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Potential Opportunities for Penalty Abatement

Nov 20, 2019

As stipulated in the April 2019 Tax Court ruling for Clay v. Commissioner, some penalties assessed by the IRS may be potentially invalid if an IRS supervisor’s approval was not obtained prior to any initial discussion of penalties as a result of an audit. This ruling raised the hurdle for the IRS even higher than the 2017 ruling made in Chai v. Commissioner. In Chai, the Second Circuit Court of Appeals stated that the IRS must have contemporaneous evidence of a supervisor’s approval before formal notice of the penalties are communicated to the taxpayer. Two other recent decisions by the Tax Court, resulting from Palmolive Building Investors v. Commissioner (February 28, 2019) and Roth v. Commissioner (10th Cir. 2019), also illuminate the fact that supervisory approval must be obtained prior to the proposed penalties being communicated with the taxpayer.

Congress enacted IRC Sec. 6751(b)(1), as part of the 1998 IRS Restructuring and Reform Act, which states the following:

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.

Not until 2017 (under Chai) was any interpretation of this statute made by the courts. The ruling made in Chai only applied to the Second Circuit, which includes New York, Vermont and Connecticut. Taxpayers in the other 47 states, the District of Columbia, and U.S. territories were not bound by this decision since there were no other appeals court rulings on this matter.  

However, also in 2017, another Tax Court case, Graev III v. Commissioner, was decided. The Graev III decision in 2017 was a regular decision issued by the full Tax Court, which stated that the Graev III case (in conjunction with the Chai case) would be applied to all Tax Court decisions in the future. As a counter measure, the IRS can appeal cases (other than in the Second Circuit) to the appeals courts that could potentially overrule the Tax Court decision in that particular appeals court circuit. Nonetheless, IRC Sec. 6751(b) (1), Clay, Graev III, Palmolive, Roth and Chai provide taxpayers with an argument against the imposition of audit-related penalties if proper procedures are not followed. It is important to note that this provision applies to accuracy, fraud and other penalties imposed against individuals and other taxpayers. Penalties imposed on responsible persons for employment and other trust fund matters are also included.

In cases where the IRS has asserted different penalties at different times, as long as there is supervisory approval for the initial determination for each separate penalty the penalties will not be invalid. The rulings in both Palmolive and Roth, the Tax Court and the 10th Circuit, respectfully, held that as long as there is supervisory approval for each separate penalty’s initial determination, the IRS may assert different penalties at different times. These cases clearly reflect that the proper steps were taken to obtain the required supervisory approval and the penalties were held to be valid.

Based upon the ruling in the Clay decision, supervisory approval must be obtained prior to formal notice of the proposed penalties being communicated to the taxpayers. Congress’ intent in IRC Sec. 6751(b), as explained in a concurring opinion by Judge Lauber, “requiring supervisory approval the first time an IRS official introduces the penalty into the conversation is faithful to Congress’ purpose by affording maximum protection to taxpayers against the improper wielding of penalties as bargaining chips.” A final definition of an “initial determination” has not yet been made by the courts. Currently the more pertinent question is when the “initial determination” occurred relative to obtaining supervisory approval and the asserted penalty being communicated to the taxpayer.

If significant penalties, as a result an audit, are or have been charged, it might be time to review the audit files and determine if there are any penalty relief opportunities. If audit files are not readily available, the files can be obtained through a Freedom of Information (FOIA) request.

If you want to learn more about resolving tax problems, be sure to sign up for our series, “Dealing with the IRS.”

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Kimberly Mumme

Kimberly Mumme is a Tax Department Senior Manager working with small to midsized companies in a variety of industries, providing accounting, consulting and tax services.

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