The Tax Times: New IRS Regs Clear Up Supervisor Penalty Sign-Off Requirement

According to Law360, an IRS supervisor would have to sign off on penalties before they're included in pre-assessment notices subject to U.S. Tax Court review under rules the agency proposed on April 10, 2023, which intend to resolve conflicting court interpretations of an oft-litigated piece of the tax code.

The proposed rules from the Internal Revenue Service and the U.S. Department of the Treasury look to clear up confusion surrounding the application of Internal Revenue Code Section 6751(b), which requires an IRS supervisor to provide approval in writing of certain tax penalties.

For penalties reviewable by the Tax Court and included in pre-assessment notices to taxpayers, such as notices of deficiency, a supervisor would need to provide sign-off before the notice is actually issued to the taxpayer under the proposed regulations. Penalties the IRS proposes for the first time in court would need to be approved in writing by a supervisor before the agency first asks that the court consider the penalties, according to the proposal.

For Penalties That Don't Get Reviewed By
The Tax Court Before They're Assessed, An
IRS Supervisor Would Need To Sign Off
On Them Only Before Assessment,
The Proposed Rules Said.

Section 6751(b) has been subject to many court challenges, and the Tax Court specifically "has imposed increasingly earlier deadlines" by which a supervisor must sign off on penalties, "formulating tests that are difficult for IRS employees to apply," the proposed rules said.

"The proposed regulations are intended to clarify the application of Section 6751(b) in a manner that is consistent with the statute and its legislative history, has nationwide uniformity, is administrable for the IRS and is easily understood by taxpayers," the IRS and Treasury said.

The proposed rules sketched out the progressively tighter deadlines for supervisory approval established by the courts. The Tax Court in 2016 initially concluded that there was no timing requirement for supervisory approval, saying in Graev v. Commissioner that sign-off must be obtained any time before penalties are assessed.

But the Second Circuit departed from that take on Section 6751(b), saying in Chai v. Commissioner that supervisory approval has to be obtained while the supervisor still has authority over the penalty. Implicit in "supervisor approval" is that a supervisor has discretion to approve or reject the penalty, the rules said, and that discretion goes away once a notice of deficiency or similar pre-assessment document is issued.

The Tax Court then adopted that holding and began to roll back the deadline for supervisor approval, the proposed rules said. By the time the Eleventh Circuit reversed the Tax Court in Carter v. Commissioner, the Tax Court had decided that supervisory approval has to be obtained before a penalty is first communicated to a taxpayer.

Several appeals courts have since rejected this first-communication rule. But two of those courts, the Ninth Circuit and the Eleventh Circuit, created different standards for satisfying the supervisory approval requirement, leading to confusion, the IRS and Treasury said.

"The difficulty in applying or anticipating how courts will construe these rules has resulted in otherwise appropriate penalties on taxpayers not being sustained and has undermined the efficacy of these penalties as a tool to enhance voluntary compliance by taxpayers," the proposed rules said.

"In addition, the evolving standards regarding interpretations of Section 6751(b) have served to increase litigation, which consumes significant government resources," they added.

It's appropriate to require supervisory approval of notices issued pre-assessment and reviewable by the Tax Court before they are actually issued, the rules said. That's effectively the rule established by the Second Circuit in the Chai case, and it lets a supervisor give their sign-off while they still have the authority to approve or reject a penalty, the rules said.

There's not an earlier deadline mentioned in either the statute or the legislative history, the proposed rules added. Likewise, it makes sense to require a supervisor's sign-off before penalties are raised for the first time in the Tax Court, the proposed rules said, given that "once a penalty is raised, the Tax Court decision will control whether it is assessed."

For penalties that don't get reviewed by the Tax Court, it's reasonable to require a supervisor's sign-off at any point before the penalties are assessed. Since there's no Tax Court review for those penalties, the supervisor's discretion over them can't be made pointless, the proposed rules said.

"Consistent with the language of Section 6751(b), supervisory approval can be made at any time before assessment without causing any tension in the statutory scheme for assessing penalties," the IRS and Treasury said.

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