Section 6751(b) and Assessable Penalties
Section 6751(b) of the Code has been a potent weapon for taxpayers since the Second Circuit held in Chai that certain penalties are not valid without written managerial approval. See Chai v. Comm’r, 851 F.3d 190 (2d Cir. 2017). In Chai, the Second Circuit reasoned that written managerial approval must occur “no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.” And, after the decision in Chai, the Tax Court has gone further in holding that the IRS must obtain written managerial approval of certain penalties before the IRS “formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.” See, e.g., Clay v. Comm’r, 152 T.C. 223 (2019). For more detailed information on Section 6751(b), readers can view my article in The Tax Adviser here.
But not all civil penalties in the Code are subject to deficiency procedures—i.e., they do not require the IRS to issue a statutory notice of deficiency to provide the taxpayer with judicial review prior to assessment. These so-called “assessable penalties” may be assessed at any time by the IRS prior to the IRS providing notice of the civil penalty to the taxpayer. Although, in some instances, the IRS will provide notification of the proposed civil penalty prior to making the assessment to permit the taxpayer to contest the penalty determination administratively.
In light of Section 6751(b)’s new significance after Chai, taxpayers and tax professionals have wrestled with how Section 6751(b) applies to assessable penalties. No doubt, the IRS must comply with Section 6751(b) and obtain written managerial approval prior to making the assessment—but, does the IRS similarly have to obtain written managerial approval of an assessable penalty prior to making a formal communication to the taxpayer regarding the penalty determination?
For some time, it seemed that the United States Tax Court had answered this riddle in early 2020 when it issued its decision in Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r, 154 T.C. No. 4 (Jan. 16, 2020). In that case, the Tax Court held that the IRS was required to obtain written managerial approval of a Section 6707A penalty (i.e., an assessable penalty) prior to formally communicating the penalty determination to the taxpayer.
The United States appealed the decision in Laidlaw’s Harley Davidson Sales to the Ninth Circuit Court of Appeals. The Ninth Circuit issued its opinion in that case on March 25, 2022. This article discusses that opinion.
In 1999, Laidlaw’s Harley Davidson (“LHD”) became a participating employer in a welfare benefit plan referred to as the Sterling Benefit Plan (the “Plan”). Later, the IRS concluded that the Plan was a “listed transaction,” which gave rise to certain reporting requirements. If taxpayers failed to comply with the reporting requirements, they could be subject to penalties under Section 6707A for failing to disclose their participation in Plan on their tax returns.
In 2009, LHD filed an original return without disclosing its participation in the Plan. In December 2010, LHD filed several IRS Forms 8886, Reportable Transaction Disclosure Statement, in which it first disclosed to the IRS its participation in the Plan during the fiscal years 1999 and 2005-2008. An IRS Revenue Agent (“Revenue Agent”) examined LHD’s tax returns and concluded that LHD should be liable for a Section 6707A penalty in the amount of $96,900. Thereafter, the Revenue Agent notified LHD of the proposed penalty by issuing a 30-day letter, dated May 26, 2011, which stated, among other things: “We are proposing the assessment of a penalty under IRC section 6707A(a) for failing to disclose [a] reportable transaction.”
LHD contested the penalty through submission of a protest letter. After the protest letter was filed with the IRS, on August 23, 2011, the Revenue Agent’s immediate supervisor signed a Form 300, Civil Penalty Approval Form (“Approval Form”), providing written approval of the Section 6707A penalty. When LHD’s appeal proved unsuccessful, the IRS assessed the Section 6707A penalty, in the amount of $96,900, on September 16, 2013.
Because LHD failed to pay the Section 6707A penalty, the IRS issued a notice of intent to levy and notice of LHD’s right to a collection due process (“CDP”) hearing. On May 21, 2014, after providing LHD with a CDP hearing, the IRS Office of Appeals sustained the Section 6707A penalty.
LHD filed a timely petition with the United States Tax Court in June 2014. Later, LHD amended its petition to assert that the IRS had failed to comply with Section 6751(b), rendering the civil penalty unlawful. The Tax Court agreed with LHD and disallowed the Section 6707A penalty. The United States government appealed the decision.
The Ninth Circuit’s Majority Decision: Section 6751(b) Satisfied.
In a 2-1 decision, the Ninth Circuit majority held in favor of the IRS. Specifically, it agreed with the IRS’s argument that it was permitted under Section 6751(b) to obtain written managerial approval of the Section 6707A penalty at any time prior to the assessment of the penalty because the IRS supervisor had discretion when it approved of the penalty to make the penalty determination. According to the Ninth Circuit, discretion meant that the supervisor had the authority to either approve or not approve of the penalty when the supervisor did so.
Under this reading of Section 6751(b), the Ninth Circuit held that the IRS had complied with that provision when the supervisor signed the Approval Form on August 23, 2011, which was prior to the date the penalty was assessed on September 16, 2013. For future cases in that circuit, the Ninth Circuit cautioned “that § 6751(b) requires written supervisory approval before the assessment of the penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment.”
The Ninth Circuit’s Dissenting Opinion: Section 6751(b) Not Satisfied.
Judge Berzon disagreed with the majority opinion. According to him, the 30-day letter was “conditionally operative” in that the penalty would become automatically effective unless LHD objected to it. Judge Berzon further stated:
It is to me substantially more likely that the form letter [i.e., the 30-day letter] used in this case is indicative of how the Internal Revenue Service actually operates. That is, the agency does treat initial determinations such as the one presented in the 30-day letter as automatically effective unless objected to. The agency’s practice thus informs the meaning of the statute, which, carefully read, does not clearly have the unlikely meaning the majority adopts.
Judge Berzon also pointed out that the majority opinion’s reading of Section 6751(b) reads the term “initial determination” out of the statute. To Judge Berzon, “[i]f the approval requirement for the ‘initial determination’ really could be satisfied so late in the game, it would be either a pointless requirement or a perverse one.”
The Ninth Circuit’s decision in Laidlaw’s is not a taxpayer-friendly one. Indeed, it is hard to fathom any set of circumstances in which an IRS supervisor would lack authority to approve or disapprove of an assessable penalty prior to the actual assessment of the penalty. Taxpayers and tax professionals should stay tuned to see whether other circuit courts agree with the decision in Laidlaw’s.