In the recent case of Belair Woods, LLC v. Commissioner , 154 T.C. No. 1 (2020) the Tax Court once again goes into its court conference room to have a discussion about the fallout from the Graev opinion and IRC 6751(b). Because Congress is really slow and has been sitting on his reappointment for a long time, neither the court nor we as consumers of the court’s opinions have the benefit of Judge Holmes’s views on the most recent iteration of a procedural statute written by someone with no background in tax procedure. This post is dedicated to him and his coining of the term ‘Chai Ghouls’ to describe the many situations the Tax Court would face in trying to provide meaning to this statute. So, the court is once again tasked with making sense out of nonsense.
The court deeply fractures, again, over what to do with this statute, and this time it is deciding when the IRS must obtain supervisory approval of the decision to impose the penalty. The taxpayer argues that the approval must come at the first whiff of the imposition of the penalty, because even at the earliest stages, mention of the imposition of a penalty can cause the penalty to be used as a bargaining chip and that’s what Congress seemed to be wanting to prevent. This is a logical argument and persuades almost half of the voting judges. Judge Lauber, writing for a plurality, picks a later time period – the issuance of a formal notification and finds that the IRS had obtained the appropriate approval by that point (for most of the penalties in contention.)
The case involves a TEFRA partnership. Normally, in a TEFRA partnership, the IRS issues a 60-day letter (much like the 30-day letter outside TEFRA) and finally an FPAA (the ticket to the Tax Court that is the basis of this case). Here, the IRS got managerial approval of the penalty before the 60-day letter, which showed a penalty. Problem is that about two years earlier, the agents had sent a calculation of the potential 60-day letter income adjustments (including showing the penalty) to the partners and suggested a conference to discuss what was effectively this proposed 60-day letter. But, the agents did not obtain penalty approval before sending this pre-60-day letter.
Judge Lauber plus seven judges hold that it is time to create as bright a line as possible, citing United States v. Boyle, 469 U.S. 241, 248 (1985) (bright-line rule for late-filing penalty in the case of filing agents), and that the required approval moment should be when a penalty “is embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.” In this case, the pre-60-day letter was just a proposal. It was not the critical moment. Judge Lauber cites the opinion in Kestin v. Commissioner, 153 T.C. No. 2, at slip op. pp. 26-27 (2019), for the similar proposition that a letter suggesting section 6702 penalties might be applied if the taxpayer does not correct a frivolous return is also not a critical moment for managerial approval under section 6751(b).
In a separate concurring opinion, Judge Morrison writes:
“On the facts of this case, I agree with the opinion of the Court that the 60-day letter was the initial determination to impose the penalties. However, I do not agree with any suggestion in the opinion of the Court that the initial determination to impose the penalties may only be ‘a formal written communication to the taxpayer, notifying him that the Examination Division has completed its work and has made a definite decision to assert penalties.’”
Judge Gustafson and six dissenters agreed with the taxpayer that the pre-60-day-letter was the critical moment for managerial approval of the penalty on these facts. Thus, only 8 of the 16 judges voted for the proposition that the initial determination to impose the penalties may only be ‘a formal written communication to the taxpayer, notifying him that the Examination Division has completed its work and has made a definite decision to assert penalties’”. It appears that there is still no bright line — at least one than can be cited outside the TEFRA partnership context of Belair Wood.
Bryan Camp has written an excellent post on this case which can be found here. I agree with Bryan’s analysis and will not rehash why it’s a good analysis, but anyone interested in this issue should read his post. Bryan concludes that Judge Lauber’s reasoning makes the most sense. Because Bryan does such a good job of explaining the case and the various reasons behind the decisions made by judges on this issue, I want to focus on another issue. Why doesn’t Congress understand what assessment means, and why doesn’t it fix an obvious mistake, instead leaving Tax Court judges to scratch their heads and spend inordinate amounts of time bonding in a conference room?
When I teach assessment, I almost always poll my students by asking how many of them have ever had taxes assessed against them. Almost no students raise their hands admitting to such a terrible tax gaffe. They think, like most people and certainly like most members of Congress, that an assessment is a bad thing. In reality, assessment is a neutral act of recording a liability on the books and in most instances is a good and important act, because it is a necessary predicate to obtaining a refund of federal taxes.
The Congressional misunderstanding of assessment comes through loud and clear in IRC 6751(b). I will circle back to IRC 6751(b), but before doing so, I want to spend a little time with an even greater screw-up by Congress in misusing the term ‘assessment’. The greater example I want to offer is found in Bankruptcy Code 362(a)(6) passed in 1978 as part of the new bankruptcy code adopted that year. This code replaced the bankruptcy code of 1898 which had been substantially updated in 1938. The adoption of the new bankruptcy code in 1978 followed almost a decade of debate and discussion.
One of the primary features of the bankruptcy code is the automatic stay. The stay protects the debtor and creditors from aggressive creditors who might seek self-help and reduce the property available to all creditors or property available to the debtor through the exemption provisions. The stay is a good thing. Congress placed the stay in BC 362 and in paragraph (a) enumerated 8 different things impacted by the stay. Because the stay does not stop everything, Congress inserted in paragraph (b) a list of (now) 28 actions not stopped by the stay. So, what went wrong?
Bankruptcy code 362(a)(6) provides:
(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
If BC 362(a)(6) stays any act to assess that arose before the commencement of the case, then it stops the IRS from assessing the liability reflected on a return for a year that ended before the filing of the bankruptcy case. We have had years since 1978 when over 1.5 million new bankruptcy cases were filed. The vast majority of those cases were filed by individuals. A decent percentage of those cases were filed during the first 3 and ½ months of the year and most of those returns sought refunds. So, how could the IRS send to these individuals in distress their tax refund when it could not assess the liability? Keep in mind also that in 1978 we were still in an era of paper filing. So, the IRS would need to set these returns to the side to be processed once the stay lifted, and they would sit in rooms in the Service Centers around the country waiting for the stay to lift, so the IRS could perform the simple act of assessment and then send out the tax refund.
You can imagine that debtors in this situation did not really want to hear about the problem Congress created with the language of 362(a)(6) prohibiting assessment as though making the assessment was a bad thing. The IRS faced a choice of what to do to avoid potentially tens of thousands of stay lift motions that would really be unnecessary if the statute were worded properly to reach its intended result. Sixteen years later, in 1994, the IRS finally convinced Congress to amend BC 362(b)(9) to permit assessment in this circumstance. The statutory language creating the stay on assessment still exists in 362(a)(6) as a lasting testament to Congressional misunderstanding of assessment, but finally the IRS did not have to stack returns in rooms in the Service Centers in order to move cases along.
Because it took over 15 years for problems in IRC 6751(b) to come to everyone’s attention, perhaps under the timeline of BC 362(a)(6) we still have another decade or more before Congress will get around to fixing its mistaken understanding of assessment in 6751. The Congressional sentiment of stopping the IRS from using penalties as a bargaining chip makes sense and is probably bipartisan. With help from the tax community, Congress could make amendments that would allow courts and the IRS to properly administer the statute. We could wish, however, that it will recognize the problem more quickly this time. In the meantime, the court conference room at the Tax Court will continue to get plenty of use as the court tries to make sense of nonsense.