Tax Court in Brief | Castro v. Comm’r | IRS Compliance with Written Supervisory Approval Requirement for Accuracy-Related Penalties

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The Tax Court in Brief – December 26th – December 30th, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation:  The Week of December 26th, 2022, through December 30th, 2022

Castro v. Comm’r, T.C. Memo. 2022-120 December 19, 2022 |J. Marvel | Docket No. 2386-17

Short Summary: After an examination by a Revenue Agent, the IRS issued to the taxpayers a notice of determination of income tax deficiencies, a tax addition, and an accuracy-related penalty. In closing the examination, the Revenue Agent issued a report containing calculations of the deficiencies, section 6662 penalties, and additions to tax under sections 6651(a)(1) and (2) and 6654. Along with the report, the Revenue Agent provided to his supervisor (the “Group Manager”) a Letter 950. The Letter 950 is a form letter that informs the taxpayer the Revenue Agent has issued a report and identifies the taxpayer’s options in responding to the report. The supervising Group Manager signed the report and the IRS sent it the same day to the taxpayers.

Around 7 weeks after the taxpayers received the report, the Group Manager reviewed the report and determined that several of the penalties were not computed correctly. In response to that determination, the Revenue Agent recalculated the additions and penalties. Then around 3 months later, the Revenue Agent issued a revised report that reflected the recalculations. After another few weeks, the Revenue Agent prepared his “final penalty lead sheet” and closed the examination. After the examination closed, the Group Manager reviewed the final report and signed the Civil Penalty Approval Form.

Key Issue:  Whether the IRS established its compliance with the written supervisory approval requirement of section 6751(b)(1) when it determined accuracy-related penalties under section 6662(a) against petitioners for the tax years in question. Petitioners argued that the Group Manager’s execution of the Revenue Agent’s revised report after closing of the examination showed conclusively that he did not approve the assertion of accuracy-related penalties until well after the IRS sent the Letter 950. Respondent contended that the Group Manager’s signature on the Letter 950 mailed to the petitioners with the original audit report is sufficient prior written supervisory approval.

Primary Holding: Respondent established conclusively that Group Manager timely approved the assertion of accuracy-related penalties in writing by signing the Letter 950 presented together with the Revenue Agent’s report. His later actions advising of miscalculations and approving the revised computations did not negate that timely approval.

Important Points of Law:

Pursuant to section 6662(a), the Commissioner may impose an accuracy-related penalty on any portion of an underpayment of tax required to be shown on a return if the underpayment is attributable to a “substantial understatement of income tax.” § 6662(a), (b)(2), (d).

In grappling with the meaning of the mandate in section 6751(b)(1) (the prior written supervisory approval requirement), the Tax Court has noted that “the ‘initial determination’ of a penalty assessment . . . is embodied in the document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.”6 Belair Woods, LLC v. Commissioner, 154 T.C. 1, 15 (2020).

If the taxpayer challenges penalty determinations, “the Commissioner must come forward with evidence of penalty approval as part of his initial burden of production.” Frost v. Commissioner, 154 T.C. 23, 34 (2020). As part of this burden, the Commissioner must produce evidence that the IRS complied with section 6751(b)(1), requiring that certain penalties be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” See Graev v. Commissioner, 149 T.C. 485, 492–93 (2017), supplementing and overruling in part 147 T.C. 460 (2016).

Upon meeting the burden of production by the IRS, the taxpayer must come forward with contrary evidence.” Id.  But shifting of the burden to the taxpayer does not permit petitioners to engage in a roving cross-examination of the “depth or comprehensiveness of the supervisor’s review.” Belair Woods, 154 T.C. at 17 (citing Raifman v. Commissioner, T.C. Memo. 2018-101, at *61). The only relevant question is whether petitioners can present evidence contradicting the Commissioner regarding timely approval as required by section 6751(b)(1).

A manager’s signature on a Letter 950 that encloses a Revenue Agent’s report, which asserts penalties, is sufficient to prove compliance with section 6751(b)(1) in the absence of contrary evidence. See Patel v. Commissioner, T.C. Memo. 2020-133, at *10–11, *25–26; Flume v. Commissioner, T.C. Memo. 2020-80, at *34–35.

The Tax Court does not require that written supervisory approval take any particular form or comply with IRS’s own internal guidance. See Palmolive Bldg. Invs., LLC v. Commissioner, 152 T.C. 75, 85–86 (2019).

The IRS’s use of a form other than the one prescribed by internal administrative regulations does not preclude a finding that the supervisory approval requirement has been satisfied. What must be in writing to satisfy section 6751(b)(1) is the supervisor’s approval.

Insights: In taking action adverse to a taxpayer, just because the IRS may not have followed a particular guideline or procedure does not meet the taxpayer has a winnable case.  The Courts will not always require that the IRS strictly follow administrative procedures that are not mandated by a statute or regulation. The relevant touchstone is whether the IRS had complied with requirements established by law.