On November 30, 2016, the Tax Court issued a fully reviewed opinion in the case of Graev v. Commissioner, 147 T.C. No. 16 addressing the issue of the requirement for managerial approval of penalties. In the Restructuring and Reform Act of 1998 (RRA 98), Congress created IRC 6751 which requires managerial approval of penalties. We have discussed this issue previously here, here and here, one post each by me, frequent guest blogger Carl Smith and Frank Agostino, respectively. The Court split pretty sharply in its opinion with nine judges in the majority deciding that the IRC 6751(b) argument premature since the IRS had not yet assessed the liability, three judges concurring because the failure to obtain managerial approval did not prejudice the taxpayers and five judges dissenting because the failure to obtain managerial approval prior to the issuance of the notice of deficiency prevented the IRS from asserting this penalty (or the Court from determining that the taxpayer owed the penalty.)
A number of IRC 6751 cases have been bottled up waiting for this opinion. Look for a number of cases to now come out on this issue and look also for some of these petitioners to take the issue to the next level.
Because I had an extensive email exchange with Carl Smith about this case, I have placed his comments at the end of the post for those interested in a more in depth review of the issues presented.
This issue first came to my attention through Frank Agostino and fittingly, Frank represents the petitioners in this case. As we have mentioned in prior posts, this issue essentially went unnoticed for almost 15 years after the passage of RRA 98. After a TIGTA report highlighted that the IRS had failed to notice and follow this requirement, Frank picked up on the issue and began asserting that the IRS failed to follow the provision. In Graev he made the argument but with somewhat unusual facts. I will briefly discuss the facts before getting to the three different views on the issue expressed by the members of the Court followed by views on the opinions by Carl Smith and me.
Petitioners claimed a charitable contribution for a façade conservation easement on a home they purchased in a historic preservation district in New York City. The easement was donated to the National Architectural Trust (NAT). In a previous opinion, Graev v. Commissioner, 140 T.C. 377 (2013), the Tax Court held that petitioners could not claim a charitable contribution deduction for the donation of the easement because NAT gave them a side letter guaranteeing that it would return the contribution if the IRS disallowed the charitable contribution.
At the time of the contribution, some concern existed about the ability to claim a deduction for a contribution of the façade easement because of a Notice the IRS had issued on a different type of conservation easement but one with enough overlap to suggest that the IRS might not allow a charitable contribution deduction for the type of easement being contributed by the Graevs. The opinion details the letters sent by NAT before and after the donation regarding pronunciations by the IRS and Congress on the donation of easements. It also recounts the actions, or inaction, of the Graevs in the face of the correspondence.
The IRS did audit the return filed by Graevs claiming the contribution of the easement. The agent not only proposed disallowing the contribution but also recommended the imposition of the 40% gross valuation misstatement penalty of section 6662(h). The agent prepared the penalty approval form – a form the IRS devised specifically to meet the requirements of section 6751 – and his manager signed the form. Because the agent could not reach an agreement with the taxpayers, he prepared a statutory notice of deficiency, which, due to the issue, required Chief Counsel review. The reviewing attorney agreed with the notice; however, he recommended that the IRS add to it, as an alternative position, the imposition of the 20% penalty under 6662(a) and (b)(1) for negligence or substantial understatement. The manager in Chief Counsel’s Office agreed with this recommendation.
The IRS added the alternate penalty to the notice of deficiency but the agent did not go back to his manager for approval of the alternate penalty. In the first Tax Court case the Court determined that petitioners were not entitled to the charitable contribution deduction because the side letter created a subsequent event that was not “so remote as to be negligible.” Because of the basis for the decision, the IRS conceded that the 40% penalty did not apply and argued that the 20% penalty did.
In defense to the application of the 20% penalty, the Graevs argued that the IRS did not comply with section 6751 because the agent’s manager did not approve the 20% penalty.
The majority determines that because the IRS has not yet assessed the liability a determination that it has failed to follow the requirements of section 6751 is premature. The statute requires “written approval of the ‘initial determination of … assessment’ before a penalty can be assessed. Notably absent from section 6751(b), however, is any requirement that the written approval of the ‘initial determination of … assessment’ occur at any particular time before the ‘assessment’ is made.”
This is a 106 page opinion. The majority (and the dissent) goes into many aspects of the statute in reaching its conclusion. The majority also spends time explaining why the dissent is incorrect. We may come back with subsequent posts about the opinion but at its core is the view that the language of the statute requires approval before assessment and the Tax Court is a pre-assessment forum. This facially logical view of the statute leads to trouble in the ability of a taxpayer to challenge the application of section 6751 and raises questions about the Tax Court’s role as a pre-assessment forum. Of course the drafters of the statute might have thought a little more about that before writing it.
The concurring judges looked to the purpose for the statute which is to prevent the use of penalties as bargain chips. Here, these judges found that even if the IRS did not strictly comply with the requirements of section 6751(b) the failure to do so did not prejudice petitioners. These judges would defer the detailed analysis of the statute until presented with a case where the facts did raise the possibility of prejudice.
The dissent would require that the IRS obtain managerial approval prior to issuing the notice of deficiency. Because the IRS issued the notice prior to obtaining approval of the alternative position, it would not sustain the penalty. The dissent discusses the role of the Tax Court in the assessment process and concludes that to properly fulfill that role it should address the penalty issue as presented in the notice of deficiency.
The majority opinion suggests a taxpayer should never raise IRC 6751 in Tax Court, or anywhere, until liability is assessed and raise it instead in the Collection Due Process (CDP) context after assessment. This seems contrary to the purpose of Tax Court and puts taxpayers in an awkward position. By allowing assessment to occur, the panoply of IRS collection options becomes available. The Tax Court may anticipate that CDP is a process available to everyone for reentry into the Court for a determination but for low income taxpayers and taxpayers with relatively low liabilities, the IRS may collect via offset and fully satisfy the liability without the need to send a CDP notice. Of course, the taxpayer whose liability is fully satisfied can sue for a refund but if the penalty is $1,200 on a liability of $6000 for wrongfully claiming the EITC, how practical is it to file an expensive suit in district court to contest this issue?
The case is before the Tax Court because the penalty, at least the penalty at issue in this case and in many cases, is a part of the notice of deficiency. For the reasons stated by the dissent, the Tax Court has jurisdiction to decide the issue. This should not be a post-assessment question. After all, to borrow from Judge Gustafson, section 6501 also precludes an assessment being made after the SOL has expired, but the Tax Court has a long history of considering compliance with section 6501’s requirements during the deficiency case – i.e. pre-assessment.
If the opinion of the majority stands up on appeal, taxpayers who know or think that the IRS did not obtain the appropriate approval prior to issuing the notice of deficiency should consider making no mention of 6751 during the Tax Court case for fear of alerting the IRS to the defect prior to the making of the assessment and allowing it to cure that defect. Here, I assume that the IRS will obtain managerial approval before it makes the assessment. One possible outcome of the case if it comes back to the Tax Court in the CDP context is that the post-decision, pre-assessment managerial approval will satisfy the language of the statute in the eyes of the judges in majority, and perhaps concurring, opinion.
Comments on Opinion by Carl Smith
In footnote 22 on page 40, the court fairly acknowledges that it is likely just kicking the issue of compliance with section 6751(b) (whatever it means) down the road until a post-assessment Collection Due Process proceeding. Doubtless, the 6751(b) issues that the court avoids today will have to be addressed in a Tax Court CDP opinion — perhaps even one that the Graevs bring after the penalties are formally assessed and a notice of intention to levy or a notice of federal tax lien (i.e., a ticket to a CDP hearings) is issued. Query, though, whether challenging an assessed penalty under section 6751(b) in a CDP hearing is prohibited by the language of section 6330(c)(2)(B), which prohibits CDP challenges to underlying liability where a taxpayer has received a notice of deficiency — as the Graevs did? Or is a section 6751(b) challenge one going to the procedural correctness of the assessment under section 6330(c)(1), not a prohibited underlying liability challenge?
In his concurrence, Judge Nega (joined by two other judges) suggests that a CDP case would be an appropriate case in which to decide the issues avoided by the majority. On page 68, he writes: “The failure of the IRS to follow the statute or its administrative practices may be challenged as an abuse of discretion in a collection action. That case is not before us.”
If one can’t challenge non-compliance with section 6751(b) through CDP, then Judge Gustafson points out a statute that might also preclude a later refund lawsuit over the penalty. See his quote and brief discussion of section 6512(a) on page 78. n. 5.
If neither CDP nor a refund suit is the way to challenge non-compliance with section 6751(b), then taxpayers would be left without a remedy. The anti-injunction act of section 7421(a) has an exception if no adequate remedy exists; however, probably the exception would not apply, and the act would likely preclude a suit to restrain assessment or collection of the penalty. And section 7433, which provides a suit for damages from wrongful collection actions would not apply, since the issue being challenged here is an assessment issue, not a collection issue.
This opinion has been a long time in coming. The case was originally with Judge Gustafson. And he foreshadowed his dissent in a brief order he issued more than two years ago on July 16, 2014. Clearly, he wrote a proposed opinion along the lines of his dissent, but then at court conference, his opinion did not prevail and Judge Thornton got the assignment to write the majority opinion. On the day the opinion was issued, an order reassigning the case from Judge Gustafson to Judge Thornton was also entered in the case.
There is an interesting new entry on the Tax Court docket sheet accompanying this opinion that I have never seen before when an opinion is issued. It reads: “Internet Sources Cited in Opinion”. The problem of URL links to court opinions disappearing over time has been a large one for all courts. Perhaps this is a warning to the Tax Court about what it must think about doing when the government printing office formally prints the opinion in a T.C. volume. Will the Tax Court later be revising its opinions in the same way that Supreme Court judges currently do? It is my understanding that the Supreme Court recently has changed its practices of modifying opinions that have already been published. Now, the court will let the public know of the post-issuance changes to the opinions. Will the Tax Court do the same? Perhaps it is worth asking the clerk’s office what the purpose of this new entry on the docket sheet implies.
Finally, Judge Gustafson decides a lot of the questions under section 6751(b) on which the majority postpones ruling. Judge Gustafson’s opinion is joined by four other judges. Readers of the opinion should not jump to the conclusion that any of the judges in the majority would disagree with those rulings of Judge Gustafson on the issues on which the majority deferred ruling if the arguments are again presented in a case (presumably a CDP case) where those arguments are ripe. Thus, this victory for the IRS in allowing a deficiency including penalties to be incorporated into the Tax Court decision may turn into no penalties ever being collected by the IRS if a court, in a future case, decides the deferred issues adversely to the IRS.
My worry about whether compliance with 6751(b) is merely a procedural compliance issue in a CDP case is based in part on the way that the Tax Court has treated compliance with 6501. The Tax Court has refused to consider 6501 arguments in a CDP case if a taxpayer previously received a notice of deficiency. But, I am pretty sure the Tax Court judges are going to treat 6571(b) compliance as a CDP procedural issue, since to treat it as an issue barred by 6330(c)(2)(B) would be to deprive a taxpayer of any possibility of judicial review of compliance with 6751(b).