November 6, 2020
Section 6751 has been catapulted to the forefront of tax litigation in recent years with decisions in the Second Circuit (Chai, 851 F.3d 190 (2nd Cir. 2017)) and the Tax Court (Graev, 149 T.C. 485 (2017); Clay, 152 T.C. No. 13 (2019)). Section 6751(b)(1) provides that accuracy related penalties imposed by the IRS must have written approval from the immediate supervisor of the IRS employee making the “initial determination” to impose that penalty. But what exactly constitutes the initial determination? Is the initial determination made when the IRS internally decides the assessment of a penalty is appropriate? Or is the initial determination only made when the IRS informs the taxpayer of its decision to assess a penalty? These questions were answered this year by the Tax Court, however it remains readily apparent that the Court is split on this issue.
A streak of recent taxpayer victories this year has expanded the scope of penalties subject to section 6751(b)(1) compliance. For example, penalties under section 6707A(a) with respect to the failure to disclose participation in a reportable transaction require compliance with section 6751(b)(1) prior to the issuance of a “30-day” letter proposing the assertion of the penalty to the taxpayer. See Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. No. 4 (1-16-2020). Trust fund recovery penalties were also held to be penalties subject to section 6751(b)(1) compliance. See Chadwick v. Commissioner, 154 T.C. No. 5 (1-21-2020). These cases demonstrate that the interpretation of section 6751(b)(1) compliance remains fluid, evolving, and likely subject to continued litigation in the years to come.
What constitutes the “initial determination” is very likely to remain at the heart of continued litigation surrounding section 6751(b)(1). With a contested 9-7 vote, the Tax Court held that “initial determination” for the purposes of section 6751 is “embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.” See Belair Woods, LLC, Effingham Managers, LLC, Tax Matters Partner, v. Commissioner, 154 T.C. 1, 23 (1-06-2020) (“Belair Woods”).
In other words, Belair Woods sets forth the rule that the initial determination occurs only when IRS sends the taxpayer a formal letter that it is going to asserting certain penalties. It is clear that the majority in Belair Woods seeks to establish a bright line rule that the “initial determination” carries a sense of definitiveness or completeness. It is clear, however, that many Tax Court judges disagree with Belair Woods. One judge flatly disagreed with “any suggestion in the opinion of the Court that the initial determination to impose the penalties may only be ‘a formal written communication to the taxpayer.’”
The seven dissenting judges argue Belair Woods veers away from Congress’ intent behind section 6751. Perhaps most notable is Judge Marvel, who advocates for a common sense application of section 6751 stating that that the IRS must obtain written supervisory approval for a penalty prior to issuing a written report to a taxpayer proposing the penalty. Indeed, Judge Marvel’s logic is consistent: the IRS employee making the initial determination to assess a penalty naturally reaches that conclusion prior to issuing a letter to a taxpayer. Thus, what exactly constitutes the “initial determination” for the purposes of section 6751(b)(1) is likely to remain a contested issue within the Tax Court.
If you have recently had penalties assessed against you or one of your clients by the IRS, please contact our office to see whether a penalty was imposed correctly.
Author: Alexander (Zan) Schindler, Attorney
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