Issues Remain for Resolution by Courts as Litigation Over IRS’s Supervisory Written Approval of Penalties Requirements Continues

Issues Remain for Resolution by Courts as Litigation Over the IRS’s Supervisory Written Approval of Penalties Continues: Who has the burden of proof to show the IRS has complied with the procedures and how low is the bar for “written approval?”

Note: This article was written on 3/1/2020. The area of law discussed herein is evolving over several court opinions and a reader should conduct her own research before arriving at a conclusion. This article is not a statement of black-letter law but, rather, an opinion piece with the author’s analysis supported as stated by the cited authority. This article is not legal advice. A reader who is engaged in a controversy with the IRS should consult with a tax controversy professional as to his or her individual circumstances.

In order to apply the accuracy-related penalties under I.R.C. § 6662(a), the IRS must show that the IRS complied with the procedural requirements of I.R.C. § 6751(b)(1)..   Section 6751(b)(1) provides that “[n]o 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.  Under Clay v. Commissioner, 152 T.C. No. 13 (2019), the relevant time frame for determining whether the IRS has complied with this written-approval requirement is no later than the date of the issuance of a 30-Day Letter.

The Tax Court clearly agrees that the IRS has the burden of production, but there is some support that the IRS may also have the ultimate burden of proof.

Opinions issued by the United States Tax Court have held that the IRS bears the burden of production with respect to a taxpayer’s liability for a penalty, including compliance with the procedures under I.R.C. § 6751.  See Graev v. Commissioner, 149 T.C. 485, 492-493 (2017).  In Chai v. Commissioner, 831 F.3d 1990 (2d. Cir. 2017), the United States Court of Appeals for the Second Circuit has held that the IRS also bears the burden of proof in these cases, and this holding has been more or less adopted by the Tax Court.  See Graev, 149 T.C. at 503 (concurrence of Hon. J. Holmes).  Distinct from other cases where the issue is whether a taxpayer’s conduct either merits or excuses a penalty, placing the burden of proof on the IRS would make sense because, were the rule any other way, it would require taxpayers to prove a negative while all evidence is in the hands of the IRS.  “[G]enerally the burden of persuasion settles on the party on whom it rests more lightly.” Rodgers v. United States, 66 F.Supp. 663, 667 (E.D. Pa. 1946).[1]

How low is the bar for “written approval?”

In Palmolive Building Investors, LLC v. Commissioner, 152 T.C. No. 4, the Tax Court held that a Form 5701, Notice of Proposed Adjustment, signed by the examining agent’s manager which both explicitly referenced the penalty by stating “Estimated Flowthrough Penalty (See F886A)” and attached the examining officer’s determination (the Form 886-A) met the statutory approval requirement.  The Tax Court in that case also found that a Form 5402-c (Appeals Transmittal and Case Memo) which attached a Form 886-A, referenced that form and was signed as “Approved by” met the statutory approval requirement.

Recently, the IRS has asked the Tax Court to go a step further and find that the IRS met the statutory approval requirement by a Letter 950, which is typically a boilerplate cover letter called a “30-day letter” which encloses an audit report and provides for administrative appeal rights. Distinct from the Palmolive Building Investors, LLC case, the cover letter neither explicitly mentions the penalty nor states that the assertion is “approved.”  Thus, the IRS is implicitly arguing that it can perform a statutory approval when the manager may not have even been aware that he was approving anything at all.  To the author of this post, this seems to be contrary to the purpose of the statute. The statutory requirement of approval in writing suggests that Congress contemplated deliberate and express approval, as opposed to implied or assumed approval, by supervisors.

The Tax Court has not yet held in a published opinion that a 30-day letter signed by the group manager satisfies the requirements of IRC § 6751. In Tribune Media Co. v. Commissioner, T.C. Memo. 2020-2, *21, the tax court noted: ” Any written manifestation of the supervisor’s intent to approve the penalty is sufficient. For example, in PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 213 (5th Cir. 2018), aff’g T.C. Dkt. No. 26096-14 (Oct. 7, 2016) (bench opinion), we had found that a signed 30-day letter sent by the supervisor of the examining agent satisfied the requirement for written approval.” However, PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 213 (5th Cir. 2018), aff’g T.C. Docket No. 26096-14 (Oct. 7, 2016), was a 5th Circuit opinion (meaning most circuits have not ruled on the issue) and concerned an unpublished, orally-issued Tax Court bench opinion.  Furthermore, the Tax Court’s reference to that case in Tribune Media Co. v. Commissioner, was immediately followed by the court’s concession that it was unable to rely on that opinion because “the [notices] in the case before us were not signed by immediate supervisor of the examining agent.”  Thus, neither of these opinions prevent the a court outside the Fifth Circuit from issuing a holding specific to the facts of the instant case.

Furthermore, neither of the aforementioned cases creates a per se rule that a manager’s signature on a 30-day letter conclusively establishes compliance with IRC § 6751.  Instead, Tribune Media Co. supports the proposition that, where the signed document is unclear, there is a question of fact for resolution by the court. 

 A per se rule with respect to signing cover letters for reports, without regard to the words on the page or the IRS employee’s own understanding (based, at least, on what the IRS’s internal guidelines tell him/her) of the purpose of the document, would not make sense in the opinion of the author of this post.  The IRS’s form letters can be revised and the Letter 950 could conceivably explicitly state that “this letter is not an approval” if the IRS revised it to say so.  It could also remove all doubt and state that “the group manager, by signing below, affirms that he has reviewed and approved the penalties asserted in the enclosed report” to the extent that the IRS wishes to avoid litigation.  Where the document is silent or ambiguous, a question of fact will exist and the court may look to extrinsic evidence.[2] If litigation continues in this area of law because of that ambiguity, only the IRS is to blame when the the cost of revision would likely be close to nothing.

[1] See also Campbell v. United States, 365 U.S. 85, 96 (1961) (where the government had the advantage of having a witness in its employ, stating that “the ordinary rule, based on considerations of fairness, does not place the burden upon a litigant of establishing facts peculiarly within the knowledge of his adversary”).

[2] See Shareholder Representative Services LLC v. Gilead Sciences Inc. et al., 2017 WL 1015621, at *2 (Del. Ch. Mar. 15, 2017).  See also Crown Central Petroleum Company, 32 FERC ¶ 61442 (1985) (Where the meaning of the regulation is ambiguous as to the procedures required, evidence concerning the contemporaneous construction given by the agency to its terms is relevant and useful in determining how to interpret whether a request is properly made.).

Posted on 01/01/2020 by Daniel Layton.