Section 6751(b)(1) and Written, Supervisory Approval of Penalties

By Stephen J. Dunn1

Stephen Dunn analyzes the IRS’s procedures for obtaining written, supervisory approval of penalties. Supervisor approval is required for a determination of penalties involving judgment, such as penalties for negligence or fraud, and to reject taxpayers’ reasonable cause arguments raised against other penalties, such as penalties for failure to timely file a tax return or pay tax.

Section 6751(b)(1) provides important due process of law in the assessment of Federal tax penalties. Ambiguity in the language of the Section 6751(b)(1) has sparked much litigation. A split has opened in the U.S. Courts of Appeal on the interpretation of Section 6751(b)(1). This article examines Section 6751(b)(1), its legislative history, cases applying it, and Internal Revenue Service pronouncements on it, and draws conclusions on the interpretation and reach of Section 6751(b)(1).

A. Internal Revenue Restructuring and Reform Act of 1998

In 1997, popular cries of excesses in Internal Revenue Service collection action led to introduction of a bill which would become the Internal Revenue Restructuring and Reform Act of 1998 (the “Act”).2 The Act altered Federal tax practice and procedure concerning penalties by the addition of two provisions to the Internal Revenue Code, Sections 6751 and 7491(c).

1. Section 6751

Section 6751 provides: § 6751. Procedural requirements.

(a) Computation of penalty included in notice. The Secretary shall include with each notice of penalty under this title information with respect to the name of the penalty, the section of this title under which the penalty is imposed, and a computation of the penalty.

(b) Approval of assessment.

(1) In general. 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 level official as the Secretary may designate.

(2) Exceptions. Paragraph (1) shall not apply to—

(A) any addition to tax under section 6651, 6654, 6655, or 6662 (but only with respect to an addition to tax by reason of paragraph (9) or (10) of subsection (b) thereof); or

(B) any other penalty automatically calculated through electronic means.

(c) Penalties.--For purposes of this section, the term “penalty” includes any addition to tax or any additional amount.

It is clear from the face of Section 6751(b)(1) that Congress did not want low-level IRS employees unilaterally making judgments to assess penalties.

The Senate Finance Committee had this to say concerning Section 6751:

Present Law

Present law does not require the IRS to show how penalties are computed on the notice of penalty. In some cases, penalties may be imposed without supervisory approval.

Reasons for Change

The Committee believes that taxpayers are entitled to an explanation of the penalties imposed upon them. The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.

Explanation of Provision

Each notice imposing a penalty is required to include the name of the penalty, the code section imposing the penalty, and a computation of the penalty.

The provision also requires the specific approval of IRS management to assess all non-computer generated penalties unless excepted. This provision does not apply to failure to file penalties, failure to pay penalties, or to penalties for failure to pay estimated tax.3

The Senate Finance Committee thus advocated the written, supervisory approval requirement of Section 6751(b)(1) to prevent rogue revenue agents from using the threat of penalties to exact better settlements from taxpayers.

To ascertain whether the IRS has secured required written, supervisory approval of penalties, a taxpayer can make a Freedom of Information Act request for the IRS’ administrative file concerning the penalties, and review the copies of documents produced in response.

2. Section 7491(c)

Section 7491(c) provides:

Notwithstanding any other provision of this title, the Secretary shall have the burden of production in any court proceeding with respect to the liability of any individual for any penalty, addition to tax, or additional amount imposed by this title.

The Conference Committee Report on the Act says the following regarding Section 7491(c):

[I]n any court proceeding, the Secretary must initially come forward with evidence that it is appropriate to apply a particular penalty to the taxpayer before the court can impose the penalty. This provision is not intended to require the Secretary to introduce evidence of elements such as reasonable cause or substantial authority. Rather, the Secretary must come forward initially with evidence regarding the appropriateness of applying a particular penalty to the taxpayer; if the taxpayer believes that, because of reasonable cause, substantial authority, or a similar provision, it is inappropriate to impose the penalty, it is the taxpayer’s responsibility (and not the Secretary’s obligation) to raise those issues.4

Thus, the burden of production to determine the appropriateness of any penalty is upon the IRS. Once the IRS meets that burden, the burden shifts to the taxpayer to raise reasonable cause, substantial authority, or other defenses to the penalty.

B. The Case Law

In Chai v. Commissioner,5 the IRS timely issued a Notice of Deficiency asserting self-employment tax on a $2 million payment, and a Section 6662(a) 20 percent accuracy-related penalty. The taxpayer petitioned the Tax Court for review. The Tax Court sustained the IRS’ determination of tax on the $2 million payment. In a post-trial brief, the taxpayer attempted to argue that the initial determination of the penalty had not been approved (in writing) by the immediate supervisor of the individual making the determination, in violation of Section 6751(b). The Tax Court found the taxpayer’s Section 6751(b) argument untimely, and declined to consider it.

On appeal, the U.S. Court of Appeals for the Second Circuit sustained the IRS’ assessment of tax on the $2 million payment, but reversed as to the penalty. The IRS sought to bring the penalty within the “automatically calculated through electronic means” exclusion of Section 6751(b)(2)(B). Citing Internal Revenue Manual 4.19.3, the Second Circuit said that it was aware of no record evidence that the IRS’ penalty determination was, or could have been, made through the IRS’ IMF Automated Underreporter Program. Further, the Court of Appeals noted that the Notice of Deficiency indicated that the determinations had been made by a named Technical Services Territory Manager, or a Revenue Agent under her authority. The Form 886-A, Explanation of Items, included with the Notice of Deficiency detailed why the IRS determined to assess the penalty, including that the IRS employee determined that the taxpayer lacked reasonable cause for the underpayment. The Court of Appeals concluded:

Because Chai’s penalty was not imposed “free of any independent determination by a Service employee as to whether the penalty should be imposed,” see I.R.S. Gen. Couns. Mem. 200211040, at 3 (Jan. 30, 2002) (emphasis added), it was not “calculated automatically through electronic means.” I.R.S. Gen. Couns. Mem. 2014004, at 2 (May 20, 2014). The IRS was therefore required to obtain written approval of the penalty pre-assessment.6 [Emphasis in original.]

Turning to the language of Section 6751(b)(1), the Second Circuit found ambiguity in the phrase, “initial determination of such assessment.” The Court of Appeals noted that “[a]ssessment under Section 6203 “is the formal recording of a taxpayer’s tax liability on the tax rolls.”7 The Court of Appeals added:

If “assessment” is the formal recording of a taxpayer’s tax liability, then § 6751(b) is unworkable: one can determine a deficiency, see I.R.C. §§ 6212(a), 6213(a), and whether to make an assessment, “but one cannot ‘determine’ an ‘assessment.’”8

The Court of Appeals noted that Section 6751(b)(1) does not define when the IRS “initial[ly] determine[es]” a penalty. The Court of Appeals divined Congress’ intent in approving Section 6751(b)(1): “The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.”9 This suggests that “initial determination” of a penalty occurs when the IRS formally communicates the penalty to the taxpayer. The Court of Appeals held that issuance of a notice of deficiency asserting a penalty is an “initial determination” of the penalty, requiring written, supervisory approval under Section 6751(b)(1).

The Court of Appeals held that compliance with Section 6751(b)(1) was part of the IRS’ initial burden of production under Section 7491(c). The Court of Appeals found that there was no evidence that the IRS had complied with Section 6751. “In fact, the Commissioner has never said there was.”10 The Second Circuit reversed the Tax Court’s order upholding the penalty assessment.

In Clay v. Commissioner,11 a revenue agent issued a Revenue Agent’s Report (“RAR”) to the taxpayers on September 13, 2010 proposing assessment of proposing Section 6662 substantial understatement and other accuracy-related penalties against the taxpayers. The revenue agent’s supervisor initialed a Civil Penalty Approval Form approving the penalties on October 18, 2010. The IRS included the penalties in a notice of deficiency issued to the taxpayers on March 14, 2011. The Tax Court noted the Senate Committee’s concern with revenue agents using the threat of penalties “as a bargaining chip” to exact better settlements from taxpayers. The Tax Court concluded that the “initial determination” of a penalty assessment for purposes of Section 6751(b)(1) occurs at the earlier of issuance of an RAR or a Notice of Deficiency asserting the penalties. As initial determination of the penalty assessment in Clay occurred on September 13, 2010, before written, supervisory approval of the assessment on October 18, 2010, the Tax Court disallowed the penalties.

The Tax Court’s Section 6751(b)(1) jurisprudence continued to develop in Belair Woods, LLC v. Commissioner 12 On October 22, 2012, the IRS sent Belair Woods LLC a Letter 1787 informing the taxpayer that “we’re beginning our audit of your partnership’s federal tax return.” The letter was signed by Ellie Pennington, the revenue agent assigned to conduct the examination.

The examination proceeded on a fast track as less than a year remained on the assessment statute of limitations. On December 18, 2012, Pennington sent to Belair Woods a Letter 1807 inviting the tax management partner (TMP) and other partners to a closing conference to discuss the IRS’ proposed adjustments. The enclosed summary report proposed to deny a $4,778,000 charitable contribution deduction in its entirety. The summary report also proposed a gross overvaluation penalty under Section 6662(h), or, in the alternative, a Section 6662(c) negligence penalty and a 6662(d) substantial understatement penalty. The summary report also explained in detail defenses that might be available against the proposed penalties, including “reasonable cause and good faith,” reliance on appraisals, and reliance on professional tax advice.

The IRS exam team attended an initial conference with Belair Woods’ representatives in February, 2013. At that conference, those representatives agreed that Belair Woods would execute Form 872-P, Consent to Extend the Time to Assess Tax Attributable to Partnership Items.

Pennington prepared a Civil Penalty Approval Form for the penalty proposed under Section 6662(h) or, in the alternative, the penalties proposed under Sections 6662(c) and (d). In the box captioned “Reason(s) for Assertion of Penalty(s)” she wrote:

The contribution deduction flowing through to the individuals is overvalued by over 8,000%. No reasonable cause was established. Discussed the assertion of penalties with the group manager. He concurred that penalties are applicable prior to issuance of the summary report.13

In a section of the Civil Penalty Approval Form captioned “Penalties Requiring Group Manager Approval,” Pennington checked the “Yes” box for a Section 6662(h) penalty as the primary position, and the “Yes” box for Section 6662(b) and (c) penalties as an alternative.14

On August 27, 2014, Pennington forwarded the case file, including the Civil Penalty Approval Form, to Cheryl Mixon, her then-supervisor. On September 2, 2014, Mixon, in her capacity as Group Manager, signed the Civil Penalty Approval Form, approving assertion of the three penalties indicated on the form.

On March 9, 2015, the IRS issued a “TMP 60-Day Letter” to Belair Woods. The 60-Day Letter offered Belair Woods the options of accepting the adjustments or appealing them to the IRS Appeals Office. Belair Woods sought review in the Appeals Office, but the appeal was unsuccessful. On June 19, 2017, the Appeals Office issued to Belair Woods a final partnership administrative adjustment (FPAA) disallowing the charitable contribution deduction in its entirety and determining a gross valuation misstatement penalty. In the alternative, the FPAA determined penalties for negligence, substantial understatement of tax, and Section 6662(e) substantial valuation misstatement. This was the first time the IRS had communicated its intention to assert a Section 6662(e) penalty to Belair Woods. The IRS admitted that it could not show timely supervisory approval of a Section 6662(e) penalty, and conceded it.15

In the Tax Court, Belair Woods contended that Section 6751(b) (1) required written, supervisory approval of the penalties to occur by the time the IRS issued the Letter 1807 to Belair Woods mentioning the penalties in December, 2012. The Tax Court said:

The Letter 1807 launched a lengthy communication and fact-gathering process during which [petitioner] had the opportunity to present its side of the story. Only after that process concluded did the Examination Division finalize its penalty determination by issuing the 60-day letter.16

The Tax Court said that “[t]he statute requires approval for the initial determination of a penalty assessment, not for a tentative proposal or hypothesis” [Emphasis in original].17 The Tax Court (somewhat arbitrarily) found that the Letter 1807 failed to rise to the level of an “initial determination” under Section 6751(b) (1). It held that issuance of the 60-day letter on March 9, 2015, “formally communicated” the IRS’ penalty determination to Belair Woods, and constituted the IRS’ “initial determination” to assert the penalties.18 Because Pennington’s Group Manager signed the Civil Penalty Approval Form on August 27, 2014, the Tax Court concluded that the written, supervisory approval of the penalties was timely under Section 6751(b)(1).

In Beland v. Commissioner,19 the IRS commenced an examination of Brian and Denae Beland’s 2011 Form 1040, U.S. Individual Income Tax Return, on October 30, 2014. Revenue Agent Ivana Raymond met with the Belands’ CPA in December, 2014, and with the Belands and their CPA in January, 2015. Following the December meeting, Raymond and her immediate supervisor, IRS Group Manager Gabriel Pardo, referred the Belands’ case to an IRS fraud technical advisor (FTA). Upon the request of the IRS Criminal Investigation Division and the FTA, on June 5, 2015 Pardo and Raymond issued an administrative summons to the Belands to appear before Raymond again on June 30, 2015. The Belands sent a letter to Raymond dated June 23, 2015 requesting postponement of the summons interview because Ms. Beland had just given birth to the Belands’ second child. In response, IRS counsel sent a letter to the Belands dated July 27, 2015 to compel their appearance before Raymond on August 19, 2015. The letter stated that “[l]egal proceedings may be brought against you in the United States District Court for not complying with [the] summons.” The Belands acquiesced and appeared with their CPA before Raymond, Pardo, and IRS Group Manager John Yu at the August 19, 2015 meeting.

The August 19, 2015 meeting was the Belands’ closing conference. During the conference, Raymond presented to the Belands a Form 4549, Income Tax Examination Changes, commonly referred to as a revenue agent’s report. The RAR included a fraud penalty of specified amount, and contained Raymond’s electronic signature. The Belands declined to sign the RAR during the meeting, because they did not agree with the fraud penalty. The Belands also declined to sign Form 872, Consent to Extend the Time to Assess Tax. With less than 240 days remaining on the assessment statute of limitations, Raymond informed the Belands that they would forgo their appeal rights, their 2011 examination case would be closed, and respondent would issue a notice of deficiency.

On August 21, 2015, Raymond sent the 2011 examination case file to Pardo. The file included a Civil Penalty Approval Form for the fraud penalty, as well as an alternative assertion of an accuracy-related penalty under Section 6662(a), which Pardo signed that day. On September 1, 2015, the IRS issued a notice of deficiency to the Belands for tax year 2011 asserting the civil fraud or, in the alternative, the accuracy-related penalty.

The Tax Court concluded that the completed RAR given to the Belands at the August 19. 2015 closing conference, coupled with the context surrounding its presentation, represented a “consequential moment” in which Raymond formally communicated to the Belands her initial determination to assess the fraud penalty. As Pardo did not approve the fraud penalty in writing until August 21, 2015, the Tax Court held that the IRS failed to meet its Section 7491(c) burden of production as to the penalty, and disallowed the penalty.

Section 6751(b)(1) jurisprudence took a different turn in Laidlaw’s Harley Davidson Sales Inc. v. Commissioner.20 Section 6011(a) and Treasury Regulation Section 1.6011-4(a), (b)(2), (e) require taxpayers to disclose on a statement filed with their tax return their participation in transactions designated by the IRS as “listed transactions.” In 1999, the taxpayer became a participating employer in a purported welfare benefit plan called the Sterling Benefit Plan (“Plan”). The IRS later determined that the Plan was the same as, or substantially similar to, the tax avoidance transactions designated as “listed transactions” in the IRS’s Notice 2007-83, and that a taxpayer participating the Plan would be subject to a penalty under Section 6707A if it did not disclose its participation on its tax return.

The IRS issued Notice 2007-83 on November 5, 2007. The taxpayer filed its 2008 income tax return on February 16, 2009, without disclosing its participation in the Plan. In December 2010, the taxpayer filed amended income tax returns for 1999 and 2005 through 2008. The amended tax returns included IRS Forms 8886, Reportable Transaction Disclosure Statement, disclosing the taxpayer’s participation in the Plan.

Revenue Agent Sandra Czora examined taxpayer’s 2007-2008 income tax returns with a view to assessing penalties under Section 6707A for failure to timely report taxpayer’s participation in the Plan. Section 6707A penalties are assessable, i.e., are not subject to deficiency procedure. On May 26, 2011, Czora sent the taxpayer a “30-day letter” proposing to assess a Section 6707A penalty in the amount of $96,900 against the taxpayer. The 30-day letter explained the taxpayer’s rights to contest the proposed penalty. The taxpayer could sign consenting to assessment of the penalty. If the taxpayer did not consent to the penalty, the taxpayer could file a written protest for IRS Appeals Office review. Alternatively, the taxpayer could pay the penalty and sue for a refund in U.S. District Court or the Court of Federal Claims. The letter said that if the taxpayer took no action by the 30-day response date (June 27, 2011), “we will assess the penalty and begin collection procedures.”

Czora enclosed with the 30-day letter a Form 4549-A, Income Tax Discrepancy Adjustments, showing her computation of the proposed penalty, and a Form 886-A, Explanation of Items, explaining the basis for the proposed penalty.

On July 21, 2011, the taxpayer filed a timely protest of the proposed penalty with the IRS Appeals Office. On August 23, 2011, Czora’s immediate supervisor, Group Manager Virginia Korzec, signed a Form 300, Civil Penalty Approval Form, approving the proposed penalty. The next day Korzec transferred the case to the Appeals Office. The taxpayer’s administrative appeal was unsuccessful, and the Appeals Office recommended assessment of the § 6707A penalty. The IRS assessed the penalty, in the amount of $96,900, on September 16, 2013.

The taxpayer did not pay the penalty after notice and demand, and the IRS issued a notice of intent to levy informing the taxpayer of its right to a Collection Due Process (“CDP”) hearing before the IRS Appeals Office. The taxpayer timely requested a CDP hearing, which was held on May 9, 2014. On May 21, 2014, the Appeals Office sustained the proposed levy, stating that the Appeals Office had “obtained verification from the IRS office collecting the tax that the requirements of any applicable law, regulation or administrative procedure with respect to the proposed levy . . . have been met,” in accordance with Section 6330(c)(1).21

In June, 2014, the taxpayer timely petitioned the Tax Court for review of the penalty assessment, as provided by Section 6330(d)(1). The Tax Court held that Section 6751(b)(1) required written, supervisory approval of the penalty to occur by the time of initial determination of the penalty, and that initial determination occurred on May 26, 2011, when the IRS first formally communicated the penalty to the taxpayer. As written, supervisory approval of the penalty occurred on August 23, 2011, after the May 26, 2011 initial determination of the penalty, the Tax Court disallowed the penalty, and granted summary judgment to Taxpayer.

On appeal, the Ninth Circuit noted that the term “assessed” in Section 6751(b)(1) “refers to a ministerial function: ‘the formal recording of a taxpayer’s tax liability on the tax rolls,’ which is ‘the last of a number of steps required before the IRS can collect’ a tax or penalty from a taxpayer.’”22 The Court of Appeals said that an IRS supervisor could “approve” a penalty only so long as the supervisor has discretion to approve the penalty. In a deficiency procedure case, a supervisor could lose discretion to approve a penalty before assessment of the penalty, i.e., upon issuance of a notice of deficiency asserting the penalty. The Court of Appeals held that Supervisor Korzec retained discretion to approve the Section 6707A penalty in Laidlaw’s, which was not subject to deficiency procedure, up to the time of assessment of the penalty on September 16, 2013, and that written, supervisory approval of the penalty on May 26, 2011 satisfied Section 6751(b)(1). As a result, the Ninth Circuit, in a 2-1 decision, reversed the Tax Court.

In Kroner v. Commissioner, the Eleventh Circuit extended the Ninth Circuit’s Section 6751(b)(1) jurisprudence to a deficiency procedure case. 23 On August 6, 2012, Revenue Agent John Cox met with the taxpayer’s representatives, and delivered to them a Letter 915 and a Form 4549, Income Tax Examination Changes. The Letter 915 and its attachments proposed accuracy-related penalties under Section 6662, and granted the taxpayer the opportunity to protest the proposed changes to the IRS Appeals Office. On October 31, 2012, Cox’ supervisor, Supervisory Revenue Agent Diane Acosta, signed Workpaper #300-1.1, Civil Penalty Approval Form. On the same day, Cox mailed to the taxpayer a Letter 950, enclosing Form 4549-A, Income Tax Discrepancy Adjustments.

The IRS issued a notice of deficiency dated July 10, 2014 to the taxpayer. It proposed assessment of substantial amounts of additional income tax, and just under $2 million in Section 6662 penalties.

The taxpayer timely requested a conference before the IRS Appeals Office, and continued negotiating with the IRS. These efforts proved unavailing, and IRS finally issued a statutory notice of deficiency to the taxpayer. The taxpayer petitioned the U.S. Tax Court for review.

After trial, the Tax Court sustained the additional tax asserted by the IRS against the taxpayer, but not the penalties. The Tax Court found that the IRS’ August 6, 2012 letter and examination report was the “initial determination” of the penalty assessment against the taxpayer for purposes of Section 6751(b). As Acosta did not sign the Civil Penalty Approval Form until October 31, 2012, the Tax Court held that the IRS had failed to obtain written, supervisory approval of the penalty within the time required by Section 6751(b)(1), and disallowed the penalty.

On appeal, the Eleventh Circuit found that Section 6751(b)(1) “regulates assessments[, not] communications to the taxpayer.”24 The Eleventh Circuit further observed, “We likewise see nothing in the text that requires a supervisor to approve penalties at any particular time before assessment.”25 The Court of Appeals reduced its interpretation of Section 6751(b)(1) to the following:

Stripped to bare bones, the statute directs that the IRS shall not take action X “unless” condition Y is met. X is the assessment of a covered penalty, and Y is the act of obtaining supervisory approval of the initial determination of assessment.26

Citing the Ninth Circuit’s opinion in Laidlaw’s Harley Davidson Sales, Inc., the Eleventh Circuit concluded “that the IRS satisfies Section 6751(b) so long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties.”27 The penalties had not yet been assessed, as a final judgment sustaining the penalties had not yet been entered when the Eleventh Circuit issued its opinion. Therefore, the Court of Appeals held Acosta’s October 31, 2012 written approval of the penalties timely under Section 6751(b)(1), and reversed the Tax Court.

The position of the Ninth Circuit in Laidlaw’s Harley Davidson Sales, Inc., and of the Eleventh Circuit in Kroner and its progeny, is problematic, for at least two reasons. First, by rendering the term “initial determination” in Section 6751(b)(1) superfluous, the position of the Ninth and Eleventh Circuits violates the Supreme Court’s “canon of superfluity.” This provides that where competing interpretations of a stature are urged, and one of them gives effect to every word and clause of the statute and one does not, the interpretation that gives effect to every word and clause of the statute should be adopted.28

Second, the position of the Ninth and Eleventh Circuits that written, supervisory approval of a penalty satisfies Section 6751(b)(1) if it occurs anytime before assessment of the penalty lacks fidelity to Congress’ intention that the spectre of penalties not be used as a “bargaining chip” in exacting concessions from taxpayers. If revenue agents need not obtain written, supervisory approval of a penalty until it is assessed, they are free to use the threat of a penalty as a bargaining chip in seeking a favorable settlement from the taxpayer throughout the long pendency of the case up to assessment.

The Supreme Court likely will need to step in and resolve the split in the Circuits. The Second Circuit’s position in Chai, embraced in Tax Court decisions, seems to be the betterreasoned position, and faithful to Congress’ intent in enacting Section 6751(b)(1).

C. Penalties Subject to Section 6751(b)

Cases have applied the Section 6751(b)(1) written, supervisory approval requirement to Section 6662 accuracy-related penalties,29 to Section 6662 substantial understatement penalties,30 and to Section 6663(a) civil fraud penalties.31 Section 6662 accuracy-related penalties and Section 6663 civil fraud penalties involve a judgment, Section 6662 accuracy-related penalties about whether the taxpayer was negligent, and Section 6663 penalties about whether the taxpayer was fraudulent. A reasonable cause argument, under Section 6664, also is available against all Section 6662 or Section 6663 penalties.

Section 6651 penalizes failure to timely report or pay tax, or failure to timely file a tax return.32 International information return penalties, too, penalize the failure to file an international information return.33 It may seem that assessment of Section 6651 penalties or international information return penalties international penalties does not involve a judgment. But each of these penalties has a reasonable cause exception: the penalty is not to be assessed if the noncompliance for which the penalty would be assessed is due to reasonable cause.34

Section 7491(c) allocates to the taxpayer the burden to raise reasonable cause, as noted above. But once the taxpayer raises reasonable cause against a penalty assertion, it is up to the IRS to decide it. And whether the taxpayer’s noncompliance is due to reasonable cause surely does involve a judgment.

The IRS does not want low-level employees unilaterally making judgments about reasonable cause, just as it does not want them making judgments about negligence or fraud. Internal Revenue Manual 20.1.5.2.3, Supervisory Approval of Penalties – IRC 6751 Procedural Requirements, provides in part:

(6) Any penalties automatically calculated through electronic means are excluded from IRC 6751(b)(1) requirement.

a. AUR (Automated Underreporter) and CEAS (Correspondence Examination Automation Support) cases in which the Substantial Understatement Penalty is systemically asserted, will fall within the exception for penalties automatically calculated through electronic means if the taxpayer does not submit any response to the 30-day letter that proposes the penalty.

b. However, if a taxpayer submits a response, written or otherwise, that challenges the penalty or the liability to which the penalty relates, written supervisory approval under IRC 6751(b)(l), is required before any written communication of penalties that offers the taxpayer an opportunity to sign an agreement, or consent to assessment or proposal of the penalty. See IRM 20.1.1.2.3.1, Timing of Supervisory Approval. The exception for penalties automatically calculated through electronic means no longer applies once a Service employee makes an independent determination to pursue a penalty or to pursue adjustments to tax for which a penalty is attributable. Similarly, Proposed Regulation § 301.6751(b)-1(a)(3)(iv) provides:

(vi) Automatically calculated through electronic means. A penalty, as defined in paragraph (a)(3)(i) of this section, is automatically calculated through electronic means if an IRS computer program automatically generates a notice to the taxpayer that proposes the penalty. If a taxpayer responds in writing or otherwise to the automaticallygenerated notice and challenges the proposed penalty, or the amount of tax to which the proposed penalty is attributable, and an IRS employee considers the response prior to assessment (or the issuance of a notice of deficiency that includes the penalty), then the penalty is no longer considered “automatically calculated through electronic means.”

Thus, by raising a good faith reasonable cause argument against a proposed Section 6651 penalty or a proposed international information return penalty, the taxpayer removes the penalty from the vague wasteland of Section 6751(b)(2) and places it within the ambit of Section 6751(b) (1). Once this happens, the IRS must secure written, supervisory approval of the penalty before sending the taxpayer a written communication asking the taxpayer to sign consenting to assessment of the penalty.35 If the IRS fails in this, by virtue of IRM 20.1.5.2.3 and Proposed Regulation § 301.6751(b)-1(a)(3)(iv) the penalty must not be sustained.

What about a Section 6651 penalty or a penalty for failure to timely file an international information return that is assessed without written supervisory approval when (1) the taxpayer was not afforded due process of law, or (2) the taxpayer failed to raise reasonable cause or other available defenses? This will have to await examination in a later article.

D. Summary

Section 6751(b)(1) requires the IRS to secure written, supervisory approval of an initial determination to assert a Section 6662 negligence penalty or a Section 6663 civil fraud penalty. Section 6662 negligence penalties and Section 6663 civil fraud penalties, as well as Section 6651 penalties and international information return penalties, are subject to a reasonable cause defense. Rejection of an asserted reasonable cause defense also requires written, supervisory approval by the IRS. Whenever written, supervisory approval is at issue, taxpayer’s counsel should make a Freedom of Information Act request for the IRS’ administrative file concerning the penalties, and obtain the file and review it for proof of required written, supervisory approval. Absence of required written, supervisory approval is a good defense to an assessed penalty.

Endnotes

1 Stephen J. Dunn is the founder and member of Dunn Counsel PLC, Troy, Michigan. He thanks Ryan Peruski for his assistance in reviewing this article. A version of this article first appeared in Tax Notes Federal and Tax Notes International. Copyright 2024 Stephen J. Dunn. All rights reserved.

2. PL 105-206 (Jul. 22, 1998), 112 Stat. 685.

3. S. Rep. 105-174, at 65, 105th Cong., 2nd Sess. 1998, 1998 WL 197371. [Emphasis added].

4. H.R. Conf. Rep. 105-599, at 241, 105th Cong., 2nd Sess. 1998, 1998 U.S.C.C.A.N. 288, 1998 WL 915495.

5. 851 F.3d 190 (2d Cir. 2017).

6. Id. at 217.

7. Id. at 218. “[A]n assessment is ‘made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.’” Id., quoting Section 6203.

8. 851 F.3d 218-219 (quoting dissenting opinion of Gustafson, J., in Graev v. Commissioner, 147 T.C. 16, No. 30638-08, 2016 WL 6996650 at *31).

9. 851 F.3d at 219, quoting S. Rep. No. 105-174, supra, at 65.

10. 851 F.3d at 223.

11. 152 T.C. 223 (2019).

12. 154 T.C. 1 (2020).

13. 154 T.C. at 5.

14. Id.

15. In an examination of a partnership income tax return, unless the partnership has 100 or fewer partners and elects out of Subtitle F, Chapter 63, subchapter C of the Code, a FPAA functions like a notice of deficiency in other examinations. The FPAA becomes final upon the partnership and the partners 90 days after issuance of the FPAA unless, within said 90 days, the partnership petitions for review of the FPAA in the U.S. Tax Court, the U.S. District Court for the district of the partnership’s principal place of business, or the U.S. Court of Federal Claims. If the partnership petitions for such judicial review, the FPAA becomes final upon issuance of a final judgment sustaining the FPAA. See Section 6234.

16. Id. at 9.

17. Id.

18. The Tax Court wrote:

In the instant case the 60-day letter determining penalties under section 6662(b), (c), and (h) was issued on March 9, 2015. That letter, like the 30-day letter in Clay, formally communicated to Belair the Examination Division’s definite decision to assert those penalties, thus concluding the Examination Division’s consideration of the case. See Internal Revenue Manual (IRM) pt. 8.19.1.6.8.4(3) (Oct. 1, 2013) (“The 60-day letter is the equivalent of a 30-day letter in deficiency proceedings. It gives the partners the opportunity to appeal the findings of the examiner.”).

154 T.C. at 8-9.

19. 156 T.C. 80 (2021).

20. 29 F.4th 1066 (9th Cir. 2022).

21. Id. at 1069.

22. Id. at 1071, quoting Chai v. Commissioner, 851 F.3d 190, 218 (2d Cir. 2017), and citing Roth v. Commissioner, 922 F.3d 1126, 1131 (10th Cir. 2019).

23. 48 F.4th 1272 (11th Cir. 2022).

24. 48 F.4th at 1275.

25. 48 F.4th at 1278.

26. Id.

27. 48 F.4th at 1276.

28. See Microsoft Corp. v. i4i Limited Partnership, et al., 564 U.S. 91, 106-107 (2011), citing Duncan v. Walker, 533 U.S. 167, 174, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001) and United States v. Menasche, 348 U.S. 528, 538–539, 75 S.Ct. 513, 99 L.Ed. 615 (1955) (“It is our duty ‘to give effect, if possible, to every clause and word of a statute”).

29. See, e.g., Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017); Carter v. Commissioner, T.C. Memo 2020-21, aff’d, 2022 WL 4232170 (11th Cir. 2022); Castro v. Commissioner, T.C. Memo 2022-120; Kroner v. Commissioner, T.C. Memo 2020-73, rev’d, 48 F.4th 1272 (11th Cir. 2022); Simpson v. Commissioner, T.C. Memo 2023-4.

30. See, e.g., Clay v. Commissioner, 152 T.C. 233 (2019), aff’d, 990 F.3d 1296 (11th Cir.), cert. denied, 142 S.Ct. 342 (2021).

31. See, e.g., Minemyer v. Commissioner, 2023 WL 314832 (10th Cir. 2023); Belanger v. Commissioner, T.C. Memo 2020-130; Benavides & Co., P.C. v. Commissioner, T.C. Memo 2019-115; Beland v. Commissioner, 156 T.C. 80 (2021); Estate of Clemons v. Commissioner, T.C. Memo 2022-95; Degourville v. Commissioner, T.C. Memo 2022-93; Dorval v. Commissioner, T.C. Memo 2018-167; Purvis v. Commissioner, T.C. Memo 2020-13.

32. Section 6651(a)(1) imposes a penalty for failure to file a tax return when due (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not willful neglect. Section 6651(a)(2) imposes a penalty for failure to pay tax reported on any return by the date prescribed therefor (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not willful neglect. Section 6651(a)(3) imposes a penalty for failure to pay tax reportable on a return, which is not so reported, within 21 days after notice and demand therefor, unless it is shown that such failure is due to reasonable cause and not willful neglect.

33. Section 6677 imposes a penalty for failure to timely file Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, reporting information required in Parts I-III thereof. Section 6677 also imposes a penalty or for failure to timely file Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. Section 6039F(c) imposes a penalty for failure to timely report on Form 3520, Part IV, the receipt of large gifts or bequests from foreign sources. 6679(a) imposes a penalty for failure to timely file Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. Section 6038B(c) imposes a penalty for failure to timely file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. 34. Sections 6651(a)(1), (2), and (3) each contain a reasonable cause exception. The Section 6677 penalty “shall [not] be imposed . . . on any failure which is shown to be due to reasonable cause and not willful neglect.” Section 6677(d). The Section 6039F penalty “shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.” Section 6039F(c)(2). The Section 6038D penalty “shall [not] be imposed . . . on any failure which is shown to be due to reasonable cause and not due to willful neglect.” Section 6038D(g). The 6679(a) penalty does not apply if “it is shown that [the] failure [to timely file Form 5471 or Form 8865] is due to reasonable cause.” Section 6679(a)(1).

The Section 6038B(c) penalty “shall not apply to any failure [to file Form 926] if the United States person shows that such failure is due to reasonable cause and not to willful neglect.” Section 6038B(c)(2). 35. The taxpayer should, of course, raise, in addition to reasonable cause and Section 6751(b)(1) written, supervisory approval, whatever other arguments the taxpayer may have against the penalty, such as first time abatement under Internal Revenue Manual 20.1.1.3.3.2.1.