Government Argues IRS Supervisory Penalty Approval Was Timely

LAIDLAW'S HARLEY DAVIDSON SALES, INC.,
Petitioner-Appellee
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

ON APPEAL FROM THE DECISION OF THE
UNITED STATES TAX COURT

BRIEF FOR THE APPELLANT

DAVID A. HUBBERT
Acting Assistant Attorney General

FRANCESCA UGOLINI (202) 514-1882
JACOB CHRISTENSEN (202) 307-0878
KATHLEEN E. LYON (202) 307-6370
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

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TABLE OF CONTENTS

Table of contents

Table of authorities

Statement of jurisdiction

Statement of the issue

Applicable statutes and regulations

Statement of the case

Summary of argument

Argument:

The Tax Court erred in determining that the supervisor's written approval of the failure-to-disclose penalty was untimely under I.R.C. § 6751(b)(1)

Standard of review

Conclusion

Statement of related cases

Addendum

Certificate of compliance

TABLE OF AUTHORITIES

Cases:

ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. 138 (2019)

Bates v. United States, 522 U.S. 23 (1997)

Becker v. Commissioner, T.C. Memo. 2018-69

Belair Woods, LLC v. Commissioner, 154 T.C. 1 (2020)

Beland v. Commissioner, 156 T.C. No. 5 (2021)

Bostock v. Clayton County, 140 S. Ct. 1731 (2020)

Carter v. Commissioner, T.C. Memo. 2020-21 (2020)

Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017)

Clay v. Commissioner, 152 T.C. 223 (2019)

Corley v. United States, 556 U.S. 303 (2009)

Davis v. Michigan Dep't of Treasury, 489 U.S. 803 (1989)

Flora v. United States, 362 U.S. 145 (1960)

G. M. Leasing Corp. v. United States, 429 U.S. 338 (1977)

Graev v. Commissioner, 147 T.C. 460 (2016), superseded, 149 T.C. 485 (2017)

Graev v. Commissioner, 149 T.C. 485 (2017)

Greenberg v. Commissioner, T.C. Memo. 2018-74

Home Depot U.S.A., Inc. v. Jackson, 139 S. Ct. 1743 (2019)

Interior Glass Systems Inc. v. United States, 927 F.3d 1081 (9th Cir. 2019), cert. denied, 140 S. Ct. 606 (2019)

Knudsen v. Commissioner, 793 F.3d 1030 (9th Cir. 2015)

Laing v. United States, 423 U.S. 161 (1976)

Lambert v. Tesla, Inc., 923 F.3d 1246 (9th Cir. 2019)

Lamie v. U.S. Trustee, 540 U.S. 526 (2004)

Limtiaco v. Camacho, 549 U.S. 483 (2007)

Luhring v. Glotzbach, 304 F.2d 560 (4th Cir. 1962)

Meyer v. Commissioner, 97 T.C. 555 (1991)

Minemyer v. Commissioner, T.C. Memo. 2020-99

Oropeza v. Commissioner, 155 T.C. No. 9 (2020)

Our Country Home Enterprises, Inc. v. Commissioner, 145 T.C. 1 (2015)

Our Country Home Enterprises, Inc. v. Commissioner, 855 F.3d 773 (7th Cir. 2017)

Ratzlaf v. United States, 510 U.S. 135 (1994)

Roth v. Commissioner, 922 F.3d 1126 (10th Cir. 2019)

Schroeder v. United States, 793 F.3d 1080 (9th Cir. 2015)

Smith v. Commissioner, 133 T.C. 424 (2009)

Thompson v. Commissioner, 148 T.C. 59 (2017)

United States v. Galletti, 541 U.S. 114 (2004)

United States v. Washington, 971 F.3d 856 (9th Cir. 2020)

Williams v. Commissioner, 131 T.C. 54 (2008)

Statutes:

Internal Revenue Code (26 U.S.C.):

28 U.S.C.:

Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, § 3306(a), 112 Stat. 685 (1998)

Regulations:

Treasury Regulations (26 C.F.R.):

Miscellaneous

9th Cir. R. 28-2.7

Federal Rules of Appellate Procedure:

Felix Frankfurter, Some Reflections on the Reading of Statutes, 47 Colum. L. Rev. 527 (1947)

IRS Notice 2007-83, 2007-2 C.B. 960 (published Nov. 5, 2007)

S. Rep. No. 105-174 (1998)

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STATEMENT OF JURISDICTION

On May 21, 2014, the IRS Office of Appeals mailed to Laidlaw's Harley Davidson Sales Inc. (“taxpayer”) a notice of determination, pursuant to Section 6330 of the Internal Revenue Code (“I.R.C.”) (26 U.S.C.), sustaining a proposed levy to collect an unpaid civil tax penalty. (ER-187-190.) On June 18, 2014, within 30 days of the notice of determination, taxpayer timely mailed a petition for review of the determination to the Tax Court, which received and filed the petition. (ER-208-213); I.R.C. §§ 6330(d)(1), 7502. The Tax Court had jurisdiction under I.R.C. § 6330(d)(1).

On August 25, 2020, the Tax Court entered a final decision disposing of all claims. (ER-4.) The Commissioner filed a timely notice of appeal on November 20, 2020, within 90 days of the decision. (ER-214); I.R.C. § 7483; Fed. R. App. P. 13(a).

This Court has jurisdiction pursuant to I.R.C. § 7482(a)(1).

STATEMENT OF THE ISSUE

Section 6751(b)(1) of the Internal Revenue Code states that “[n]o penalty 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[.]” The Internal Revenue Service (“IRS”) determined that taxpayer was liable for a civil tax penalty for failing to disclose on its tax return its participation in a tax avoidance transaction. The initial determination to assert the penalty was made by the examining revenue agent in May 2011, at which time it was also communicated to the taxpayer. The revenue agent's immediate supervisor personally approved the initial penalty determination in writing a short time later, in August 2011 — more than two years before the penalty was assessed (in September 2013) and at a time when the supervisor had full discretion to approve or disapprove the penalty. Was the supervisor's approval untimely under § 6751(b)(1) so as to invalidate the penalty assessment?

APPLICABLE STATUTES AND REGULATIONS

The statutes relevant to the disposition of this appeal are included as an addendum to this brief. See Fed. R. App. P. 28(f); 9th Cir. R. 28-2.7.

STATEMENT OF THE CASE

Taxpayer failed to timely disclose on its federal income tax returns its participation in a purported employer welfare benefit plan that the IRS determined was the same as, or substantially similar to, the tax avoidance transactions designated as “listed transactions” in IRS Notice 2007-83, 2007-2 C.B. 960 (published Nov. 5, 2007). The IRS proposed a penalty of $96,900 — later reduced to $10,000 — under I.R.C. § 6707A for the failure to report the transaction. (ER-97-133.) Taxpayer appealed the proposed penalty to the IRS Appeals Office, which upheld the proposed assessment. (ER-183-184.) The IRS then assessed the penalty. (ER-185-186.)

When taxpayer failed to pay the penalty after notice and demand, the IRS sought to collect the penalty through a proposed levy. Taxpayer challenged the proposed levy in a collection-due-process hearing before the IRS Appeals Office, which subsequently issued a notice of determination sustaining the proposed levy. (ER-134-181.) Taxpayer then filed a petition in the Tax Court pursuant to I.R.C. § 6330(d)(1) for review of the Appeals Office's determination. (ER-208-213.)

The Tax Court granted summary judgment in favor of taxpayer based on its conclusion that the IRS failed to obtain timely supervisory approval of the penalty under I.R.C. § 6751(b)(1). (ER-6-32; ER-5.) The court then entered a decision holding that taxpayer was not liable for the penalty and declining to sustain the IRS's proposed levy. (ER-4.) The Commissioner timely filed this appeal from the Tax Court's decision. (ER-214-217.)

A. Background

Taxpayers must disclose their participation in transactions designated by the IRS as “listed transactions” by attaching a disclosure statement to their return for each taxable year in which they participate in the transaction. I.R.C. § 6011(a); Treas. Reg. (26 C.F.R.) §§ 1.6011-4(a), (b)(2), (e). To compel compliance with this obligation, Congress has imposed monetary penalties on those who fail to file the required disclosure statement. I.R.C. § 6707A(a).

On November 5, 2007, the IRS published Notice 2007-83, 2007-2 C.B. 960, alerting taxpayers and their representatives that certain trust arrangements claiming to be welfare benefit funds and involving cash-value life insurance policies were being promoted to improperly claim federal income and employment tax benefits and were tax avoidance transactions. The Notice designated these and substantially similar transactions as listed transactions, and it warned that taxpayers who failed to disclose on their return their participation in the transactions would be subject to a civil tax penalty under I.R.C. § 6707A. See generally Interior Glass Systems Inc. v. United States, 927 F.3d 1081, 1083-84 (9th Cir. 2019) (discussing the Notice), cert. denied, 140 S. Ct. 606 (2019).

Taxpayer in this case is a corporation with its principal place of business in Baldwin Park, California. (ER-81 ¶ 1.) In 1999, taxpayer became a participating employer in a purported welfare benefit plan called the Sterling Benefit Plan. (ER-96.) The plan was amended and restated on January 1, 2003. (ER-109.) The IRS later determined that the Sterling Benefit Plan was the same as, or substantially similar to, the tax avoidance transactions designated as listed transactions in Notice 2007-83 and that a taxpayer participating in the Sterling Benefit Plan would be subject to a penalty under I.R.C. § 6707A if it did not disclose its participation on its tax return. See Our Country Home Enterprises, Inc. v. Commissioner, 145 T.C. 1, 57, 64 (2015) (holding that the Sterling Benefit Plan was “substantially similar to the transaction described in Notice 2007-83”).

Taxpayer participated in the Sterling Benefit Plan during the years preceding and including its fiscal tax year ended May 31, 2008 (the 2007-2008 fiscal year).¹ (ER-96.) After the IRS issued Notice 2007-83 in November 2007, however, taxpayer still failed to disclose its participation in the plan by not attaching the required disclosure statement to its return for the 2007-2008 fiscal year, which taxpayer signed and filed on February 16, 2009. (ER-84 ¶¶ 16-18.) In December 2010, taxpayer filed several Reportable Transaction Disclosure Statements (IRS Form 8886), in which taxpayer disclosed to the IRS for the first time its participation in the Sterling Benefit Plan during the fiscal years ended 1999, 2005, 2006, 2007, and 2008. Taxpayer acknowledged that the Sterling Benefit Plan was a listed transaction by checking the corresponding box on each of its Forms 8886. (ER-84-85; see, e.g., ER-94 (Line C.2a).)

B. The examination and assessment of the penalty

IRS Revenue Agent Sandra Czora was assigned to examine taxpayer's liability for the civil tax penalty imposed by § 6707A for failing to disclose a reportable transaction on its return for the 2007-2008 fiscal year. (ER-35 ¶ 56.) On May 26, 2011, Revenue Agent Czora sent taxpayer a “30-day” letter enclosing her examination report and notifying taxpayer of a “proposed penalty” under I.R.C. § 6707A in the amount of $96,900.² (ER-97-99.) The letter requested that taxpayer inform her whether it agreed with the proposed penalty and advised that taxpayer could request a conference with the IRS Appeals Office if it disagreed. (ER-98.) If taxpayer did nothing by the 30-day response date, the letter stated, the IRS would “assess the penalty and begin collection procedures.” (ER-99.))

Revenue Agent Czora's examination report, enclosed with the 30-day letter, included (1) a Form 4549-A, Income Tax Discrepancy Adjustments, showing her computation of the proposed penalty under I.R.C. § 6707A based on the claimed income tax benefit resulting from taxpayer's participation in the Sterling Benefit Plan, and (2) a Form 886-A, Explanation of Items, explaining the basis for the proposed penalty. (ER-88 ¶ 39; ER-100-133.)

In July 2011, taxpayer submitted a letter protesting the proposed penalty and requesting a conference with the Appeals Office. (ER-134-182.) On August 23, 2011, Revenue Agent Czora's immediate supervisor, Virginia Korzec, signed a Form 300, Civil Penalty Approval Form, providing her written approval of the § 6707A penalty. (ER-36-37 ¶¶ 58, 66-67; ER-39-40.) The next day, Supervisor Korzec signed a transmittal form authorizing the transfer of the case to the Appeals Office. (ER-37-38 ¶¶ 68-69; ER-41.)

Taxpayer's administrative appeal was unsuccessful, and, in August 2013, the Appeals Office recommended assessment of the § 6707A penalty. (ER-88-89 ¶ 41; ER-183-184.) On September 16, 2013, the IRS assessed the penalty in the amount of $96,900. (ER-89 ¶¶ 43-44; ER-185-186.)

C. The proposed levy and the collection-due-process hearing

When taxpayer failed to pay the penalty after notice and demand, the IRS issued a notice of intent to levy and notice of taxpayer's right to a collection-due-process (“CDP”) hearing before the Appeals Office under I.R.C. § 6330. (ER-199-204.) Taxpayer timely requested a CDP hearing. (ER-205-207); I.R.C. § 6330. At the hearing, taxpayer sought to challenge the merits of its liability for the § 6707A penalty. (ER-192, entry of 5/09/2014.)

On May 21, 2014, after the hearing, the Appeals Office issued a notice of determination sustaining the proposed levy. (ER-187-191.) The Appeals Office determined that, under I.R.C. §§ 6330(c)(2)(B) and 6330(c)(4)(A)(i), taxpayer could not challenge its underlying liability for the penalty in the CDP hearing because taxpayer had been given a previous opportunity to do so before the Appeals Office — and had availed itself of that opportunity — in response to the 30-day letter proposing the penalty. (ER-190.) The notice of determination also stated that the Appeals Office had verified that the IRS had complied with all applicable laws, regulations, and administrative procedures with respect to the penalty assessment, in accordance with I.R.C. § 6330(c)(1). (ER-190-191.) The notice did not expressly state whether the IRS had complied with the requirements of I.R.C. § 6751(b)(1) concerning written supervisory approval of the initial penalty determination.

D. Proceedings in the Tax Court

1. The parties' positions

In June 2014, taxpayer timely filed a petition in the Tax Court challenging the Appeals Office's notice of determination from the CDP hearing. (ER-208-213); I.R.C. § 6330(d)(1). On the Commissioner's motion for partial summary judgment, the Tax Court determined that taxpayer could not challenge its underlying liability for the penalty because taxpayer had already done so before the Appeals Office in response to the 30-day letter proposing the penalty. (ER-196.) The Tax Court then remanded the matter to the Appeals Office to consider certain statute-of-limitations and penalty-rescission arguments raised by taxpayer. (ER-196-198.)

On remand, the Appeals Office again sustained the proposed levy in a supplemental notice of determination. (ER-46-79.) The supplemental notice of determination expressly determined, among other things, that the § 6707A penalty was validly assessed after being approved in writing by Revenue Agent Czora's immediate supervisor in accordance with I.R.C. § 6751(b)(1). (ER-51.)

Following the supplemental notice of determination, the parties stipulated in the Tax Court to a reduction in the amount of the penalty at issue to $10,000 — the minimum amount imposed by I.R.C. § 6707A. (See ER-80.) The Tax Court thereafter permitted taxpayer to file an amended petition. (ER-236, docket entry 91.) In the amended petition, taxpayer asserted that the IRS had not complied with the written supervisory approval requirement in I.R.C. § 6751(b)(1) and that the Appeals Office had, therefore, abused its discretion in sustaining the proposed levy. (ER-43-44.) Taxpayer then moved for summary judgment on that ground, and the Commissioner opposed. (ER-239-241, docket entries 102, 103, 110-112.)

2. The Tax Court's opinion

The Tax Court (Judge Gustafson) granted summary judgment to taxpayer, holding that the Appeals Office abused its discretion in sustaining the collection action, and disallowed the penalty. (ER-6-32.)

In its opinion, the Tax Court first determined that the supervisory approval requirement of I.R.C. § 6751(b) applies to the assessable penalty imposed by I.R.C. § 6707A for failure to disclose a reportable transaction — a point that was uncontested by the parties. (ER-24-25.) The court then proceeded to hold that the Appeals Office abused its discretion when verifying that all applicable laws and administrative procedures had been followed for collection of the § 6707A penalty, in accordance with I.R.C. § 6330(c)(1). That is because, the court concluded, the IRS had failed to obtain timely supervisory approval of the penalty under § 6751(b)(1). (ER-25-28.)

The Tax Court rejected the Commissioner's argument that, for assessable penalties — including penalties under § 6707A that are not subject to the Code's deficiency procedures — § 6751(b)(1) requires only that the IRS secure supervisory approval before assessing the penalty. (ER-28-32.) Relying on its prior decision in Clay v. Commissioner, 152 T.C. 223 (2019), and other precedent involving penalties that were subject to the Code's deficiency procedures (see I.R.C. §§ 6211-6215, 6665), the court ruled that supervisory approval of an assessable penalty is required before the IRS “formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty” (ER-27), whether that “initial determination” is formally communicated for the first time in a notice of deficiency or at an earlier point (ER-30). The court reasoned that it “did not intimate [in Clay] that our holding was limited to the deficiency context” and that “the reasoning of Clay applies with equal force in non-deficiency cases, including those involving assessable penalties.” (ER-26.) The court stated that to conclude otherwise would contravene Congress's purpose to prevent the IRS's use of penalties as a “bargaining chip” to pressure taxpayers into settlement. (ER-31.)

Applying its precedent from these cases, the Tax Court held that Revenue Agent Czora's 30-day letter embodied the “initial determination” to assert the § 6707A penalty because it was “the first formal communication by the IRS of the conclusion” that the § 6707A penalty applied to taxpayer. (ER-27; see also ER-36 ¶¶ 61-62.) The court thus ruled that, under its interpretation of § 6751(b)(1), Supervisor Korzec's written approval of the penalty after that communication to the taxpayer (but more than two years before the penalty was assessed) was untimely under the statute, thus invalidating the penalty assessment. (ER-27-28.)

Accordingly, the Tax Court entered an order (ER-5) granting taxpayer's motion for summary judgment and a decision (ER-4) directing that the proposed levy was not sustained and that taxpayer was not liable for the § 6707A penalty for the year at issue.

SUMMARY OF ARGUMENT

The Tax Court erred in holding that supervisory approval of the §6707A penalty at issue was untimely under I.R.C. § 6751(b)(1), and its decision should be reversed.

Supervisory approval of penalties is timely under the plain language of § 6751(b)(1) so long as it is obtained before the penalty is “assessed” and while the supervisor still has discretion to approve the initial penalty determination. Implicit in the word “approved” in the statute is that the approval must be obtained while the supervisor has discretion to give or withhold it. In the assessable penalty context, the supervisor retains discretion to approve a penalty until the time of assessment. Therefore, the supervisor's written approval of the initial penalty determination in this case, more than two years before the penalty was assessed, was timely under § 6751(b)(1).

The Tax Court's reliance on legislative history to create an earlier deadline for supervisory approval under § 6751(b)(1) was improper. Any ambiguity in the statute's phrase “initial determination of such assessment” relates only to what must be approved by the supervisor — not when that approval must occur. Therefore, the Tax Court's resort to legislative history to create a timing rule for supervisory approval that is untethered from the statutory text was error. Neither the text nor the legislative history of § 6751(b)(1) ties supervisory approval to the mere communication of proposed penalties to the taxpayer.

In Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), the Second Circuit adopted an analogous standard to the one advocated here by the Commissioner in the context of penalties subject to the Code's deficiency procedures. The notice-of-deficiency deadline for supervisory approval established by the court of appeals in that case was grounded in its analysis of the supervisor's discretion to approve penalties, which is limited by the Code's deficiency procedures after the IRS issues a notice of deficiency. Applying Chai's analogous reasoning to the assessable penalty context, supervisory approval of the initial determination for an assessable penalty is timely if obtained before the time of assessment, when the supervisor still has discretion to grant or withhold the approval. The Tax Court's rule, focused on the mere communication of the initial penalty determination to the taxpayer, is incompatible with the Second Circuit's notice-of-deficiency deadline in Chai that turned on the supervisor's discretion to approve the penalty.

Further, the Tax Court's reliance on Congress's asserted purpose of preventing IRS officials from using a potential penalty as a bargaining chip to encourage a taxpayer to settle also is misplaced. Under the Commissioner's interpretation of § 6751(b), subordinate IRS officials lack the authority to impose any penalty (that is not excepted from the statute's supervisory approval requirement) unless the supervisor approves, which is what Congress intended. Moreover, any concern about unjustified penalties loses force here, where the penalty (like most assessable penalties) is not an add-on to a tax liability that could be misused as a bargaining chip but, instead, is the sole consequence of not reporting the listed transaction.

The Tax Court's rule also is unsound as a policy matter because it requires supervisory approval before the taxpayer has had a full opportunity to present its position on the proposed penalties or to present reasons why the penalty should not apply, thereby creating risk that penalties will be approved improperly by the supervisor based on limited facts and information. Finally, the Tax Court's rule threatens to undermine the efficacy of civil tax penalties as a deterrent against taxpayers who, as relevant here, fail to report listed (i.e., abusive) transactions. This Court should decline to adopt the Tax Court's poorly reasoned rule.

The Tax Court's decision disallowing the penalty should be reversed.

ARGUMENT

The Tax Court erred in determining that the supervisor's written approval of the failure-to-disclose penalty was untimely under I.R.C. § 6751(b)(1)

Standard of review

This Court reviews the Tax Court's conclusions of law, including its interpretations of the Internal Revenue Code, de novo. Knudsen v. Commissioner, 793 F.3d 1030, 1033 (9th Cir. 2015).

I.R.C. § 6751(b)(1) states: “No penalty 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.” The Tax Court's determination that the supervisor's written approval of the initial penalty determination under § 6707A — more than two years before the penalty was assessed and at a time when the supervisor still had full discretion to approve or disapprove the penalty — was nonetheless untimely under § 6751(b)(1) was erroneous and should be reversed. The plain language of § 6751(b)(1) requires only that supervisory approval be obtained (1) before the penalty is “assessed” and (2) while the supervisor still has discretion to “approve[ ]” the “initial determination of such assessment,” I.R.C. § 6751(b)(1); see Chai v. Commissioner, 851 F.3d 190, 220 (2d Cir. 2017), a standard that was satisfied here. For assessable penalties, like the

§6707A penalty at issue, the supervisor retains full discretion to grant or withhold such approval until the time of assessment. Accordingly, the supervisor's approval of the revenue agent's initial § 6707A penalty determination in this case, over two years before the IRS assessed the penalty, was timely under § 6751(b)(1).

A. Overview of civil tax penalties and assessments

1. I.R.C. § 6707A

Voluntary compliance is essential to our nation's federal tax system based on self-assessment. See G. M. Leasing Corp. v. United States, 429 U.S. 338, 350 (1977). Civil tax penalties serve an important function in encouraging voluntary compliance with the internal revenue laws and in deterring taxpayer abuses. Roth v. Commissioner, 922 F.3d 1126, 1131 (10th Cir. 2019); Thompson v. Commissioner, 148 T.C. 59, 64-65 (2017). Penalties under I.R.C. § 6707A, in particular, serve the “important objective” of encouraging the voluntary disclosure of “reportable transactions,” including tax avoidance transactions that have been specifically designated by the IRS as “listed transactions.” Interior Glass Systems, Inc. v. United States, 927 F.3d 1081, 1087 (9th Cir. 2019).³

Under I.R.C. § 6707A, any person who fails to include on any return or statement any information about a reportable transaction that is required by I.R.C. § 6011 to be included “shall pay a penalty” of “75 percent of the decrease in tax shown on the return as a result of such transaction[.]” I.R.C. §§ 6707A(a), (b). In the case of a taxpayer other than a natural person, the maximum amount of the penalty for a reportable transaction that is a listed transaction is $200,000 ($50,000 for other reportable transactions), and the minimum penalty is $10,000. I.R.C. § 6707A(b).

The IRS has determined, and the Tax Court has held, that the Sterling Benefit Plan in which taxpayer participated during the 2007-2008 fiscal year (and prior years) is a listed transaction that must be disclosed on the taxpayer's return to avoid the penalty imposed by § 6707A. Our Country Home Enterprises, 145 T.C. at 57, 64. Taxpayer, however, failed to timely disclose its participation in the plan on its 2007-2008 fiscal year return and was, therefore, subject to a minimum penalty of $10,000.

2. The statutory scheme for assessing civil tax penalties

Section § 6751(b)(1)'s procedural restriction on assessment of certain civil tax penalties, absent supervisory approval, must be understood within the context of the Internal Revenue Code's statutory scheme for assessing penalties. In that regard, Congress has “authorized and required” the Secretary of the Treasury “to make the inquiries, determinations, and assessments of all taxes (including interest, additional amounts, additions to the tax, and assessable penalties) imposed by” the Internal Revenue Code. I.R.C. § 6201(a); see I.R.C. § 7601 (“The Secretary shall, to the extent he deems it practicable, cause officers or employees of the Treasury Department to proceed, from time to time, through each internal revenue district and inquire after and concerning all persons therein who may be liable to pay any internal revenue tax.”). The Secretary has delegated these duties to the Commissioner of Internal Revenue, who has further delegated them to IRS officials. See Treas. Reg. §§ 301.6201-1(a), 301.7601-1, 301.7701-9.

Still, “[t]he Federal tax system is basically one of self-assessment, whereby each taxpayer computes the tax due and then files the appropriate form of return along with the requisite payment.” United States v. Galletti, 541 U.S. 114, 122 (2004) (internal quotation omitted). The Commissioner is authorized to immediately “assess” the amount of tax determined by the taxpayer on his or her return, as well as certain penalties that are not subject to the Code's deficiency procedures (described below). I.R.C. § 6201(a)(1); Meyer v. Commissioner, 97 T.C. 555, 559-60 (1991). “Assessment” is a ministerial function: it is “the formal recording and establishment of a taxpayer's liability.” Roth, 922 F.3d at 1131 (citation and internal quotation marks omitted). An assessment is made “by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary.” I.R.C. § 6203; see also Treas. Reg. § 301.6203-1 (describing the method of assessment).

If the Commissioner determines the taxpayer owes more tax — or, in other words, that there is a “deficiency”⁴ — he may send the taxpayer a “notice of deficiency.” I.R.C. § 6212(a). If the taxpayer does not file a petition for a redetermination with the Tax Court within 90 days, the Code provides that “the deficiency . . . shall be assessed.” I.R.C. § 6213(c). If, after receiving a notice of deficiency, the taxpayer files a timely petition in the Tax Court, the IRS is restricted from assessing the deficiency “until the decision of the Tax Court has become final.” I.R.C. § 6213(a). In this “deficiency proceeding,” the Tax Court has jurisdiction to “redetermine the correct amount of the deficiency . . . and to determine whether any additional amount, or any addition to the tax should be assessed.” I.R.C. § 6214(a). The Commissioner also may assert penalties for the first time in an answer or amended answer to a taxpayer's petition in the Tax Court, in which event the Tax Court “shall have jurisdiction . . . to determine whether [such penalties] should be assessed[.]” Id. At the conclusion of the Tax Court proceedings, “the entire amount redetermined as the deficiency by the decision of the Tax Court which has become final shall be assessed.” I.R.C. § 6215(a).

Some civil tax penalties imposed by the Code are subject to the deficiency procedures described above, requiring the IRS to assert such penalties in a notice of deficiency (or in an answer to a Tax Court petition) before those penalties can be assessed. See I.R.C. § 6665(a). But the majority of civil tax penalties imposed by the IRS are not subject to the Code's deficiency procedures. See Graev v. Commissioner, 149 T.C. 485, 517-19 (2017) (Holmes, J., concurring in result) (noting that only 7.22% of the total amount of civil tax penalties assessed between October 2015 and September 2016 were subject to the Code's deficiency procedures). For instance, the penalties imposed by § 6651 (failure to file return or pay tax); § 6654 (failure to pay estimated individual income tax), and § 6655 (failure to pay estimated corporate income tax) are generally not subject to the Code's deficiency procedures. I.R.C. § 6665(b). These particular penalties are also expressly exempted from § 6751(b)(1)'s procedural restriction on assessment absent supervisory approval. I.R.C. §6751(b)(2)(A). Accordingly, such penalties may be assessed immediately upon receipt of the taxpayer's return. Meyer, 97 T.C. at 559-60; ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. 138, 149-50 (2019).

Similarly, the “assessable penalties” provided in Subtitle F, Chapter 68, Subchapter B, of the Code (§§ 6671-6725) are not subject to the Code's deficiency regime. Williams v. Commissioner, 131 T.C. 54, 58 n.4 (2008). This includes the penalty at issue here — imposed by § 6707A for failure to disclose a reportable transaction. Our Country Home Enterprises, Inc. v. Commissioner, 855 F.3d 773, 778 (7th Cir. 2017); Smith v. Commissioner, 133 T.C. 424, 428-30 (2009). Nevertheless, the § 6707A penalty at issue is not exempted from, and is therefore subject to, § 6751(b)(1)'s restriction on assessment absent supervisory approval of the penalty. See I.R.C. § 6751(b)(2).

After a taxpayer's liability for tax, additions to tax, and penalties has been determined and assessed, if the taxpayer does not pay, then the IRS can employ administrative enforcement methods to collect the unpaid liability through the filing of a notice of federal tax lien or a levy action. I.R.C. §§ 6665(a), 6321-6327 (lien), 6331-6344 (levy); see Galletti, 541 U.S. at 122. When that happens, the taxpayer may request a pre-payment, administrative CDP (collection-due-process) hearing before the Appeals Office regarding the IRS's collection actions, and the taxpayer may also seek judicial review in the Tax Court of a determination to sustain the collection actions, as taxpayer did in this case. I.R.C. §§ 6330, 6320.

At the CDP hearing, the taxpayer may raise any relevant issue relating to the unpaid tax or the proposed collection action, except that the taxpayer may not challenge the underlying tax liability unless the taxpayer did not have a prior opportunity to dispute the liability. I.R.C. § 6330(c)(2). Also, as part of the CDP hearing, the Appeals Office must verify that all required administrative procedures and legal requirements have been met for the collection of the tax liability. I.R.C. §6330(c)(1). As the Tax Court concluded here (ER-20, ER-22), compliance with the written supervisory approval requirement of §6751(b)(1) is part of the verification requirement of § 6330(c)(1); therefore, compliance with § 6751(b)(1) may be challenged in a CDP hearing (including on review by the Tax Court), even if the taxpayer is otherwise barred from challenging its underlying liability for the penalty because the taxpayer had a prior opportunity to do so.

Otherwise, the taxpayer can obtain judicial review of an assessed tax liability (including assessed penalties) only through filing a proper refund suit in district court or the Court of Federal Claims after full payment of the liability. See 28 U.S.C. §§ 1346(a), 1491(a)(1); I.R.C. §7422; Flora v. United States, 362 U.S. 145, 177 (1960); Interior Glass Systems, 927 F.3d at 1086 (discussing these limitations on judicial review in the context of a § 6707A penalty assessment).

B. Supervisory approval is timely under I.R.C. § 6751(b)(1) if obtained before the penalty is assessed and while the supervisor has discretion to approve the penalty

Supervisory approval is timely under the plain language of I.R.C. § 6751(b)(1) so long as it is obtained (1) before the penalty is “assessed” and (2) while the supervisor still has discretion to “approve[ ]” (or disapprove) the initial penalty determination. I.R.C. § 6751(b)(1). With respect to assessable penalties that are not subject to the Code's deficiency procedures, including the § 6707A penalty at issue, the supervisor retains such discretion until the time of assessment. Here, Supervisor Korzec's approval of Revenue Agent Czora's initial determination to assert the § 6707A penalty, more than two years before the IRS assessed the penalty and at a time when she had full discretion to grant or withhold such approval, was timely under § 6751(b)(1).

1. The statutory text supports the Commissioner's interpretation

Statutory construction always “begin[s] with the text of the statute.” Limtiaco v. Camacho, 549 U.S. 483, 488 (2007). It is well established that the “starting point in discerning congressional intent is the existing statutory text” and that “when the statute's language is plain, the sole function of the courts — at least where the disposition required by the text is not absurd — is to enforce it according to its terms.” Schroeder v. United States, 793 F.3d 1080, 1082-83 (9th Cir. 2015) (quoting Lamie v. U.S. Trustee, 540 U.S. 526, 534 (2004)).

As noted, I.R.C. § 6751(b)(1) states:

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.

By its terms, § 6751(b)(1) does not require much: simply that a penalty may not be “assessed” — i.e., the ministerial act of assessment shall not be carried out — unless the “initial determination of such assessment” is personally “approved” in writing by the immediate supervisor of the individual making such determination (or by a higher-level designated official). Section 6751(b)(1) thus imposes two distinct timing requirements:

First, by stating that “[n]o penalty . . . shall be assessed unless” a supervisor has approved the initial determination, the statute makes supervisory approval a condition precedent to any assessment. This language clearly requires supervisory approval before the ministerial act of assessment.

Second, implicit in the word “approved” is that the supervisor's approval must occur at a time when the supervisor still has discretion to approve (or disapprove) the subordinate IRS official's initial penalty determination. “If supervisory approval is to be required at all, it must be the case that the approval is obtained when the supervisor has the discretion to give or withhold it.” Chai, 851 F.3d at 220. As the Second Circuit explained in Chai, the required supervisory approval would not be meaningful if the statute were construed to allow such approval when the supervisor no longer had discretion or authority to prevent the penalty assessment. Id. at 220-21 (construing § 6751(b)(1) in the context of a penalty subject to the Code's deficiency procedures); see also Corley v. United States, 556 U.S. 303, 314 (2009) (“[A] statute should be construed so that effect is given to all its provisions, so that no part will be inoperative . . . or insignificant[.]” (citation and internal quotation marks omitted)).

Beyond this, however, § 6751(b)(1)'s text does not impose additional timing requirements for supervisory approval, and none should be read into the statute. Bates v. United States, 522 U.S. 23, 29 (1997) (“[We] ordinarily resist reading words or elements into a statute that do not appear on its face.”); United States v. Washington, 971 F.3d 856, 863 (9th Cir. 2020) (“We are not free to add text to a statute that is not there.”), amended, 2020 WL 9211306 (Aug. 19, 2020). For just as important as what a statute says is what it does not say. See Felix Frankfurter, Some Reflections on the Reading of Statutes, 47 Colum. L. Rev. 527, 536 (1947) (“One more caution is relevant when one is admonished to listen attentively to what a statute says. One must also listen attentively to what it does not say.”).

Therefore, under a plain reading, the timeliness requirements of § 6751(b)(1) are satisfied so long as supervisory approval is obtained before the penalty is “assessed” and while the supervisor still has the discretion to “approve[ ]” or disapprove the examining agent's initial penalty determination.

In the context of civil tax penalties that are subject to the Code's deficiency procedures, the supervisor loses that discretion after the IRS issues a notice of deficiency. Chai, 851 F.3d at 220-21. That is because, as the Second Circuit explained in Chai, once a notice of deficiency is issued, if the taxpayer allows the deadline for seeking Tax Court review to expire, “the deficiency, notice of which has been mailed to the taxpayer, shall be assessed.” I.R.C. § 6213(c) (emphasis added). And if the taxpayer does file a petition, then the Tax Court, not the IRS, determines the amount of the deficiency, including any penalties, which “shall be assessed.” I.R.C. §§ 6214(a), 6215(a). In either case, assessment is mandatory once the Tax Court has ruled or the taxpayer's deadline for seeking Tax Court review of a deficiency notice has expired. Thus, in the context of penalties subject to the Code's deficiency procedures, supervisory approval must be obtained “no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.” Chai, 851 F.3d at 221.

On the other hand, for assessable penalties that are not subject to the Code's deficiency procedures, including the § 6707A penalty at issue, the supervisor retains full discretion to give or withhold approval of the initial penalty determination until the time of assessment. Unlike penalties that are subject to the Code's deficiency procedures, where assessable penalties are involved, there are no intervening deficiency proceedings or potential litigation in the Tax Court that would otherwise limit the supervisor's discretion to grant or withhold such approval before assessment of the penalty.

In this case, Supervisor Korzec provided written supervisory approval of Revenue Agent Czora's initial determination to assert the § 6707A penalty when she signed the Form 300, Civil Penalty Approval Form, on August 23, 2011 — more than two years before the penalty was assessed on September 16, 2013. (ER-39-40; ER-13-14.) Because written supervisory approval of this assessable penalty was given before the penalty was assessed (and while Supervisor Korzec still had discretion to give or withhold such approval), the requirements of § 6751(b)(1) were satisfied, and the penalty assessment was valid.

2. The Tax Court improperly relied on legislative history to create a timing rule untethered from the statute's text

By contrast, the Tax Court's interpretation of § 6751(b)(1) to require supervisory approval before the examining agent's initial determination to assert a penalty is “communicate[d] to the taxpayer” (ER-26-28) has no basis in the statutory text. The Tax Court derived this standard from its prior decision in Clay v. Commissioner, 152 T.C. 223 (2019), which relied on § 6751(b)(1)'s legislative history. See id. at 248-49.

Resort to legislative history is only appropriate, however, if the statutory language under consideration is ambiguous. Schroeder, 793 F.3d at 1085; Lambert v. Tesla, Inc., 923 F.3d 1246, 1251 (9th Cir. 2019) (citing Ratzlaf v. United States, 510 U.S. 135, 147-48 (1994) (“[W]e do not resort to legislative history to cloud a statutory text that is clear.”)). Although the courts have found § 6751(b)(1)'s phrase “initial determination of such assessment” to be ambiguous, see Chai, 851 F.3d at 218; Roth, 922 F.3d at 1132, this phrase in the statute merely describes what it is that must receive approval from the supervisor. Hence, any ambiguity in the statute relates only to what must be approved, not when the approval itself must occur. Therefore, although consideration of § 6751(b)'s legislative history might be justified to determine what, exactly, must be approved, resort to the legislative history to create a timing rule for the approval itself is improper. Here, the parties agreed that the 30-day letter embodied Revenue Agent Czora's “initial determination” to assert penalties (ER-36 ¶ 62); so there is no dispute about what had to be approved. The only question is when the approval needed to occur to be valid under the statute. In this regard, no court has identified any ambiguity in § 6751(b)(1)'s language as it relates to the distinct issue of timing of the requisite supervisory approval, with which we are concerned here.

Even if § 6751(b)(1)'s legislative history supported the Tax Court's interpretation, it would not justify reading into the statute additional timing requirements that have no basis in the statutory text. “When the express terms of a statute give us one answer and extratextual considerations suggest another, it's no contest. Only the written word is the law[.]” Bostock v. Clayton County, 140 S. Ct. 1731, 1737 (2020). In its opinion, the Tax Court hinted at a textual argument for its rule, stating that if a supervisor does not approve the initial determination before it is communicated to the taxpayer, then the supervisor would be approving “something more like a final determination” rather than the “initial” one. (ER-30-31.) But, again, that argument improperly conflates the what and when questions.

Therefore, the Tax Court erred in ruling (ER-26-28) that supervisory approval was required before Revenue Agent Czora's initial proposal to assert the § 6707A penalty was “communicate[d] to the taxpayer” — language that is simply not found anywhere in the statute.

3. In any event, the legislative history also supports the Commissioner's interpretation

As we have demonstrated, the plain text of I.R.C. § 6751(b)(1) confirms that supervisory approval is timely if it is obtained before the penalty is assessed and while the supervisor has discretion to grant or withhold the required approval. At best, any ambiguity in the statutory text relates only to what must be approved (i.e., the “initial determination of such assessment”), not when it must be approved. Because the statute is not ambiguous as to when supervisory approval must be obtained, there is no need to resort to the statute's legislative history. Nevertheless, even if this Court were to consider extrinsic evidence of Congress's intent, the Commissioner's reading of § 6751(b)(1) is aligned with the statutory purpose, as evidenced by the legislative history.

Section 6751(b)(1)'s legislative history — like its text — makes clear that Congress was concerned with subordinate IRS officials imposing or assessing penalties without first obtaining supervisory approval, not with examining agents merely suggesting or communicating proposed penalties to the taxpayer. Congress added § 6751 to the Code with the enactment of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, § 3306(a), 112 Stat. 685, 744 (1998). As stated in the Senate Finance Committee Report, Congress enacted

§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) (emphasis added). The report further stated that “[t]he Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.” Id. (emphasis added). The report went on to provide that, to achieve this goal, § 6751(b)(1) “requires the specific approval of IRS management to assess all non-computer generated penalties unless excepted.” Id. (emphasis added). And, in case there were any lingering doubt, the report stated that the new “provision applies to . . . penalties assessed . . . more than 180 days after the date of enactment.” Id. (emphasis added).

Thus, unlike the Tax Court's rule, neither the text nor the legislative history of § 6751(b)(1) ties supervisory approval to the mere communication of proposed penalties to the taxpayer.

Rather, as Congress intended, the effect of § 6751(b)(1) is that a subordinate IRS official lacks the authority to impose or assess any penalty (besides those excepted from the statute's requirements) unless the supervisor approves. In Chai, the Second Circuit stated that §6751(b)(1) “was meant to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle.” 851 F.3d at 219; see also Roth, 922 F.3d at 1132-33. And the Commissioner's interpretation furthers that purpose. It does so, however, not by preventing the “threat” of penalties from being communicated to the taxpayer, but by ensuring taxpayers and their representatives that no subordinate IRS official can carry out the threat of imposing penalties unless the supervisor approves.

Indeed, the hallmark of an “initial” penalty determination under § 6751(b)(1) is that it is made by the lower-ranking official within the IRS's decision-making process. In requiring that the initial determination must be approved by “the immediate supervisor of the individual making such determination,” § 6751(b)(1) describes that initial determination as being made by an individual IRS official, not by the agency as a whole. Accordingly, the Commissioner's interpretation of the statute ensures that no single IRS official can decide on behalf of the agency to impose penalties against the taxpayer (including where the taxpayer agrees to an administrative settlement of its liability with the IRS). Construed in this manner, § 6751(b)(1) serves as a meaningful check on a subordinate revenue agent's ability to pursue penalties on behalf of the government — precisely what Congress appears to have intended, as evidenced by the legislative history and confirmed by the statute's actual text.

C. The Second Circuit's decision in Chai supports the Commissioner's interpretation

1. The Second Circuit in Chai adopted an analogous standard in the context of penalties subject to the Code's deficiency procedures

The Second Circuit in Chai, 851 F.3d 190, adopted an analogous standard as that advocated by the Commissioner here in the context of penalties subject to the Code's deficiency procedures. There, in addressing the timeliness of supervisory approval under I.R.C. § 6751(b)(1), the Second Circuit emphasized the supervisor's discretion to approve penalties.

Although noting that § 6751(b)(1) contains “no express requirement that written approval be obtained at any particular time prior to assessment,” Chai, 851 F.3d at 218, the Second Circuit nevertheless rejected the Tax Court's conclusion in Graev v. Commissioner, 147 T.C. 460 (2016), superseded, 149 T.C. 485 (2017), that supervisory approval of penalties that are subject to the Code's deficiency procedures may be obtained at any time prior to, even if just before, assessment, Chai, 851 F.3d at 219. In that context, the Second Circuit agreed with the dissent in Graev that, after the Tax Court sustains a penalty in a deficiency proceeding, “the supervisor's Johnny-come-lately approval of the 'initial determination' would add nothing to the process,” and it would be “completely moot” if the Tax Court were to disallow the penalty. Chai, 851 F.3d at 219 (quoting Graev, 147 T.C. at 513 (Gustafson, J., dissenting)). The court of appeals reasoned that “[i]f supervisory approval is to be required at all, it must be the case that the approval is obtained when the supervisor has the discretion to give or withhold it,” but that discretion is lost once the Tax Court's decision in a deficiency proceeding becomes final. Id. at 220. For that matter, the court continued, “the last moment the approval of the initial determination actually matters is immediately before the taxpayer files suit,” and because a taxpayer can file a Tax Court petition at any time after receiving a notice of deficiency, “the truly consequential moment of approval is the IRS's issuance of the notice of deficiency (or the filing of an answer or amended answer asserting penalties).” Id. at 221. The Second Circuit thus held that, with respect to penalties subject to deficiency procedures, “§ 6751(b)(1) requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer asserting such penalty).” Id.

The Second Circuit's notice-of-deficiency deadline in Chai for penalties subject to the Code's deficiency procedures recognizes that § 6751(b)(1)'s supervisory approval requirement would be meaningless in that context if the supervisor could wait to approve the penalty until after the conclusion of the IRS's administrative proceedings and potential Tax Court litigation regarding the taxpayer's liability for the penalty. Although the statute does not explicitly refer to the notice of deficiency, that is the point after which the supervisor no longer has discretion to approve or prevent the assessment of a penalty subject to the Code's deficiency procedures, as § 6751(b)(1) requires. Chai, 851 F.3d at 220-21; see also Graev, 147 T.C. at 508 (Gustafson, J., dissenting) (outlining this argument). By giving meaningful effect to the word “approved” in § 6751(b)(1), the Second Circuit's decision in Chai adhered to the basic interpretive canon that “a statute should be construed so that effect is given to all its provisions, so that no part will be inoperative . . . or insignificant.” Corley, 556 U.S. at 314 (citation and internal quotation marks omitted).

In this manner, the Second Circuit's notice-of-deficiency deadline in Chai is analogous to the Commissioner's position here that supervisory approval is timely under § 6751(b)(1) if it is obtained (1) before the penalty is assessed and (2) while the supervisory has discretion to approve or disapprove the initial penalty determination. Unlike the penalty at issue in Chai, there are no intervening deficiency procedures or judicial proceedings with respect to an assessable penalty like the one imposed by § 6707A that limit the supervisor's discretion to give or withhold approval of the penalty before the time of its assessment. The IRS is not required to issue a notice of deficiency to the taxpayer before assessing a § 6707A penalty. Smith, 133 T.C. at 430. And, unlike in the deficiency context, the supervisor's approval of an assessable penalty — even if just prior to assessment — is still meaningful. See discussion supra pp. 37-38.

As we have demonstrated, the most straightforward interpretation of § 6751(b)(1)'s language is that supervisory approval of an assessable penalty is timely so long as it is obtained before assessment of the penalty. Because the statute may be so construed without rendering any part of it inoperative or insignificant, that is the meaning that should prevail in this context.

2. The Tax Court's interpretation of Chai is unsupported

a. The Tax Court ignores Chai's emphasis on supervisory discretion

The Tax Court erred (ER-30-31) by dismissing Chai's focus on supervisory discretion as a mere “truism” (ER-30) that written approval must be obtained when the supervisor has authority to give it and that Chai, therefore, poses no barrier to requiring supervisory approval long before that discretion is lost. Thus, the Tax Court found that while Chai establishes that supervisory approval in a deficiency case must be obtained no later than the issuance of the notice of deficiency, under the Tax Court's prior decision in Clay the approval “must be obtained earlier” (ER-31) if the initial determination is “made and formally communicated” (ER-30) to the taxpayer before the notice of deficiency is issued — the rule it extended to assessable penalties here.

In so concluding, the Tax Court repeated the error it made in Clay in interpreting Chai as having “left open” the question “whether approval can come after the agent sends the taxpayer proposed adjustments that include penalties.” Clay, 152 T.C. at 248; see also ER-30-31. The Tax Court in Clay distinguished Chai on the purported ground that the revenue agent's report in Clay constituted the “initial determination” under § 6751(b)(1), whereas in Chai the initial determination came later in the notice of deficiency. See Clay, 152 T.C. at 248-49.

But that is not an accurate distinction. Chai did not address what act or document constituted the “initial determination” in that case, let alone decide that the notice of deficiency was the initial determination. Chai focused instead solely on the timeliness of the supervisor's approval of the initial penalty determination under the statute. The Second Circuit examined the notice of deficiency in that case because of its effect in cutting off supervisory discretion to approve a penalty, not because it was determining whether the “initial determination” under § 6751(b)(1) was made before the notice was sent.

In fact, just like the taxpayer in Clay, the taxpayer in Chai almost certainly also received prior notice of proposed penalties before the notice of deficiency was issued in that case. Under standard procedures reflected in the IRS Statement of Procedural Rules, unless a taxpayer has agreed to the assertion of tax deficiencies and penalties in advance, a notice of proposed adjustments (e.g., a 30-day letter) will ordinarily be issued to the taxpayer before the IRS sends a notice of deficiency. 26 C.F.R. § 601.105(d)(1); see generally 26 C.F.R. §§ 601.105(b), (c), (d). Exceptions are limited to instances in which expiration of the statutory period of limitations for assessment of the tax under I.R.C. § 6501 is imminent, criminal prosecution is being considered, or assessment or collection of the tax would be jeopardized by delay. 26 C.F.R. §§ 601.105(f), (g), and (h). The Tax Court's reading of Chai would thus improperly cabin its holding to apply only in those unusual circumstances in which an exception applies to the IRS's standard procedure of proposing penalties to the taxpayer before issuing a notice of deficiency; the decision would otherwise be largely academic.

In any event, the Second Circuit expressly disagreed with the view that supervisory approval of the initial penalty determination must occur at or near the same time when “the individual [is] making such determination.” Chai, 851 F.3d at 220 n.23 (alteration in original). As Chai recognized, nothing in the statute requires the supervisor's approval to be contemporaneous with the initial penalty determination.

Therefore, contrary to the Tax Court's view, Chai cannot correctly be understood to have left open the question whether § 6751(b)(1) may require supervisory approval when the “initial determination” is “made and formally communicated” to the taxpayer. (ER-30.) Chai's holding that § 6751(b)(1) requires supervisory approval “no later than the date the IRS issues the notice of deficiency” was based the court's conclusion — in the preceding sentence — that “the truly consequential moment of approval is the IRS's issuance of the notice of deficiency” because that is the final moment when the supervisor retains the discretion to approve the penalty in a deficiency case. 851 F.3d at 221. Where, as here, a supervisor retains discretion to approve a penalty through the time of assessment, there is no basis for requiring supervisory approval at some earlier point, depending on when the initial determination was “made and formally communicated” to the taxpayer, as the Tax Court did here. (ER-30.)

b. The Tax Court misconstrues Chai's discussion of congressional purpose and its application to assessable penalties

The Tax Court also erred in concluding (ER-31) that Chai's reliance on Congress's purpose in § 6751(b)(1) supports its interpretation that the statute requires supervisory approval before the IRS “formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty” (ER-27).

As we discussed previously, the Second Circuit stated in Chai that § 6751(b)(1) “was meant to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle,” 851 F.3d at 219, and the Commissioner's interpretation of § 6751(b)(1) furthers that purpose. See discussion supra pp. 37-38. Yet, even so, the Second Circuit did not hold in Chai, as the Tax Court did below, that supervisory approval was required before the examining agent's initial determination to assert a penalty was “communicated” to the taxpayer. Instead, Chai's actual holding, which established a notice-of-deficiency deadline, ultimately rested on the Second Circuit's analysis of the supervisor's discretion to approve penalties subject to the Code's deficiency procedures — an analysis that, unlike the Tax Court's rule, has a textual basis in the statute.

Moreover, as we have explained, the Tax Court's reliance on § 6751(b)(1)'s legislative history to create a timing rule for supervisory approval was inappropriate. As we have explained, although the Second Circuit concluded in Chai that § 6751(b)(1)'s phrase “initial determination of such assessment” is ambiguous, 851 F.3d at 218, this phrase merely describes what must be approved by the supervisor. Hence, any ambiguity in the statute relates only to what must be approved, not when it must be approved. Therefore, resort to the legislative history to create a timing rule for supervisory approval is improper in light of the statute's otherwise unambiguous terms.

Further, the Tax Court's concern (see ER-31) about unjustified penalties being used as a “bargaining chip” to coerce a settlement loses force in the context of an assessable penalty, like the one here, that is imposed for failure to report a listed transaction. As is the case with most assessable penalties, the § 6707A penalty is not an add-on to a tax liability that could be misused as a bargaining chip. Rather, the penalty is the sole and manifest consequence of not reporting the required information, and the penalty amount — 75 percent of the decrease in tax shown on the return as a result of the listed transaction, with a minimum of $10,000 and a maximum of $200,000 for an entity — is set by statute. I.R.C. §§ 6707A(a), (b). The IRS's first communication to a taxpayer for failure to report a listed transaction necessarily will state that the failure may subject the taxpayer to a penalty, as the revenue agent's 30-day letter did here. (ER-11; ER-97-99.) The Tax Court's first-communication rule has the absurd effect of requiring an IRS agent to obtain supervisory approval for the penalty before he or she even notifies the taxpayer of the reporting violation. (ER-84 ¶ 18; see also ER-85 ¶¶ 21, 25; ER-93-96.)

D. The Tax Court's interpretation of I.R.C. § 6751(b)(1) poses practical problems in administering the statute and undermines the Code's broader penalty scheme

Finally, the Tax Court's rule requiring supervisory approval before the “initial determination” to assert penalties is “communicated” to the taxpayer suffers from practical problems and threatens to undermine the Code's broader penalty scheme. See Home Depot U.S.A., Inc. v. Jackson, 139 S. Ct. 1743, 1748 (2019) (“It is a fundamental canon of statutory construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme.”) (quoting Davis v. Michigan Dep't of Treasury, 489 U.S. 803, 809 (1989)).

To begin with, the Tax Court's rule requires the supervisor to approve penalties before the taxpayer has even had a chance to respond to a subordinate examining agent's proposed penalties or to present reasons why the penalty should not apply. See Roth, 922 F.3d at 1134 (a revenue agent's “proposed” penalties may constitute an “initial determination” under § 6751(b)(1)). But a supervisor is in a far better position to determine the appropriateness of a penalty after considering the taxpayer's side of the story, or at least after giving the taxpayer an opportunity to present it, before approving a proposed penalty. Indeed, the appropriateness of a penalty often depends on information available only to the taxpayer. Belair Woods, LLC v. Commissioner, 154 T.C. 1, 12 (2020) (“In some circumstances, facts that bear on the appropriateness of penalties may be exclusively in the taxpayer's possession.”). Congress likely did not intend for § 6751(b) to require revenue agents to obtain supervisory approval before taking appropriate steps to gather all pertinent information from the taxpayer that may bear on the appropriateness of penalties.

In this case, in July 2011, approximately two months after Agent Czora issued the 30-day letter here, taxpayer submitted a letter disagreeing with the proposed penalty and requesting a conference with the Appeals Office. (ER-134-142.) In the letter, taxpayer raised several arguments regarding why the transaction at issue should not be deemed a listed transaction and why taxpayer had properly disclosed the transaction. (ER-135-142.) Supervisor Korzec approved the initial determination that a penalty applied one month later, on August 23, 2011, and approved transfer of the case to Appeals the next day. (ER-37-38 ¶¶ 66-69; ER-39-41.) Under the Tax Court's rule, Supervisor Korzec was required to approve assertion of the penalty before taxpayer had presented its reasons for disagreeing with the penalty. The Tax Court's reading of § 6751(b)(1) to require supervisory approval before the initial determination is first “communicated” to the taxpayer is untenable.

The Tax Court's deadline for supervisory approval under §6751(b)(1) also threatens to undermine the efficacy of civil tax penalties as the deterrent Congress intended in the Code's broader penalty scheme. As noted, penalties play an important role in encouraging voluntary compliance with federal tax law, Roth, 922 F.3d at 1131, and penalties under I.R.C. § 6707A serve the “important objective” of encouraging the voluntary disclosure of listed transactions, Interior Glass Sys., 927 F.3d at 1087. But the Tax Court's various decisions interpreting § 6751(b)(1) have become moving goal posts, leaving IRS employees uncertain of when they must obtain written supervisory approval of penalties.

For example, in Clay v. Commissioner, 152 T.C. at 249, the Tax Court held that supervisory approval needed to be obtained no later than the date the IRS issued a notice of proposed adjustments that included penalties and allowed the taxpayer to pursue an administrative appeal. In Belair Woods, LLC v. Commissioner, 154 T.C. 1, 15 (2020), the court switched gears and held that supervisory approval needed to be obtained no later than the date that the IRS formally notified the taxpayer that the IRS's Examination Division had completed its work and made an unequivocal decision to assert penalties. Then, in Carter v. Commissioner, T.C. Memo. 2020-21, at *10 (2020), the court shifted again and held that supervisory approval needed to be obtained no later than the date of the first communication to a taxpayer demonstrating that an initial determination to assert penalties has been made. In this case, the Tax Court extended its precedents involving penalties subject to the Code's deficiency procedures to the assessable penalty imposed by § 6707A.

This lack of uniformity in the Tax Court's decisions is precisely the problem engendered by that court having adopted an interpretation untethered from § 6751(b)(1)'s text. And the Tax Court's trend of moving up the deadline by which the IRS needs supervisory approval has resulted in penalties not being sustained due to technical violations of a shifting, judge-made timing rule created after the IRS conducted the audit. As the deficiency cases show, this trend has, in turn, encouraged taxpayers to raise the § 6751(b) timing argument in hopes of securing a “deus ex machina” for penalties they would have otherwise faced, thereby undermining the penalties' efficacy as the deterrent Congress intended. See, e.g., Beland v. Commissioner, 156 T.C. No. 5 (2021) (disallowing fraud penalties); Oropeza v. Commissioner, 155 T.C. No. 9, at *4-7 (2020) (disallowing penalties connected to micro-captive insurance arrangement where taxpayer substantially understated his tax liability and participated in a “transaction lacking economic substance”); Minemyer v. Commissioner, T.C. Memo. 2020-99, at *2-3 (disallowing fraud penalties asserted against convicted tax evader); Greenberg v. Commissioner, T.C. Memo. 2018-74, at *22 (disallowing penalties where taxpayers participated in an abusive Son-of-BOSS tax shelter: “Were it not for section 6751, we would find them liable for the 40% gross-valuation-misstatement penalty.”); Becker v. Commissioner, T.C. Memo. 2018-69, at *18 (disallowing fraud penalties even though taxpayer's “fraud is evident”).

When a subordinate revenue agent errs in the timing of obtaining the requisite supervisory approval under § 6751(b)(1), it frustrates congressional intent, as relevant here, to encourage voluntary compliance by imposing a penalty based on the failure to report listed (i.e., abusive) transactions — a failure taxpayer conceded in this litigation. (ER-84 ¶ 18; ER-34 ¶ 5.) This Court should decline to adopt the Tax Court's poorly reasoned rule that has no basis in the statutory text. The Tax Court's rule is also incompatible with the Second Circuit's notice-of-deficiency deadline in Chai that turned on the supervisor's discretion to approve the penalty. The Tax Court compounded its error in this case by extending its erroneous rule from deficiency cases to the assessable penalty context, where the limitations on supervisory discretion upon which the Chai decision was grounded do not apply.

CONCLUSION

The decision of the Tax Court should be reversed.

Respectfully submitted,

DAVID A. HUBBERT
Acting Assistant Attorney General

FRANCESCA UGOLINI (202) 514-1882
JACOB CHRISTENSEN (202) 307-0878
KATHLEEN E. LYON (202) 307-6370
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

APRIL 19, 2021

STATEMENT OF RELATED CASES

Pursuant to Ninth Circuit Rule 28-2.6, counsel for the Commissioner respectfully inform the Court that they are not aware of any cases related to the instant appeal that are pending in this Court.