The whole month of February passed without us writing a blog post on another Graev issue. While we did not write a Graev based post in February 2021, the Tax Court issued another precedential opinion on the issue of supervisory approval. In Beland v. Commissioner, 156 T.C. No. 5 (2021) the Tax Court determined that the fraud penalty the IRS sought to assert failed the requirements of IRC 6751(b) allowing the taxpayers to avoid the 75% penalty proposed by the IRS without getting to the merits. The Court issued this opinion granting partial summary judgment on the fraud issue only five years after the case was filed. Presumably, it will now hold a trial at some point in the future to determine what amount of tax the taxpayers owe.
The Tax Court had previously ruled in a non-precedential opinion that the IRS flubbed the approval process in a fraud penalty case in Minemyer v. Commissioner, T.C. Memo 2020-99 – a case that took 10 years to decide. I wrote about the Minemyer case here and expressed surprise that IRC 6751(b) would stop the application of the fraud penalty in a case that involved a prior prosecution of the taxpayer, since the assertion of the fraud penalty following prosecution occurred automatically, with the hands of the agent and the agent’s supervisor essentially tied. Of course, the statute does not specifically address prior criminal cases or create any special exception for them.
Beland does not involve the imposition of the fraud penalty in a prior criminal case but does bring out in its discussion the special processing that occurs when the IRS seeks to impose the fraud penalty. As I will discuss below, that processing generally provides the protections sought by the legislation but does not follow the format adopted by the statute. For another take on the decision read Bryan Camp’s post on this case as part of his lessons from the Tax Court. As usual Bryan has great insight on the case.
The opinion does not really discuss what Mr. Beland did to cause the IRS to impose the fraud penalty as the issue here arises on a motion for summary judgement concerning the timely approval of the penalty. When a revenue agent seeks to impose the fraud penalty, the agent must send the case from exam over to obtain approval from the fraud technical advisor (FTA). The FTA is a Small Business/Self Employed revenue agent specially trained on tax fraud issues. The IRS set up the system of having agents refer cases to FTAs so that an investigator trained specifically in fraud detection could determine if the revenue agent had gathered enough information to support the fraud penalty and to allow the FTA to determine if this case should chart a path toward criminal prosecution prior to imposition of the civil fraud penalty. See IRM 220.127.116.11 (08-12-2016).
Requiring that the imposition of the fraud penalty first go through an FTA seems to provide even better protection against the use of the fraud penalty as a bargaining chip than having the immediate supervisor sign off of the penalty, but the statute has a specific structure applicable to all penalties. It does not recognize the special handling the IRS has long pursued when it perceives that fraud exists. In addition to sending the case through the FTA, before the agent can issue a notice of deficiency, the agent must obtain prior approval from Chief Counsel’s office. See IRM 18.104.22.168(14) (04-29-2016). This approval occurs because the burden of proof in fraud cases rests on the IRS and before sending out a notice of deficiency, the IRS wants to make sure that it has the necessary proof to sustain the fraud penalty.
The opinion notes that the agent did seek assistance from the FTA. It even says that the agent and her supervisor referred the case to the FTA. If the supervisor signed off on the referral to the FTA, an argument exists that the supervisor has engaged in at least some form of approval of the penalty given the reason for the referral to the FTA.
Here, the FTA requested that the agent summons petitioners to appear before them. I found this an odd request. I do not remember seeing a summons in this situation when I worked for Chief Counsel but perhaps procedures have changed. After some delay due to the birth of a child, petitioners came to the IRS for a meeting which not only served as the response to the summons but also as the closing conference. As is normal, the agent attempted to obtain the agreement of the petitioners to the proposed adjustments. And as is normal in a fraud case, the petitioners declined to sign up for the tax and fraud penalty. The number of taxpayers who willingly consent to the assessment of the fraud penalty cannot be a very high number.
After the meeting the agent obtained the signature of his immediate supervisor on the Civil Penalty Approval Form. Keep in mind that this all occurred in 2015 before the Graev opinion and the attention on IRC 6751. The Tax Court had not yet, and would not for several more years, opine on when an initial determination occurred. It’s possible to fault the IRS for not getting in front of the IRC 6751 issue shortly after it because law in 1998, but the agent obtained the supervisory signature in a reasonable time frame and had already, presumably, obtained approval to assert fraud from the FTA. Nothing in the agent’s actions appears to point toward use of the penalty as a bargaining chip.
Between the time of the supervisory signature and the hearing on the motion for summary judgment, the Tax Court held in Clay v. Commissioner, 152 T.C. at 249 that an initial determination occurred when the IRS issued an agent’s report proposed the penalties and included the 30 day letter. In Oropeza II, 155 T.C. at (slip opinion pp. 4-6) the Tax Court held that the agent’s report (together with the letter saying the taxpayer would not be offered a trip to Appeals due to the running of the statute of limitations) served as the initial determination.
Here, the Court finds that presenting petitioners with the agent’s report at the closing conference “sufficiently denoted a consequential moment in which RA Raymond had made the initial determination to impose the fraud penalty.” The Court went on to explain:
While the revenue agents in Clay, Belair Woods, and Oropeza II sent the taxpayers the RARs through the mail, we have never held that an initial penalty determination must be communicated by letter. Rather, the Court’s focus is on the document and the events surrounding its delivery that formally communicate to the taxpayer the IRS’ decision to definitively assert penalties.
The Court also noted that using the summons to essentially force the petitioner to attend the closing conference added to the formality of the meeting. So, the Court pushes the time period of the initial determination back before the formal issuance of the 30-day letter. This may open up additional opportunities for taxpayers seeking to attack the imposition of a penalty.
Although the Court knew of the referral to the FTA, it does not talk about that process in reaching its conclusion. In discussing the arguments made by the IRS, it does not appear that the IRS sought to argue the referral process used in fraud cases played in role in determining when approval occurred.
This decision is important for taxpayers in cases where the immediate supervisor has signed prior to delivery of the agent’s report, but the agent has had some formal meeting before the delivery of the report. That aspect of the decision makes sense to me, given the purpose of the statute in preventing the IRS from using penalties as a bargaining chip. Where I have trouble in the cases involving the fraud penalty is the countervailing policy argument that the IRS has taken other steps to protect the taxpayer from having the fraud penalty used as a bargaining chip.