The Tax Court’s recent decision in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. No. 4 (2020), addresses section 6751(b)’s requirement for supervisory approval in the context of a section 6707A penalty for reportable transactions. The Tax Court addressed the question of whether section 6751(b)(1)’s supervisory approval requirement applies to a section 6707A assessable penalty. The answer: Yes, it does apply. And in the case of the section 6707A assessable penalty (at issue in the Laidlaw’s case), section 6751(b)(1) requires that the IRS obtain written supervisory approval before it formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.
The issue in Laidlaw’s arose many years after the assessment and in the context of a Collection Due Process hearing (“CDP” hearing). Laidlaw had engaged in a “listed transaction” and failed to disclose the transaction on its tax return. It did subsequently amend its return and file an IRS Form 8886 to disclose the listed transaction.
The IRS ultimately assessed a section 6707A penalty. However, before doing so, the revenue agent assigned to the case mailed a “30-day letter” to the taxpayer stating the IRS’s initial determination that the penalty applied. Approximately a month later, the IRS agent obtained her supervisor’s approval on a Civil Penalty Approval Form. The penalty was originally asserted and upheld.
Years later, the taxpayer received a notice of intent to levy (an I.R.C. section 6330 notice). The taxpayer requested a CDP hearing. This obligated IRS Appeals to verify that the IRS had originally complied with section 6751.
Section 6751’s Supervisory-Approval Requirement
Section 6751(b)(1) provides that:
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.
When Congress enacted section 6751(b)(1), it did so with the purpose of helping to ensure “that penalties [w]ould only be imposed where appropriate and not as a bargaining chip.” Chai v. Commissioner, 851 F.3d 190, 219 (2d Cir. 2017) (quoting S. Rept. No. 105-174, at 65 (1998), 1998-3 C.B. 537, 601), aff’g in part, rev’g in part T.C. Memo. 2015-42; Clay v. Commissioner, 152 T.C. 223, 248 (2019); accord Roth v. Commissioner, 922 F.3d 1126, 1132-1133 (10th Cir. 2019), aff’g T.C. Memo. 2017-248.
The IRS’s compliance with section 6751(b)(1) is appropriately considered in a CDP case. ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. at 148-154.[1] If, in the course of that consideration, it is determined that the IRS failed to secure written supervisory approval for a penalty subject to section 6751(b)(1), then the penalty cannot be sustained. See Graev III, 149 T.C. at 493.
As the Tax Court stated in Graev III, 149 T.C. at 495 n.17:
By its terms sec. 6751(b) applies to the assessment of all penalties under this title—i.e., title 26, the Internal Revenue Code. This encompasses not only penalties subject to deficiency procedures but a great many so-called assessable penalties in subch. B of ch. 68, secs. 6671 through 6725, which are generally not subject to deficiency procedures. [Emphasis altered.]
While assessable penalties were not at issue in Graev III, the Tax Court has addressed several assessable penalties since it was decided, and has held that the section 6751 requirement applies to the assessable failure-to-file penalty of section 6699[2] and to the assessable penalty of section 6701 for aiding and abetting understatement of tax liability.[3] In Laidlow, the Tax Court reached the question whether the supervisory approval requirement of section 6751(b)(1) applies to the assessable penalty of section 6707A. It answered in the affirmative, holding that the section 6751 required does apply in the context of the section 6707A penalty.
Section 6751 applies to an Assessable Section 6707A Penalty
The Tax Court reasoned that the penalty for failure to report a “reportable transaction” is repeatedly identified as a “penalty” in the title and text of section 6707A. The provision is plainly—in the language of section 6751(b)(1)—”under this title” (i.e., under title 26 of the United States Code).
While section 6751(b)(2) does provide for two exceptions, the Tax Court found that neither applies in the context of section 6707A penalties. First, while written supervisory approval is not required for “any addition to tax under section 6651, 6654, or 6655,” sec. 6751(b)(2)(A), this list of exceptions does not include section 6707A.
Second, sec. 6751(b)(2)(B) provides that written supervisory approval is not required for “any other penalty automatically calculated through electronic means.” The Tax Court noted, however, that the IRS did not argue that section 6707A constitutes a penalty “automatically calculated through electronic means.” It added that, in any event, it could not be. The parties have stipulated that the revenue agent—not a computer—”made the initial determination to assert the I.R.C. § 6707A penalty against petitioner,” so the penalty was not an instance in which “the penalty was determined mathematically by a computer software program without the involvement of a human IRS examiner”. See Walquist v. Commissioner, 152 T.C. 61, 70 (2019). Accordingly, the Tax Court concluded that the written supervisory approval requirement of section 6751(b)(1) applies to the assessable section 6707A penalty.
The Timing of the Written Supervisory Approval
The Tax Court then addressed the final issue: at what point in time is the written supervisory approval required? The court held that in the case of the assessable penalty of section 6707A, section 6751(b)(1) requires the IRS to obtain written supervisory approval before it formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.
The Tax Court’s relevant reasoning and analysis follows:
We arrive now at the crux of this case: whether the written supervisory approval of the disputed section 6707A penalty came too late. On this point, the Commissioner argues that under section 6751(b)(1), the IRS is required only to secure supervisory approval for assessable penalties before the time of assessment. LHDS, by contrast, urges that approval must precede the first proposal of the penalty by the IRS to the taxpayer.
Our recent Opinion in Clay v. Commissioner, 152 T.C. at 249, held that when it is “communicated to the taxpayer formally * * * that penalties will be proposed”, section 6751(b)(1) is implicated. We concluded that the issuance of an RAR and a 30-day letter embodied an “initial determination” for purposes of section 6751(b)(1), and we held that the IRS had not complied with that provision because it did not have penalty approval in hand before formally communicating the determination of those penalties to the taxpayers for the first time in the 30-day letter. Id. at 249-250.
Though Clay was a deficiency case, we did not intimate that our holding was limited to the deficiency context. On the contrary, in view of our previous Opinions in ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. at 148-154 (applying section 6751(b)(1) in a CDP case), and Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. at 82-86 (applying section 6751(b)(1) in a TEFRA partnership case), the reasoning of Clay applies with equal force in non-deficiency cases, including those involving assessable penalties. Accordingly, we now hold that in the case of the assessable penalty of section 6707A here at issue, section 6751(b)(1) requires the IRS to obtain written supervisory approval before it formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.
The Laidlaw’s case addresses an issue that is likely to recur: the application of section 6751(b) to section 6707A penalties for reportable transactions. Taxpayers facing years-old tax shelter-related penalties may be entitled to penalty relief depending upon the circumstances.
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[1] The IRS’s compliance with section 6751(b)(1) is also appropriately considered in a deficiency case, see Graev v. Commissioner(Graev III), 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016); and in a TEFRA partnership case premised on a final partnership administrative adjustment (“FPAA”), see Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. 75, 82-86 (2019), among other contexts.
[2] In ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. 138, 154 (2019), the Tax Court held that section 6751(b)(1) was potentially applicable but did not apply to the section 6699 penalty at issue in that case because it had been “automatically calculated through electronic means” and was therefore excepted from the written supervisory approval requirement under section 6751(b)(2)(B).
[3] See Kapp v. Commissioner, T.C. Memo. 2019-84, at *94 (“For penalties under section 6701, respondent’s burden of production includes the burden of producing evidence establishing that the penalties were `personally approved (in writing) by the immediate supervisor of the individual making such determination’ as required by section 6751(b)”).
