Proposed Supervisory Approval of Penalties Rules, Sec 6751(b)

Proposed Supervisory Approval of Penalties Rules, Sec 6751(b)

On April 11, 2023, the Internal Revenue Service proposed regulations for Section 6751(b) — supervisory approval of penalties. In recent years, the statute involving supervisory approval for penalties has become increasingly litigated in the world of international tax law. Some of the more important tax cases involve Graev v. Commissioner, Chai v. Commissioner, and Clay v. Commissioner. From a procedural perspective, assessable penalties, such as Form 3520 penalties are completely unfair, because they are not issued via deficiency procedures, but are rather automatically assessed — so that the Taxpayer does not have any opportunity to dispute the penalty until after it was assessed. In fact, recently some courts including the Tax Court have come down hard on the Internal Revenue Service on matters involving assessable penalties. In the recent case of Farhy, the Tax Court went so far as to state that in order to pursue these types of assessable penalties (at least in the realm of Form 5471), it would require filing a lawsuit since the statute does not provide proper mode to enforce assessable penalties via administrative enforcement. Let’s walk through the basics of the proposed rule as of April 11, 2023, noting that the comment will extend for 90 days.

Timing of Supervisory Approval

One of the key litigated issues involving supervisor approval is when does the actual supervisory approval have to take place? In other words, must it occur earlier in the assessment process or does it just have to be ultimately before the final penalty amount is approved?

History

• • • “Section 6751 was added to the Code by section 3306 of the Internal Revenue Service Restructuring and Reform Act of 1998 (1998 Act), Public Law 105–206, 112 Stat. 685, 744 (1998). Section 6751(a) sets forth the content of penalty notices. Section 6751(b) provides procedural requirements for the Secretary of the Treasury or her delegate (Secretary) to assess certain penalties, including additions to tax or additional amounts under the Code. See section 6751(c).

    • Section 6751(b)(1), as added by the 1998 Act, 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 or such higher level official as the Secretary may designate.” As an exception to this rule, section 6751(b)(2), as added by the 1998 Act, provides that section 6751(b)(1) “shall not apply to—(A) any addition to tax under section 6651, 6654, or 6655 [of the Code]; or (B) any other penalty automatically calculated through electronic means.”

Purpose of the Code Section

• • • “The report of the United States Senate Committee on Finance regarding the 1998 Act (1998 Senate Finance Committee Report) provides that Congress enacted section 6751(b)(1) because of its concern that, “[i]n some cases, penalties may be imposed without supervisory approval.” S. Rep. No. 105–174, at 65 (1998), 1998–3 C.B. 537, 601. The report further states that “[t]he Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.” The report provides that, to achieve this goal, section 6751(b)(1) “requires the specific approval of IRS management to assess all non-computer generated penalties unless excepted.”

Proposed Regulations

• • • “The proposed regulations would adopt three rules regarding the timing of supervisory approval of penalties under section 6751(b) that are based on objective and clear standards. One rule addresses penalties that are included in a pre-assessment notice that is subject to the Tax Court’s review, such as a statutory notice of deficiency. One rule is for penalties that the IRS raises in an answer, amended answer, or amendment to the answer to a Tax Court petition. And one rule is for penalties assessed without prior opportunity for review by the Tax Court.”

Penalties Subject to Pre-Assessment Review in the Tax Court

• • • “Proposed § 301.6751(b)–1(c) provides that, for penalties that are included in a pre-assessment notice issued to a taxpayer that provides the basis for jurisdiction in the Tax Court upon timely petition, supervisory approval may be obtained at any time before the notice is issued by the IRS. Section 6751(b) clearly provides that there be supervisory approval before the assessment of a penalty and contains no express requirement that the “written approval be obtained at any particular time prior to assessment.” Chai, 851 F.3d at 218.”

Penalties Raised in the Tax Court After a Petition

• • • “Proposed § 301.6751(b)–1(d) provides that, for penalties raised in the Tax Court after a petition, supervisory approval may be obtained at any time prior to the Commissioner requesting that the court determine the penalty. The proposed rule gives full effect to the language in both sections 6214 and 6751(b)(1) because once a penalty is raised, the Tax Court decision will control whether it is assessed. Section 6214(a) permits the Commissioner to raise penalties in an answer or amended answer that were not included in a notice that provides the basis for Tax Court jurisdiction upon timely petition.

    • The proposed rule allows the exercise of this statutory grant of independent judgment by the IRS Office of Chief Counsel (Counsel) attorney, while maintaining the intent of Congress that penalties be imposed only where appropriate, and with meaningful supervisory review. Any concern about a Counsel attorney using penalties raised in an answer or amended answer as a bargaining chip is mitigated by the requirement in proposed § 301.6751(b)–1(d) for supervisory approval within Counsel before the answer or amended answer is filed. Moreover, by raising a penalty on answer, amended answer, or amendment to the answer to, the Commissioner will likely bear the burden of proof at trial regarding the application of the penalty, thus reducing further the possibility that Counsel will attempt to use a penalty as a bargaining chip in a docketed case. See Tax Court Rule 142. Furthermore, Tax Court Rule 33(b) provides that signature of counsel on a pleading constitutes a certificate by the signer that the pleading is not interposed for any improper purpose, thus diminishing the potential for abuse. No case has found that a penalty raised on answer, amended answer, or amendment to the answer was untimely under section 6751(b).”

 Penalties Not Subject to Pre-Assessment Review in the Tax Court

• • • “Proposed § 301.6751(b)–1(b) provides that supervisory approval for penalties that are not subject to pre-assessment review in the Tax Court may be obtained at any time prior to assessment. This includes penalties that could have been included in a pre-assessment notice that provides the basis for Tax Court jurisdiction upon timely petition, but which were not included in such a notice because the taxpayer agreed to their immediate assessment.

    • Unlike penalties subject to deficiency procedures before assessment, there is no Tax Court or potential Tax Court decision that would make approval of an immediately assessable penalty by an IRS supervisor meaningless. Instead, 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 proposed rule is also consistent with congressional intent that penalties not be used as a bargaining chip. Most penalties not subject to pre-assessment review in the Tax Court cannot be used as a bargaining chip because they are not in addition to a tax liability. Rather, the penalty is the sole liability at issue.”

Exceptions to the Rule Requiring Supervisory Approval of Penalties

• • • Proposed § 301.6751(b)–1(a)(2) provides a list of penalties excepted from the requirements of section 6751(b). Proposed § 301.6751(b)–1(a)(2) excepts those penalties listed in section 6751(b)(2)(A), along with penalties imposed under section 6673 of the Code. Penalties under section 6673 are imposed at the discretion of the court and are designed to deter bad behavior in litigation and conserve judicial resources. Section 6673 penalties are not determined by the Commissioner, and the applicable Federal court may impose them regardless of whether the Commissioner moves for their imposition. The proposed rule excepts penalties under section 6673 from the requirements of section 6751(b)(1) because section 6751(b)(1) was not intended as a mechanism to restrain Federal courts. This rule is consistent with the Tax Court’s holding in Williams Commissioner, 151 T.C. 1 (2018).”

Clarification of Definitions

Proposed regulations also intend to clarify/modify certain definitions such as

• • • Immediate Supervisor

    • Personally Approved (in Writing)

    • Automatically Calculated through Electronic Means

More information about the regulation and the definitions can be found in the Federal Register.

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