Eleventh Circuit Sides with Ninth Circuit on Section 6751(b) Circuit Split
Introduction: Section 6751(b) and the Timing of Supervisory Approval of a Penalty
The Eleventh Circuit’s decision in Kroner v. Commissioner[1], is the latest opinion to address section 6751(b) and, specifically, the appropriate timing of the supervisory approval of a penalty.[2] The Eleventh Circuit reversed the Tax Court which held, consistent with its recent section 6751(b) jurisprudence that section 6662 penalties were disallowed because the supervisory approval did not occur before the IRS examiner sent the taxpayer a letter asserting penalties. In reversing the Tax Court, the Kroner court agreed with the Ninth Circuit’s decision in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner[3]. While the IRS has continued to unsuccessfully litigate the issue before the Tax Court[4] it has gained significant victories in two Circuit Courts whose holdings are in direct conflict with the Second Circuit’s opinion in Chai v. Commissioner[5]. Importantly, the Kroner and Laidlaw’s Harley Davidson Sales, Inc. decisions set up a circuit split on the timing of section 6751(b) supervisory approval and raise the possibility that the United States Supreme Court may resolve the dispute.
Background Facts
In Kroner, the taxpayer failed to report millions in income. After an audit, an IRS examiner sent the taxpayer a Letter 915 and an examination report detailing the IRS’s proposed changes to his tax bill and asserting penalties under section 6662. The IRS examiner’s letter asked the taxpayer to state whether he agreed with the proposed changes and if not, he could (1) provide the IRS with additional information, (2) discuss the report with the examiner, (3) discuss it instead with the examiner’s supervisor, or (4) request a conference with the IRS’s Appeals Office. The letter noted that if the taxpayer took none of those steps within ten days, the IRS would process his case based on the examination report and issue him a statutory notice of deficiency. The taxpayer timely responded to the letter and for the next several months tried to negotiate with the IRS to reach a settlement.
Subsequently, the IRS sent the taxpayer a Letter 950, this time a “30-day letter” and an updated examination report. The updated report contained the same changes as the first letter plus accrued interest. However, this second letter was signed by the examiner’s immediate supervisor and explained to the taxpayer his options for agreeing or not with the proposed changes to his taxes. On the same day that the examiner’s immediate supervisor signed the 30-day letter, she also signed a Civil Penalty Approval Form blessing the proposed penalties. The taxpayer requested a conference with the Appeals Office and again negotiated with the IRS without reaching a settlement. The IRS issued the taxpayer a statutory notice of deficiency and the taxpayer filed a timely petition in the Tax Court challenging the deficiency and the proposed penalties.
Tax Court Decision: Section 6751(b) Not Satisfied Where Supervisory Approval Did Not Occur Before Initial Determination of Penalty
The Tax Court sustained the IRS’s conclusion that the taxpayer failed to report income but disallowed the proposed penalties under its section 6751(b) jurisprudence. The Tax Court held that the IRS made its initial determination of the section 6662 penalties no later than when it had sent the taxpayer the first Letter 915. Moreover, because the initial determination was made no later than the date the IRS sent the taxpayer the Letter 915, and before the Civil Penalty Approval form was signed, respondent could not satisfy its burden of production under section 6751(b). As a result, the Tax Court held that the taxpayer was not liable for the section 6662 accuracy-related penalties.
Eleventh Circuit Decision: If Supervisory Approval Occurs Before Assessment Section 6751(b) is Satisfied.
Overview of the Eleventh Circuit’s Rationale
On appeal, the Eleventh Circuit disagreed with the Tax Court’s interpretation of the statute that, in the view of the Eleventh Circuit, “restricts communications between the IRS and a taxpayer.” The Eleventh Circuit noted the Tax Court’s holding in Clay v. Commissioner, that an initial determination of an assessment is any “communication that advises the taxpayer that penalties will be proposed.” The court also noted the Tax Court’s additional holding in Clay v. Commissioner, that a supervisor must approve the communication before it is delivered. The court interpreted the Tax Court’s holdings as reading section 6751(b) as “No penalty shall be communicated to a taxpayer until such communication has been approved by the communicator’s immediate supervisor.”
What Must be Approved
The Eleventh Circuit reversed the Tax Court and relied on the Ninth Circuit’s opinion in Laidlaw’s Harley Davidson Sales, Inc., to conclude that the IRS satisfies section 6751(b) “so long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties.” Notably, the court’s opinion takes a textualist analysis of the statute. In Kroner, the court determined that the IRS did not violate section 6751(b) because a supervisor approved the taxpayer’s penalties, and they had not yet been assessed. The Kroner court reasoned that this was the best reading of the statute because (1) it is more consistent with the meaning of the phrase initial determination of such assessment, (2) it reflects the absence of a timing requirement in the statute, and (3) “it is a workable reading in the light of the statute’s purpose.”
The Kroner court’s analysis focused on what the statute requires a supervisor to approve and when the supervisor is required to approve it. In analyzing the phrase “initial determination of such assessment,” the Kroner court stated that the word “assess” has an established legal meaning in the context of the Code, which is the act of recording a taxpayer’s liability onto the government’s books. In the context of this nomenclature, the Kroner court stated that the IRS makes a determination of assessment when it concludes it has the authority and duty to assess penalties and actually does so. It rejected the taxpayer’s arguments that the term “initial determination of such assessment” relates to the IRS’s communication with the taxpayer. Instead, the court stated that it only deals with the formal process of calculating and recording the tax debt on the government’s books. The Eleventh Circuit described this process as “ministerial.”
When Supervisory Approval Must Occur
Additionally, the Kroner court addressed the question of when supervisory approval is required for purposes of section 6751(b). It rejected the taxpayer’s arguments and the Tax Court’s holding below that an IRS supervisor must approve the initial determination of assessment before any penalty is communicated to the taxpayer. The Kroner court agreed with the Ninth Circuit’s reasoning in Laidlaw’s Harley Davidson Sales, Inc., and stated that this interpretation has no basis in the statutory text because the statute makes no reference to the communication of a proposed penalty to the taxpayer. Additionally, the Kroner court did not read anything in the statutory text requiring supervisory approval of penalties at any time before assessment.
Dual Policy Considerations
Finally, the Kroner court reasoned that its reading of the statute is workable without the Tax Court’s communication-based pre-assessment deadline for supervisory approval. Addressing the Tax Court and the Chai court’s focus on the ambiguity in the phrase “initial determination of such assessment” and the statute’s legislative history, the Kroner court stated that the other courts focused on only one purpose of the statute to the exclusion of others. The Kroner court stated that a court must evaluate statutory purpose in terms of the “full scope of a statute’s application.” The court believed that supervisory review serves two functions: (1) ensuring penalties are only imposed when appropriate, and (2) preventing penalties from being used only as bargaining chips during pre-assessment negotiation. It believed the Tax Court and Second Circuit focused exclusively on the latter while not addressing the former.
As to the latter, the Kroner court rejected the idea that the statute needs a pre-assessment deadline to prevent penalties from being used improperly as bargaining chips because in its view, “negotiations do not end after a penalty is assessed.” It hypothesized that after assessment the IRS would issue a tax lien and collecting via levy, which would give taxpayers access to administrative and judicial remedies that might encourage continued negotiations. Alternatively, the taxpayer could decide to pay the penalty and sue the government for a refund in District Court, also spurring further negotiation. For the sake of argument, the Kroner court accepted the Chai court’s focus on pre-assessment bargaining but reasoned that a pre-assessment deadline is not necessary because taxpayers and agents know that supervisory approval is required and a supervisor that approves an improper penalty, regardless of when it was approved, would be responsible for such approval. Accordingly, that disincentivizes agents from proposing improper penalties for purposes of negotiation. Finally, the Kroner court returned to its dual-purpose view of the statute and that the Tax Court and the Chai court focused too heavily on one purpose of the statute – to prevent the penalties from being used as bargaining chips – to the detriment of the other purpose of the statute which is to ensure that penalties are imposed where appropriate.
Observations on Kroner v. Commissioner
The Eleventh Circuit takes a different view than the Tax Court on what the initial determination means and when supervisory approval is required. As discussed, the Kroner court takes a textualist approach in analyzing the statute and tries to balance the statute’s dual-purposes. The Kroner court stated that the word “initial” merely describes what must be approved and not when. However, if the word initial only describes what must be approved, query whether the Eleventh Circuit would hold that there can only be one “initial determination,” (i.e., the what), and if the initial determination was deficient in some way, whether the IRS could not make a subsequent determination to assess a penalty?
Additionally, the Kroner court’s emphasis of one purpose of section 6751(b) – to ensure that penalties are only imposed when appropriate – does not account for the nature of a deficiency case and the Tax Court’s role in deciding whether liabilities should be assessed. In deficiency cases where the taxpayer has filed a petition with the Tax Court for a redetermination of a deficiency, the deficiency may not be assessed until a decision of the Tax Court is final. Once the Tax Court’s decision is final the assessment of the penalty is mandatory and the IRS supervisor’s approval at that point would be a ministerial act. Moreover, if supervisory approval can be made at any time prior to assessment consider whether that undermines the other stated purpose of the statute to prevent such penalties from being used as leverage in pre-assessment negotiations.
It is unclear whether this circuit split between the Eleventh and Ninth Circuits on the one hand, and the Second Circuit on the other, may be resolved by the United States Supreme Court. This issue would appear to be a good candidate for certiorari as section 6751(b) is implicated in every case in which the IRS determines a deficiency that also imposes a penalty. However, unless or until the United States Supreme Court addresses the issue, it is governed by the Golsen[6] rule, which requires the Tax Court to follow precedent of the Circuit to which a case is appealable. Accordingly, for cases that are appealable to the Eleventh Circuit (Florida, Georgia, and Alabama) and the Ninth Circuit (Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington), taxpayers will not be able to argue that section 6751(b) was not met when a penalty was communicated to the taxpayer before supervisory approval, but the approval was before assessment. The IRS is likely to continue to litigate the issue in other circuits that have not yet addressed it. Taxpayers should consult with their advisors on developments in this area to determine the best approach for contesting tax penalties in light of the circuit split.
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[1] 48 F.4th 1272 (11th Cir. 2022).
[2] For a detailed discussion on Graev v. Commissioner, 149 T.C. 485 (2017), supplementing and overruling in part 147 T.C. 460 (2016), its progeny, and the history of the Tax Court litigation on section 6751(b) see our prior blog post.
[3] 29 F.4th 1066 (9th Cir. 2022). For a detailed discussion on the Laidlaw case see our prior blog post.
[4] See The Cannon Corp v. Commissioner; No. 12466-16, Clay v. Commissioner, 152 T.C. 223 (2019), aff’d on other grounds, 990 F.3d 1296 (11th Cir. 2021); Oropeza v. Commissioner, 155 T.C. No. 9 (2020); Belair Woods, LLC v. Commissioner, 154 T.C. 1 (2020).
[5] 851 F.3d 190 (2d. Cir. 2017).
[6] Golsen v. Commissioner, 54 T.C. 742 (1970).
