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Changing a Penalty – Graev Effect

Posted on Jan. 13, 2023

In Castro v. Commissioner, TC Memo 2022-120 petitioner sought to strike an IRC 6662 accuracy related penalty for failure to meet the requirements of IRC 6751(b).  The Court determined that the manager’s approval met the statutory requirements.  The decision here affirms prior case law holding that the Court will not look behind the signature just as it does not look behind a notice of deficiency.  In effect, the Graev test has a Greenberg Express overlay.  Signing the right form at the right time is the key to success for the IRS not proving that it had a good reason for signing the form.

The manager signed the 30-day letter. It approved the imposition of an accuracy related penalty. Later, the IRS revised the penalties. In doing so a manager approved the change, but the Castros complained that by the time of the change the original penalty proposal had been communicated. The parties submitted his case fully stipulated under Rule 122 after resolution of all issues except the penalty. As we have discussed before, this rule allows the parties to avoid the time consuming and messy trial if they can agree to all of the facts necessary for the Court to reach its opinion.

As a result of review of the original revenue agent’s report, the report was revised:

On October 18, 2016, GM Relf signed a Civil Penalty Approval Form with respect to the years at issue. In that form, under the “Assert Penalty” heading, an “X” was marked under the “Yes” column for an addition to tax under section 6651(a)(1) and an accuracy-related penalty for substantial understatement of income tax under section 6662(d) for each year at issue.4 Conversely, under the “Assert Penalty” heading, an [*4] “X” was marked under the “No” column for additions to tax under sections 6651(a)(2) and 6654 for the years at issue.

On October 26, 2016, respondent issued the notice of deficiency underlying this case. The penalties and additions to tax determined in the notice of deficiency corresponded to the penalties and amounts shown in the corrected RAR. Specifically, respondent determined only additions to tax under section 6651(a)(1) and accuracy-related penalties under section 6662(a) (not additions to tax under sections 6651(a)(2) and 6654) for each of the years at issue. The amount of each accuracy-related penalty under section 6662(a), and of each addition to tax under section 6651(a)(1) that had been asserted in the original RAR dated July 6, 2016, was also revised downward to reflect the amount shown in the corrected RAR dated October 5, 2016.

The Tax Court has prior precedent holding that the confusing language in IRC 6751(b) regarding “the ‘initial determination’ of a penalty assessment … 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.” That document is usually the 30-day letter. Here, the original 30-day letter does not match the revised one or the notice of deficiency. Here, the manager approved the 30-day letter by signing the letter transmitting the report to them. This was insufficient according to the Castros because other evidence suggests that the manager did not really review the penalty until later:

on the totality of the stipulated record, the signature found on the Letter 950 does not demonstrate written managerial approval of the contents of the enclosed RAR, including the asserted accuracy-related penalties. Specifically, petitioners note that the Letter 950 was mailed to them on July 8, 2016, with an enclosed RAR asserting penalties or additions to tax under four distinct Code provisions. The stipulated record, petitioners argue, proves that the first review of the penalties and additions to tax asserted in the RAR did not occur until August 30, 2016, and, once that occurred, GM Relf found errors with respect to the penalties and additions to tax. Accordingly, petitioners argue that when GM Relf signed the Civil Penalty Approval Form on October 18, 2016, he expressly disapproved of two additions to tax that were purportedly the subject of his approval when he signed the Letter 950 on July 8, 2016, and he approved revised amounts of the other penalties and additions to tax. This later and express disapproval, petitioners contend, is the type of contrary evidence that precludes a conclusion that GM Relf’s signature on the Letter 950 approved the contents of the RAR. On the contrary, petitioners insist that the “most logical conclusion [to be drawn from the stipulated record] is that the group manager did not view the Letter 950 as an approving document and did not view the signing of the Letter 950 as an event which triggered his responsibility to review the penalties.”

The Court finds for the IRS because the evidence showed that the manager signed the initial correspondence. Basically, the Court harks back to earlier cases in which taxpayers sought to have the court look behind the approval. The Court has consistently rejected efforts by petitioners to have it look behind the approval to see if the manager made a good decision or an informed decision. It simply looks to see if the manager signed. If the manager signs the approval form with his or her eyes closed, that will be good enough.

If the Court must gauge the depth of a manager’s understanding of the penalty imposition, it would be even more hopelessly tied up by IRC 6751(b) than it is now. The decision not to look behind the signature, like the decision not to look behind the notice, provides a logical way for the Court to determine whether the requirements of the statute are met without having to get into the mind of the manager.

Petitioners here made logical arguments that the actions of the manager at a later stage indicated that he paid little or no attention to the document at the time he signed it.  Proving that, however, does them no good.

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