According to the Internal Revenue Code, the IRS must follow certain specific procedures when assessing penalties, such as approval in writing by the immediate supervisor of the individual making the penalty determination. The IRS must comply with these procedures for the Tax Court to uphold the penalties. Supreme Court Justice Kavanaugh previously held: “A court’s assessment of an agency’s compliance with statutory limits does not depend on whether the agency’s policy is good or whether the agency’s intentions are laudatory.”[1]While it may be generally difficult to defend the IRS’s procedures as “good” or “laudatory,” the IRS’s lack of compliance with the statutory procedures in I.R.C. § 6751 may prove beneficial to taxpayers.
According to I.R.C. § 6751:
(a) Computation of penalty included in notice
The Secretary shall include with each notice of penalty under this title information with respect to the name of the penalty, the section of this title under which the penalty is imposed, and a computation of the penalty.
(b) Approval of assessment
(1) In general
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.
(2)Exceptions Paragraph (1) shall not apply to—
(A)any addition to tax under section 6651, 6654, or 6655; or
(B) any other penalty automatically calculated through electronic means.
(c) Penalties
For purposes of this section, the term “penalty” includes any addition to tax or any additional amount.
Graev v. Commissioner
In Graev v. Commissioner, Mr. and Mrs. Graev contributed cash and a conservation easement to the National Architectural Trust (“NAT”) with a letter stating that if the IRS disallowed their charitable contribution deductions, NAT would refund the cash and remove the easement.[2]The IRS did, in fact, disallow the Graevs’ charitable contributions and determined tax deficiencies in the amounts of $237,481 for 2004 and $412,620 for 2005. The IRS also determined the taxpayers were liable for accuracy-related penalties under I.R.C. § 6662(h) and alternatively under I.R.C. § 6662(a). The Graevs petitioned the Tax Court for redetermination of the penalties and tax deficiencies. The Tax Court upheld the tax deficiencies.[3]
Three years later, the Tax Court needed to determine whether the Graevs were liable for the 20-percent accuracy-related penalty under I.R.C. § 6662(a).[4]Specifically, the Tax Court needed to determine “whether respondent failed to include a computation of the 20% penalty in the notice of deficiency, as required by section 6751(a), and whether respondent [was] barred from assessing [the] penalty because of a lack of proper written approval for assessment of the penalty, as required by section 6751(b)(1).” The Tax Court, in what is known as Graev II, ultimately held that the notice of deficiency complied with I.R.C. § 6751(a), and the argument that the IRS failed to comply with I.R.C. § 6751(b) was premature.[5]
In Graev v. Commissioner (Graev III), the Tax Court overruled, in part, the holding in Graev II.[6]Between Graev IIand Graev III, the Second Circuit Court of Appeals, in Chai v. Commissioner, held that (1) the written-approval requirement of I.R.C. § 6751(b)(1) is an element of a penalty claim, and (2) I.R.C. § 6751(b)(1) requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.[7]As a result, the Tax Court held that the argument under I.R.C. § 6751(b) was not premature. However, the Court held that while compliance with the written-approval requirement is part of the IRS’s burden of I.R.C. § 7491(c), the IRS met its burden. Accordingly, the Graevs were liable for the 20-percent penalty.[8]
The “Graev” Notice
On June 6, 2018, the Office of IRS Chief Counsel issued a notice (the “Graev” Notice) to its attorneys, advising them on how to address IRS compliance with I.R.C. § 6751(b) in litigation.[9]In part, the notice provides as follows:
Counsel attorneys should not dispute that compliance with section 6751(b)(1) is part of the Service’s burden of production if section 7491(c) places the burden of production on the Service. Counsel attorneys should submit evidence of compliance with section 6751(b)(1) to satisfy the burden of production. . . . In any Tax Court deficiency case in which a penalty is at issue and is not excepted from supervisory approval under section 6751(b)(2), attorneys must submit evidence of compliance with section 6751(b)(1), even if the taxpayer does not raise the issue.[10]
Importantly, the Notice provided the following concession related to counsel’s inability to establish compliance:
If a Counsel attorney cannot find evidence to establish compliance with section 6751(b)(1), and no exception under section 6751(b)(2) applies, the attorney must concede the penalty. The concession should be done at the earliest opportunity, which will typically be in the answer, and in all events at the very latest in the pretrial memorandum.[11]
Conclusion
Ultimately, whenever a taxpayer receives a non-computer-generated penalty, the taxpayer should obtain evidence that the IRS has complied with I.R.C. § 6751(b). Moreover, taxpayers should raise this same compliance issue in any administrative refund claims. The IRS does not have unfettered authority to assess accuracy-related penalties. It must comply with the procedures established in the Internal Revenue Code and ultimately has the burden of proof regarding compliance with supervisory approval. While the Graevs were ultimately still responsible for the 20-percent penalty, other taxpayers may be more fortunate. As the “Graev” Notice provided, “the attorney must concede the penalty” if compliance with I.R.C. § 6751(b) cannot be established. Compliance is key, and the burden is on the IRS.
[1]Coalition for Responsible Regulation, Inc. v. EPA, 2012 U.S. App. LEXIS 25997, *88 (D.C. Cir. 2012).
[2]Graev v. Comm’r, 140 T.C. 377 (2013).
[3]Id.at 378.
[4]Graev v. Comm’r (Graev II), 2016 U.S. Tax Ct. LEXIS 33, *1 (2016).
[5]Id.
[6]Graev v. Comm’r (Graev III), 2017 U.S. Tax Ct. LEXIS 58, *1 (2017).
[7]See generally Chai v. Comm’r, 851 F.3d 190 (2d Cir. 2017).
[8]See Graev III, at *1.
[9] Notice: Section 6751(b) Compliance Issues for Penalties in Litigation, CC-2018-006, IRS Office of Chief Counsel (June 6, 2018).
[10]Id.
[11]Id.(emphasis added).
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