When is Written Managerial Approval Required?

In 1998, Congress sought to provide additional protections to taxpayers through passage of the Internal Revenue Service Restructuring and Reform Act (the “Act”).  Buried within the Act was new section 6751(b), which requires the IRS to comply with certain procedural requirements prior to making a penalty assessment against a taxpayer.[i]  Currently, section 6751(b) reads:

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.

Since 2016, federal courts have struggled with the meaning of the key term “initial determination of such assessment.”  As one Tax Court judge aptly stated, one can determine a deficiency and whether to make an assessment, but one cannot “determine” an assessment.  Due to this ambiguity, federal courts have parted ways on precisely when the IRS must obtain written managerial approval of particular penalties.  The question is more than academic:  if the IRS fails to obtain proper managerial approval of a penalty, the penalty is waived or abated on procedural grounds under section 6751(b).

On April 10, 2023, the IRS issued proposed regulations under section 6751(b).  See REG-121709-19.  The proposed regulations seek to clarify the timing of when written managerial approval must be obtained by the IRS for a penalty to be effective under section 6751(b).

Background

Congress did not define the term “initial determination” within section 6751(b).  Rather, in the legislative history, Congress simply stated that it enacted section 6751(b) because it had concerns that the IRS was imposing penalties without supervisory attention and that it further “believe[d] that penalties should only be imposed where appropriate and not as a bargaining chip.”[ii]

In 2016, a majority of the Tax Court in Graev concluded that the IRS could comply with section 6751(b) by obtaining written managerial approval at any time prior to making an assessment.[iii] But in Chai, the Second Circuit Court of Appeals disagreed with the rationale in Graev, reasoning that such an interpretation went against the legislative purpose of section 6751(b).[iv]  Accordingly, the Chai court held that the IRS must obtain written managerial approval of a penalty no later than the date that the IRS issues a notice of deficiency to a taxpayer or files an answer or amended answer asserting the penalty.  After Chai, the Tax Court reversed its previous decision in Graev and adopted the rationale of Chai.

And the Tax Court took Chai a step further.  In Clay, it concluded that a civil penalty was ineffective under section 6751(b) where the IRS obtained written managerial approval prior to the issuance of a notice of deficiency but after the issuance of a “30-day Letter.”[v]  Later, in Belair Woods, the Tax Court held that supervisory approval must be obtained before the IRS sends a notice that “formally communicates to the taxpayer, the [IRS] Examination Division’s unequivocal decision to assert a penalty.”[vi]

Federal appellate courts have disagreed with the Tax Court’s decisions in Clay and Belair Woods.  For example, the Ninth Circuit Court of Appeals in Laidlaw’s concluded that the IRS must obtain written supervisory approval prior to the assessment of the penalty or, in some instances, prior to the immediate supervisor losing discretion as to whether to approve the penalty assessment.[vii]  On the other hand, the Tenth Circuit Court of Appeals in Minemyer held that the IRS must obtain written supervisory approval under section 6751(b) prior to the issuance of a notice of deficiency asserting the penalty.[viii]  Finally, the Eleventh Circuit Court of Appeals in Kroner held that the IRS must obtain supervisory approval prior to the penalty assessment.[ix]  Notwithstanding these recent decisions, the Tax Court has continued to follow its decisions in Clay and Belair Woods, even after the decisions in Laidlaw’s and Kroner.[x]

The Proposed Regulations

The proposed regulations adopt three significant timing rules regarding when the IRS must obtain supervisory approval under section 6751(b).

First, the proposed regulations provide that the IRS must obtain written supervisory approval at any time prior to the issuance of a notice that provides the Tax Court with jurisdiction over the penalty to the extent the taxpayer timely files a petition with the Tax Court.  For example, if the IRS asserts an accuracy-related penalty for negligence or disregard of rules or regulations, the proposed regulations require the IRS to obtain the section 6751(b) approval prior to the IRS’s issuance of the notice of deficiency to the taxpayer.  In effect, the proposed rule does away with the Tax Court’s decisions in Clay and Belair Woods.

Second, the proposed regulations provide rules for IRS counsel regarding penalties that counsel asserts for the first time after a timely petition has been filed by a taxpayer.  Under this rule, IRS counsel must obtain supervisory approval of the proposed penalty at any time prior to the Commissioner requesting that the Tax Court determine the penalty.

Third, the proposed regulations provide rules for assessable penalties and other penalties that are not subject to pre-assessment review in the Tax Court (e.g., where a taxpayer does not file a timely Tax Court petition).  In these instances, the IRS must obtain written supervisory approval of the penalty at any time prior to making the penalty assessment.  For example, if a taxpayer agrees to an immediate assessment of a civil penalty after an examination, the IRS would nevertheless be required to obtain written supervisory approval of the penalty prior to the agreed-upon assessment.

Parting Thoughts  

Given the ambiguity amongst various federal courts on the proper timing of the section 6751(b) supervisory approval, it is no surprise that the IRS has opted to issue regulations on the issue.  To the extent the regulations become finalized after the notice-and-comment period, the IRS will be able to contend that its interpretation of section 6751(b) via the above rules are entitled to deference, effectively eliminating the more taxpayer-friendly rules in Clay and Belair Woods.  Regardless, taxpayers should continue to raise the section 6751(b) defense to certain penalties where appropriate.

[i] Section 6751(b) does not apply to all civil penalties under the Code.  For example, section 6751(b) supervisory approval is not required with respect to failure-to-file penalties, failure-to-pay penalties, estimated tax payment penalties, and penalties computed electronically.

[ii] S. Rep. No. 105-174, at 65 (1998), 1998-3 C.B. 537, 601.

[iii] Graev v. Comm’r, 147 T.C. 460, 477-81 (2016).

[iv] Chai v. Comm’r, 851 F.3d 190, 218-19 (2d Cir. 2017).

[v] See Clay v. Comm’r, 152 T.C. 223, 249-50 (2019).

[vi] Belair Woods, LLC, 154 T.C. 1, 13 (2020).

[vii] See Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r, 29 F.4th 1066 (9th Cir. 2022).

[viii] See Minemyer v. Comm’r, No. 21-9006 & 21-9007, 2023 WL 314832 (10th Cir. Jan. 19, 2023).

[ix] See Kroner v. Comm’r, 48 F.4th 1272 (11th Cir. 2022).

[x] See, e.g., Simpson v. Comm’r, T.C. Memo. 2023-4; Castro v. Comm’r, T.C. Memo. 2022-120.

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