We welcome back frequent guest blogger Carl Smith on an obscure topic we have written about before but which appears poised for a burst of activity. Keith
Section 6751(b)(1), enacted in 1998, has to date engendered almost no judicial interpretation. That will soon change. With a few exceptions not relevant here, the section 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.” In several Tax Court cases, Frank Agostino has questioned whether the IRS had complied with section 6751(b)(1). In one of his cases, Graev, Docket No. 30638-08 (appealable to the Second Circuit), issues about the application of section 6751(b)(1) are currently briefed and pending in a fully stipulated case submitted to Judge Gustafson . Frank Agostino did a prior post on the Graev case on August 4, 2014. On June 5, Judge Holmes issued orders in two dockets appealable to the Eleventh Circuit that, rather casually (apparently on little or no briefing), appeared to decide one of the section 6751(b)(1) issues presented in Graev. These two other cases were not filed by Frank. However, on July 9, Judge Holmes served an order inviting the parties to argue for him to reconsider his June 5 orders in those two cases and directing the parties to brief the section 6751(b)(1) issue so that the Tax Court could coordinate its forthcoming rulings in Graev and these two cases. Further, on July 9, in a third docket before Judge Holmes (involving another case appealable to the Eleventh Circuit where Frank was not counsel), he directed the parties to submit evidence at trial and brief any section 6751(b)(1) issue presented — also for the purposes of coordinating with Graev — even though he had not previously issued any ruling on the issue in the case. This post describes both the facts and the legal issues under section 6751(b)(1) in Graev and, as best I can tell, in the three cases under the jurisdiction of Judge Holmes.
First, to set up the issue, I want to quote from Frank’s prior August 4, 2014 post about the façade easement case of Graev:[T]he IRS [in the notice of deficiency] asserted deficiencies exceeding $650,000 and [40%] gross valuation misstatement penalties exceeding $135,000. The notice of deficiency also asserts in the alternative, . . . [20%] accuracy-related penalties under section 6662(a) and (b)(1), (2) or (3). The IRS has [since] stipulated that the taxpayers are not liable for the [40%] gross valuation misstatement penalties. The underlying penalty approval form in Graev [, signed by the revenue agent’s immediate supervisor prior to issuance of the notice of deficiency,] approved the assertion of gross valuation misstatement penalties but not the alternative 6662(a) and (b)(1), (2) or (3) penalties ultimately asserted against the taxpayers. [The 20% penalties were added to the draft notice of deficiency at the request of counsel, without getting a new written approval of the agent’s immediate supervisor.]
On April 14, 2014, the taxpayers moved for partial summary judgment with regard to the penalty issue on the ground that the IRS failed to comply with section 6751’s signed supervisory approval for the alternative accuracy-related penalty position. The IRS took the position that, for purposes of section 6751(b)(1), “the individual” who made “the initial determination” of the section 6662(a) and (b)(1), (2) or (3) accuracy-related penalties was an attorney in the Office of Chief Counsel – not the revenue agent originally assigned to this case (or any another individual in Exam or the Technical Services Unit) – and it was the attorney’s immediate supervisor that approved his determination, purportedly in compliance with section 6751(b)(1).
On July 16, 2014, the Court in Graev issued a detailed Order, stating that its assigned Judge “understand[s] respondent’s contention to be not that [the attorney] simply advised or recommended the penalty to IRS examination personnel who then made the determination (since advising and recommending are evidently not subject to section 6751(b)), but rather that [the attorney] was ‘the individual’ who made ‘the initial determination.’” The court noted that the Secretary is authorized to issue a Statutory Notice of Deficiency (“SNOD”) pursuant to Delegation Order 4-8 (Internal Revenue Manual Part 126.96.36.199 (Sept. 4, 2012); however, “that delegation does not seem to extend to the Office of Chief Counsel.” The Court posited that “[i]f, in fact, it was [the attorney] who made ‘the initial determination of such [sec. 6662(a) penalty] assessment’, then it would seem that there must be some delegation of authority to Chief Counsel to make such a determination.” However, as the assigned judge [Judge Gustafson] “is unaware of any other delegation to Chief Counsel of the authority to determine a penalty liability in an SNOD; and respondent has not yet identified a relevant delegation of authority that would enable a Chief Counsel attorney to be ‘the individual’ who makes such a determination,” the Court ordered the IRS to file a response by August 4, 2014, “identifying any relevant delegation of authority to Chief Counsel and commenting on or correcting the foregoing tentative discussion.”
After Frank’s blog post, and as a protective measure to respond to the July 16, 2014 order, the IRS in Graev then moved to amend its answer under section 6214(a) to assert the 20% penalties that were not approved by the agent’s supervisor — even though the 20% penalty was already included in the notice of deficiency, so this did not really seek a greater deficiency. The IRS did not point the court to any delegation order that allowed an attorney’s supervisor to approve the determination of a penalty. In Graev or another case that Frank is handling, the IRS has also argued, in the alternative, that section 6751(b)(1)’s written approval limitation applies only to the ministerial IRS employee and only the moment before the ministerial assessment of the penalty at the Service Center after the Tax Court case is over. Frank argues, by contrast, that the statute should be read to refer to the auditing agent and the agent’s immediate supervisor – not the IRS employee at the Service Center who has no authority to deviate from the assessment of the deficiency found by the Tax Court. After some back and forth briefing by the parties, in an order dated October 6, 2014, Judge Gustafson wrote as follows:
ORDERED that respondent’s alternative motion for leave [to amend the answer] is granted, for the reasons stated in respondent’s motion and reply. If the Court grants petitioners’ motion for partial summary judgment, then the Court would thereby have determined that the purported penalty determination in the notice of deficiency was not valid, leaving the amended answer as pleading the “initial determination” of the penalty (as to which respondent contends that he complied with section 6751(b) in any event). Respondent is permitted by section 6214(a) to plead in his answer a penalty not validly asserted in the notice of deficiency, and we see nothing in the language or purpose of section 6751(b) to abrogate that opportunity. Moreover, given petitioners’ prior awareness of respondent’s position that petitioners are liable for the penalty, and given the months that still intervene between now and any trial of this case, we see no possible prejudice to petitioners that would result from allowing the amendment of the answer to plead the penalty.
It is further ORDERED that the Court will take under advisement petitioners’ motion for partial summary judgment and expects to resolve that motion only in the event that the issue it presents proves to be outcome-determinative. The situation appears as follows: As to the penalty, respondent will have the burden of production under section 7491(c) in any event. If the Court were to grant petitioners’ motion, then respondent would also have the burden of proof under the “new matter” provision of Rule 142(a)(1). On the other hand, if the Court were to deny petitioners’ motion, then petitioners would have the burden of proof under the general rule of Rule 142(a)(1). That is, respondent will have the burden of production in any case, and section 6751(b) will affect only which party thereafter has the burden of proof, and that will affect the outcome of the case only if the evidence is in equipoise and neither party wins by the preponderance–a circumstance that seldom happens.
I am not exactly sure what Judge Gustafson meant by this order. But, on January 16, 2015, he denied the taxpayer’s motion for partial summary judgment without prejudice and then allowed the Graev case to be submitted fully stipulated. Further briefing was filed — including on the section 6751(b)(1) issues. The Graev case has been fully briefed and awaiting decision since May 15, 2015.
Rajagopalan and Sapp Cases
On June 5, Judge Holmes — apparently unaware of the existence of Graev — issued identical orders in two façade easement cases on his Birmingham, Alabama calendar (Rajagopalan, Docket No. 21394-11 and Sapp, Docket No. 21575-11) — both appealable to the Eleventh Circuit — in which he allowed the IRS to amend its answers to include gross valuation misstatement penalties under section 6662(h) that were not originally set forth in the notices of deficiency, notwithstanding that the taxpayers’ argument that the amendment of the answer might violate section 6751(b)(1). The taxpayers argued that the amendments would prejudice them, since the subsection (h) 40% penalties had not been personally approved in writing by the auditor’s supervisor before the notice of deficiency was issued, and either the notice of deficiency (or 30-day letter) reflects the “initial determination of such [penalty] assessment”. In effect, the taxpayers argued that section 6751(b)(1)’s restriction overrode the general permission of section 6214(a) that allows the IRS to amend its answer in the Tax Court to argue for a higher deficiency. In his June 5 orders (found here and here), Judge Holmes dismissed this argument as follows:
Respondent has a perfectly plausible excuse — this is to a large extent a valuation case and it wasn’t until the expert reports came in that respondent could do the math and decide he had a chance to assert a larger penalty for gross valuation misstatement. We also agree with him that petitioners would suffer no prejudice by the amendment — there is no special defense to the gross valuation misstatement penalty that petitioners cannot assert. (Petitioners argue that they are deprived of a procedural defense under § 6751(b)(1) by this late amendment. That section places an additional burden on the IRS before assessment, and the assessment of deficiencies for tax years before this Court don’t happen until the decision in a case becomes final and unappealable. See §§ 6213, 6665(b) and 7485.) [emphasis in original]
On June 10, through a “notice of judicial ruling” filed in Graev, the IRS brought to Judge Gustafon’s attention Judge Holmes’ orders of June 5. The IRS pointed out that Judge Holmes had apparently accepted its alternative argument that section 6751(b)(1) applies only to the ministerial IRS employee and only the moment before the ministerial assessment of the penalty at the Service Center after the Tax Court case is over. Apparently, Jude Gustafson immediately got in communication with Judge Holmes. Then, on June 12, Judge Holmes issued a joint order in the two cases covered by his June 5 orders. Oddly, although the order is dated June 12, it was not served or published as a designated order on the Tax Court’s website until July 9. I wonder what was going on at the Tax Court in the interim?
Anyway, in the two cases in which he had issued June 5 orders, Judge Holmes wrote as follows in his June 12 joint order:
These cases were tried during the Court’s June 8, 2015 trial session in Birmingham, Alabama. Respondent had moved shortly before trial to amend his answers, and the Court granted those motions on June 5. This division of the Court has very recently become aware of another case where taxpayers raised the IRC § 6751(b) issue that petitioners pointed out in their opposition to respondent’s motions. See Graev v. Commissioner, Dkt. No. 30638-08. The issue has now been much more extensively briefed in Graev, and may also be lurking in other conservation-easement cases. Since one of the aims of Tax Court is the uniform interpretation of the Code the Court invites petitioners to include any arguments for reconsideration of this division’s June 5 orders in their posttrial briefs –particularly any relevant developments in these other cases on this issue.It is therefore ORDERED that the briefing schedule in these cases remains unchanged, but petitioners shall include in their posttrial briefs any arguments in favor of reconsideration of the Court’s June 5 orders.
Judge Holmes also apparently realized that he had another façade easement case under his jurisdiction where the section 6751(b)(1) issue might be lurking, Kissling, Docket No. 19857-10. That case is appealable to the Eleventh Circuit and is set for a special trial session in August. On July 9, Judge Holmes also issued an order in Kissling stating:
Respondent moved on July 1, 2015 for leave to file an amendment to his answer to assert a gross valuation-misstatement penalty under IRC § 6662(h). Tax Court Rule 41(a) provides that when more than 30 days have passed after an answer has been served, “a party may amend a pleading only by leave of Court or by written consent of the adverse party, and leave shall be give freely when justice so requires.”
Whether a party may amend its answer lies within the sound discretion of the Court. Quick v. Commissioner, 110 T.C. 172, 178 (1998) (citations omitted). In determining the justice of allowing a proposed amendment, the Court must examine the particular circumstances of the case, and consider, among other factors (a) whether an excuse for the delay exists; and, (b) whether the opposing party would suffer unfair surprise, disadvantage, or prejudice. Estate of Ravetti v. Commissioner, 64 T.C.M. (CCH) 1476, 1478 (1992).
Respondent has a perfectly plausible excuse — this is to a large extent a valuation case and it wasn’t till the expert reports came in that respondent could do the math and decide he had a chance to assert a larger penalty for gross valuation misstatement. We also agree with him that petitioners would suffer no prejudice by the amendment — there is no special defense to the gross valuation misstatement penalty that petitioners cannot assert.
ORDERED that respondent’s July 1, 2015 motion for leave to file amendment to answer to amended petition is granted, and the Clerk shall file the amendment to the answer that was lodged with the motion.
Since one of the aims of Tax Court is the uniform interpretation of the Code, the parties should also note that in at least one similar case the taxpayers have raised an issue under IRC § 6751(b) when respondent asserts this penalty. See Graev v. Commissioner, Dkt. No. 30638-08. The issue has been extensively briefed in Graev, and may also be lurking in this case as well. If it is, the Court invites the parties to develop any relevant facts at trial and address the issue in posttrial briefs.
In sum, we can soon expect out of the Tax Court a series of coordinated rulings — in cases of first impression — about how section 6751(b)(1) operates in the context of notices of deficiency seeking penalties not originally approved by the agent’s immediate supervisor prior to the issuance of the notice of deficiency. And these rulings will no doubt be appealed to at least two different courts of appeals — the Second and Eleventh. This is an interesting issue — and one that I suggest taxpayers, in the meantime, raise in appropriate cases. Personally, I think Frank’s interpretation of the statute makes more sense than either of the alternative interpretations of the IRS. But, who knows?
Also, I wanted to note the similarity of the section 6751(b)(1) issue to an issue raised in another Tax Court case on which Les did a post on April 20, Illinois Tool Works. In that case, the taxpayer unsuccessfully argued that the inclusion in an answer of a penalty not set forth in the notice of deficiency violated the Administrative Procedure Act (APA). In an unpublished order in that case, Judge Lauber held that the procedures at section 6214(a) allowing the IRS, in Tax Court, to seek a deficiency larger than that set forth in the notice of deficiency trumped any APA procedures that might provide otherwise. The ruling did not, however, mention whether section 6751(b)(1) trumped section 6214(a), as the taxpayer apparently failed to present any argument under section 6751(b)(1). So, Illinois Tool Works appears to have no bearing on the issues before Judges Gustafson and Holmes.