Avid readers of Procedurally Taxing know that we have been closely following the litigation over IRC § 6751(b) and the Graev line of cases. This litigation has also received attention from Congress in the Build Back Better Act, H.R. 5376, in which § 138404 repeals this provision and replaces it with a toothless requirement of quarterly certification to the Commissioner. The repeal is retroactive to its enactment in the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98).
I’m not going to go through all the cases raising this issue – you can read about them here and here and here and here and here and so forth. Suffice it to say that for nigh on to twenty years the IRS just ignored the language of § 6751(b), which provides:
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.
IRS issued no regulations or other guidance on this point, and it wasn’t until the Treasury Inspector General for Tax Administration (TIGTA) issued a report in 2013 noting the IRS was not complying with the provision that Frank Agostino decided to challenge the imposition of a penalty in Graev because there was no written approval by a supervisor.
Why did Congress see fit to enact this provision in the first place? During the hearings leading up to the enactment of RRA 98, Congress heard from many sources that the IRS was using penalties as bargaining chips in audit and appeals context. That is, as Gwen Moore wrote in a recent Forbes blog,
When the law was passed in 1998, the Senate Finance Committee explained the legislation was needed to correct glaring problems in tax administration and provide much-needed taxpayer protections. The first problem was that at that time, the IRS was not required to “show how penalties are computed on the notice of the penalty.” S. Rep. 105-174, at 65 (1998). The second was that penalties were used as a bargaining chip, and “[i]n some cases, penalties may be imposed without supervisory approval.” Id. Section 6751 was added to the Internal Revenue Code because the Senate Finance Committee “believes that taxpayers are entitled to an explanation of the penalties imposed upon them,” and “that penalties should only be imposed where appropriate and not as a bargaining chip.” Id.
In fact, I was a witness at one RRA 98 hearing when penalties-as-bargaining-chips were discussed. At that February 5th, 1998, hearing, no less an authority than Michael Saltzman (of IRS Practice and Procedure treatise fame) in his formal testimony wrote,
In practice, the penalty has become a penalty for “being wrong” in the opinion of the revenue agent. Many practitioners also believe that the penalty is asserted at the district level solely to gain some bargaining advantage at the Appeals level. This creates additional expense for taxpayers in fighting the penalty when all that may truly be in dispute is a frank difference of opinion as to what the law requires. (IRS Restructuring, Hearings before the Senate Committee On Finance, S. Hrg. 105-529, at 372.)
Section 6751(b) was Congress’ response to these legitimate concerns, echoed by other witnesses, including Stefan Tucker, then Chair-elect of the American Bar Association Section of Taxation (see page 92 of the Hearing record). Supervisor approval helps ensure consistent and equitable treatment for taxpayers. As Michael Saltzman noted, each examiner approaches the job and issues with a little bit (or sometimes a lot) different mindset. What one thinks is negligent or fraudulent will be different from what another thinks. Laying a second set of eyes and judgement on the case can smooth out the edges of differing value systems and mindsets of examiners. If done correctly, the supervisor should ask a few questions which could reveal gaps in the examiner’s exam procedures (such as the examiner failing to ask a salient question that might have clarified why the taxpayer did what they did, which might show a penalty isn’t warranted). This process could eliminate some penalties but perhaps strengthen others where penalties are in order. In this way, supervisor review promotes good tax administration and reinforces effective exam procedures. A quarterly report is not going to accomplish that.
Now, the language of 6751(b) could be more clearly stated. Courts have struggled with when the written supervisory approval should be obtained – before issuance of the notice of deficiency (NOD), or just before the tax is assessed. And how does this provision apply to immediately assessable penalties or penalties not otherwise subject to deficiency procedures? If supervisor approval must only occur before assessment, this approach gives the IRS plenty of time to correct a failure to obtain the approval earlier in the process, but it does nothing to avert the harm to taxpayers caused by use of penalties as negotiating tools, nor does it promote effective exam procedures discussed above. Timing is important to achieve the goal of the statute, which was to ensure that someone was looking over front-line employees’ shoulders on the important issue of penalty imposition so that penalties are imposed for the appropriate reasons (to promote voluntary compliance and to discourage noncompliance).
Why would Congress now want to make this provision disappear – retroactively, back to enactment, as if the underlying concern never existed? I would hazard a guess that someone suggested that well-heeled taxpayers were pulling a fast one over the IRS and avoiding appropriate penalties simply because of a technical foot-fault.
But penalties are not a foot-fault. They can be a significant expense to taxpayers, and in most instances interest accrues on penalties daily, so that often, if a taxpayer has entered into an installment agreement, after years of paying, the actual remaining liability is made up of only penalties and interest. Research I published as the National Taxpayer Advocate shows that improperly assessed penalties actually increases noncompliance in future years. So it is well worth it for the IRS to take the extra time to ensure the appropriate application of penalties.
To come back to the topic of well-heeled taxpayers getting off easy, I suggest you review two research studies published in the National Taxpayer Advocate Annual Reports to Congress in 2013 and 2019. In these studies we looked at the IRS application of the IRC § 32(k) two-year ban of the Earned Income Tax Credit where the IRS made “a final determination that the taxpayer’s claim of credit was due to reckless or intentional disregard of rules and regulations.”
In 2013, the Taxpayer Advocate Service (TAS) reviewed a representative sample of the 32(k) cases and found:
In almost 40% of the cases, the ban was imposed without the required “determination” of the taxpayer’s state of mind;
In 69% of the cases IRS employees did not obtain required managerial approval before imposing the penalty; and
In almost 90% of the cases, “neither IRS work papers nor communications to the taxpayer contained an adequate explanation of why the ban was being imposed.
Following our study, TAS negotiated with the IRS to update the Internal Revenue Manual provisions to include a requirement that auditors must note the reason for imposition in their workpapers. Both the 2013 and 2016 IRMs required supervisory approval of 32(k) penalty revision. Here’s what IRM 126.96.36.199.1 ban requires Correspondence Exam Technicians to do before asserting (or not) the 2 year ban:
● Review the documentation submitted by the taxpayer
● Determine whether the 2-year ban should be asserted based on applicable tax law and
1. the taxpayer’s documentation
2. taxpayer contact
3. IDRS research
4. Prior year CEAS workpapers
● Clearly document workpapers as indicated in 188.8.131.52, Workpapers for All Cases, including the decision and reason to impose or not impose the 2-year ban
● Get managerial approval on CEAS Non-Action note prior to asserting the 2-year ban
Do not use standard statements such as 2-year ban is applicable because taxpayer showed intentional disregard of the rules and regulations for EIC/CTC/ACTC/ODC or AOTC. Proper workpaper documentation should clearly outline the audit steps taken and fully explains the decision to assert or not assert the 2-year ban.
In 2019, TAS undertook an updated study to see how IRS examiners were complying with the new IRM procedures. Here’s what TAS found:
In 54% of the cases, the auditor imposed the ban without the required managerial approval; and
In 84% of the cases, the explanation provided to the taxpayer on Form 886-A for imposition of the ban was inadequate.
In over half of the cases where taxpayers submitted documentation and the ban was imposed, it appeared from the documentation taxpayers believed they were eligible for the credit (thus negating the requirement of reckless and intentional disregard).
It is not clear why Congress would want to let the IRS off the hook here. The TAS studies show the amount of 32 (k) penalty imposed (disallowance of future EITC) can be as much as 23 percent of taxpayers’ adjusted gross income. It is one thing to violate the IRM, but why should we reward the IRS for ignoring the statutory mandate, especially where the imposition can create financial havoc for the taxpayer?
This is a problem of the IRS’s own making. It could have issued clear guidance back in 1999 following the enactment of RRA 98 and established quality review procedures to ensure adherence to this guidance. (I know this is possible – at times in TAS we imposed 100% supervisor or analyst review of certain aspects of casework where we determined those elements were critical to the fair and accurate treatment of taxpayers. It can be done. That is Management 101.) It could have saved itself (and the public fisc) millions of dollars in litigation costs had it taken these steps decades ago. The IRS finally got around to issuing IRM guidance in October, 2020 addressing the timing of supervisory approval (IRM 184.108.40.206.3.1) which PT discusses here.
Because the IRS ignored the statutory protection for two decades, the problem that existed in 1998 is still present – the IRS imposes penalties as punishment and without adequate explanation, to itself or its taxpayers, and it doesn’t seem to care enough to fix it on its own.
It doesn’t have to be this way – we don’t need to repeal 6751 to address the issue of “foot faults.” All that Congress needs to do is amend 6751(b) to make clear that supervisory approval must occur before the issuance of a notice of deficiency where one is required, or with respect to immediately assessable penalties or those not subject to deficiency procedures, “prior to issuing any written communication of penalties to a taxpayer that offers the taxpayer an opportunity to sign an agreement, or consent to assessment or proposal of the penalty,” as the current IRM requires. Further, direct the Secretary to issue guidance as to the level and process of supervisory approval. Then the litigation will have had a salutary effect, and accomplished what Congress tried to do the first time around.