On March 1, 2021, the Tax Court issued its opinion in Beland v. Commissioner (156 T.C. No. 5). The underlying issue presented in Beland v. Commissioner was whether the civil fraud penalty was not timely approved pursuant to IRC § 6751(b)(1).

Background to Beland v. Commissioner

The petitioners filed a joint return for 2011.  The IRS audited the return and required the petitioners to attend an in-person closing conference.  During the conference, the revenue agent presented the petitioners with a completed, signed Form 4549 (Income Tax Examination Changes), which reflected an IRC § 6663(a) civil fraud penalty. The petitioners declined to consent to the assessment of the civil fraud penalty. Thereafter, the revenue agent obtained written approval from her immediate supervisor for the civil fraud penalty and sent the petitioners a notice of deficiency determining the same. The petitioner’s mood for partial summary judgment under IRC § 6751(b)(1), arguing that the revenue agent had not obtained timely supervisory approval before her initial determination of the penalty.

Framework for Initial Determination

The petitioners argued that the revenue agent’s report (Form 4549) embodied the first formal communication of the revenue agent’s initial determination to assert the civil fraud penalty. The IRS, on the other hand, argues that the notice of deficiency represented the first formal communication of the initial determination to assert fraud penalty.

The IRS bears the burden of production with respect to an individual taxpayer’s liability for a penalty, and he is required to present sufficient evidence showing that the penalty is appropriate. IRC § 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). The IRS’s burden of production includes establishing compliance with IRC § 6751(b)(1). See Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo. 2015-42; Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling in part 147 T.C. 460 (2016).

Specifically, IRC § 6751(b)(1) provides that “[n]o 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.” While there is no statutory or regulatory guidance on when an “initial determination” is made, the Tax Court does have developing caselaw on this issue.

In Clay v. Commissioner, 152 T.C. 223, 249 (2019), the Tax Court held that the IRS must show that written supervisory approval for any penalty was obtained before the first formal communication to the taxpayer of the initial determination to assess penalties.

In Belair Woods, LLC v. Commissioner, 154 T.C. 1, 15 (2020), the Tax Court further observed that the “initial determination” of a penalty assessment “is embodied in the document by which the [IRS] Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.”

Next, in Oropeza v. Commissioner (Oropeza II), 155 T.C. No. 9, *10 (Oct. 13, 2020), the Tax Court held that, “[d]epending on how a particular examination is conducted, the taxpayer may receive this notification in a notice of deficiency, or he may receive the notification in a document that the IRS sent him at an earlier date.” In this context, the term “initial determination” of a penalty assessment “denotes a communication with a high degree of concreteness and formality” and represents a “‘consequential moment’ of IRS action.” Belair Woods, LLC v. Commissioner, 154 T.C. at 15 (quoting Chai v. Commissioner, 851 F.3d at 220-221).

The IRS’s Unavailing Argument

The IRS argued that the notice of deficiency, which was issued after written approval of the fraud penalty was received, represented the first formal communication of the initial determination to assert the fraud penalty. Specifically, the IRS claimed (1) that the revenue agent’s work remained incomplete and an unequivocal decision to assert the fraud penalty was not made until after the Form 4549 was prepared; and (2) that appeal rights must accompany an initial determination, and only the notice of deficiency provided petitioners with a right to appeal or protest the fraud penalty.

The Tax Court was not impressed, especially since it held (not so very long ago) that a completed Form 4549 embodied an initial determination.  See Belair Woods, 154 T.C. at 11-12 (citing Oropeza v. Commissioner, T.C. Memo. 2020-111, *8); accord Carter v. Commissioner, T.C. Memo. 2020-21, *30 (finding that Letters 5153 and attached RARs that included penalties embodied an initial determination to assess penalties).

The Tax Court Explains

Presenting petitioners with the revenue agent’s report at the closing conference for an opportunity, if not expectation, to legally bind petitioners to that assessment sufficiently denoted a consequential moment in which the revenue agent had made the initial determination to impose the fraud penalty. Cf. Thompson v. Commissioner, 155 T.C. No. 5, *10 (Aug. 31, 2020) (finding that a preliminary proposal of “applicable penalties” in an offer letter during a nonfinal phase of the examination process did not support a finding of an initial determination); Kestin v. Commissioner, 153 T.C. 14, 29-30 (2019) (finding that an IRS letter giving a “stern” and “contingent…warning” of a possible penalty did not constitute an initial determination).

The revenue agent’s report that was provided to the petitioners included the title “Income Tax Examination Changes” without additional text indicating to petitioners that the form was meant to serve as a discussion tool for purposes of the meeting or that the fraud penalty within it was preliminary.[1]  Further, it contained the revenue agent’s signature (electronic is enough), a specific fraud penalty of a determinate amount, and a signature box for petitioners to consent to the assessment of that penalty.

Finally, when the petitioners refused to sign the revenue agent’s report or consent to extend the limitations period, the revenue agent informed them that the next step would be to close the petitioners’ exam and to issue a notice of deficiency for the unagreed items in the revenue agent’s report, thereby confirming that the fraud penalty contained in the revenue agent’s report was in no way tentative and that no further substantive examination work remained.

Takeaway from the Opinion

An initial penalty determination need not be communicated by letter. Rather, the Tax Court’s focus is on the document and the events surrounding its delivery that formally communicate to the taxpayer the IRS’ decision to definitively assert penalties.  Such communication may occur in person during a formal IRS meeting held at the final stage of the examination process.  See, e.g., Tribune Media Co. v. Commissioner, T.C. Memo. 2020-2, *16-*18 (holding that suggestion of penalties during informal discussion without an accompanying formal document was insufficient as a communication of an initial determination).  Whether the revenue agent intended the revenue agent’s report just for “communication purposes” does not matter a lick to the Tax Court; rather, the court looks at “what the IRS actually communicates to the taxpayer.”

Further, it does not matter that appeal rights were not available to the petitioners when the revenue agent presented the Form 4549 to the petitioners.  Appeal rights are not a “necessary component of an initial determination.”  See Carter, T.C. Memo. 2020-21, at *17.

(156 T.C. No. 5) Beland v. Commissioner

Footnote:

[1] IRM 4.10.8.4.2 requires that any revenue agent’s report meant to be used for informational purposes only, i.e., not for the proposal of a tax liability, is to be labeled “FOR INFORMATION ONLY”; cf. Tribune Media Co. v. Commissioner, T.C. Memo. 2020-2, at *19 (finding that Form 5701, Notice of Proposed Adjustment, that included penalties with disclaimer text “proposed adjustment” fell short of an initial determination).

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