the IRS has been more cognizant of the supervisory approval requirement and, regardless of the split of authority, it may be that the IRS will continue to seek approval before the initial determination (as opposed to the assessment) of a penalty. Obtaining approval early in the process comports with US Congress' intent that civil tax penalties are not used as "bargaining chips" during an audit. If during an examination civil tax penalties are asserted, determine if—and when—their imposition was approved by a supervisor. We will continue to provide updates on this issue as they develop.
Please see the links to our prior commentary on Code Section 6751 below:
- Tax Court Holds IRS Chief Counsel Attorneys May Make Initial Penalty Determination
- Using IRS Supervisory Approval Rules To Fight Tax Penalties
- IRS Failed to Prove Supervisory Approval for Penalty Based Upon Redacted Document
- Expect More Civil Tax Penalties—So, Now What?
- A Notice of Deficiency Is Not Set in Stone
- IRS Required to Obtain Supervisory Approval to Assert Penalties
- Graev v. Commissioner: Tax Court Divided on Penalty Procedural Rules
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.