On January 6, 2020, the Tax Court issued a Memorandum Opinion in the case of Chicago Baseball Holdings, LLC v. Commissioner (T.C. Memo. 2020-2). The issue presented in Chicago Baseball Holdings was whether prior written supervisory approval of penalties was required before the IRS communicates the penalties to the taxpayer for the first time, even if such communication was informal.
The Tax Court has jurisdiction to redetermine a deficiency if a taxpayer files a timely petition challenging a notice of deficiency. IRC § 6213(a). This jurisdiction includes the authority to redetermine any penalties or additions to tax and to readjust the adjustments made in a final partnership administrative adjustment (FPAA), if a timely petition is filed. IRC § 6214(a) (redetermination of penalties); IRC § 6226(a) (readjustment of adjustments made in FPAA). Further the Tax Court has the authority to determine all partnership items, as well as the applicability of any penalty, addition to tax, or additional amount related to an adjustment to a partnership item. IRC § 6226(f).
In redetermining whether a penalty applies, as a threshold issue, the Tax Court reviews whether the IRS complied with the prior written supervisory approval requirement of IRC § 6751(b)(1). Such review is appropriate in a deficiency proceeding, Graev v. Commissioner, 149 T.C. 485 (2017), and in a TEFRA partnership proceeding, when penalties are asserted in the FPAA. See Endeavor Partners Fund, LLC v. Commissioner, T.C. Memo. 2018-96, at *63, aff’d, 943 F.3d 464 (D.C. Cir. 2019).
Burdens of Production and Proof – Disparate Treatment of Individuals and Corporations under IRC § 7491
Any determinations made by the IRS in a notice of deficiency or in a FPAA are generally presumed to be correct, and the taxpayer bears the burden to prove that the determinations were incorrect. Tax Court Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In a proceeding regarding the liability of an individual for a penalty or addition to tax, the IRS bears the initial burden of production. IRC § 7491(c). The IRS’s burden of production requires the agency to produce sufficient evidence indicating that the relevant penalty was appropriately imposed. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
It is important to note, however, that the plain language of IRC § 7491(c) applies only to the liability of an individual, not a corporation. Thus, the IRS does not bear the initial burden of production when the penalty liability at issue is related to a corporation and not an individual. NT, Inc. v. Commissioner, 126 T.C. 191 (2006) (holding that IRC § 7491(c) does not apply to corporations). Interestingly, the IRS similarly does not generally bear the burden of proving prior written supervisory approval with respect to a corporate (or partnership-level) penalties under IRC § 6751(b)(1). Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 231-32, 236 (2018).
Congress Intended to End the Use of Penalties as “Bargaining Chip” against Taxpayers
Congress enacted IRC § 6751(b)(1) in response to concerns that the IRS had been increasingly using the threat or imposition of penalties as a strong-arm tactic or “bargaining chip” to leverage taxpayers into decidedly one-sided settlements. S. Rept. No. 105-174, at 65 (1998), 1998-3 C.B. 537, 601; 144 Cong. Rec. 7627, 7873 (1998). Notwithstanding it being on the books for a decade, few petitioners availed themselves of the protection of the statute against Uncle Sam’s unchecked penalty powers until the mid-2010s.
Application of IRC § 6751(b)(1) – The Influence of Chai on Timeliness of Approval
In the 2017 Graev case, the IRS argued that because supervisory approval of a penalty could occur at any time (even after a Tax Court proceeding), the Tax Court should never consider IRC § 6751(b)(1) in a deficiency proceeding. The Tax Court rejected this contention, finding that the Tax Court had jurisdiction in a deficiency proceeding to consider compliance with IRC § 6751(b)(1). Slow your roll, Chief.
In reaching the decision in Graev, the Tax Court relied on the Second Circuit’s decision in Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), which held that IRC § 6751(b)(1) requires written approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty. See also Endeavor Partners Fund, LLC v. Commissioner, T.C. Memo. 2018-96, at *63 (applying the same rationale to an FPAA).
Application of IRC § 6751(b)(1) – Clay Moves the Approval Needle Earlier in the Process
The Tax Court followed Graev a year and a half later with its decision in Clay v. Commissioner, 152 T.C. 223 (2019), in which the Tax Court held that IRC § 6751(b)(1) requires written supervisory approval of the initial determination no later than the earlier of (a) when the determination to assert a penalty is communicated to the taxpayer in the form of a notice of deficiency or (b) when another form of formal communication is sent to the taxpayer that (1) advises it that penalties were determined and (2) gives the taxpayer the opportunity to appeal that determination. Clay, 152 T.C. at 249. Decided in April 2019, the opinion in Clay was published during the pendency of litigation in the present matter (subsequent to the filing of the parties’ respective motions for summary judgment).
“First Proposal” of Penalty to Taxpayer not IRC § 6751(b)(1) Litmus Test
The petitioners argued that supervisory approval is required by or before the first time an IRS official “introduces the penalty into the conversation.” See Graev, 149 T.C. at 501 (Lauber, J., concurring). The petitioners’ position relies on the phrase “first proposal,” that is, when did the IRS first propose the imposition of penalties to the taxpayer. The statutory language, however, uses the word “determination” not “proposal.” Judge Buch noted in his concurring opinion in Graev that a “determination” is, by definition, authoritative or conclusive. A mere proposal is not.
No One Form Rules Them All
To satisfy the IRC § 6751(b)(1) requirement of written penalty approval, the writing must manifest the supervisor’s intent to approve the penalty. Courts have not restricted the IRS to using specific forms to comply with the written approval requirement. See Palmolive Bldg. Inv’rs v. Commissioner, 152 T.C. 75, 85-86 (2019). Simply put, a duly executed cocktail napkin would likely carry the day for the IRS.
Any written manifestation of the supervisor’s intent to approve the penalty is sufficient. The IRS has a number of forms commonly used, such as Form 300 (Civil Penalty Approval Form (Lead Sheet)), Form 8278 (Assessment and Abatement of Miscellaneous Civil Penalties), Form 4700, Form 5772, and Form 5809; however, the Chicago Baseball Holdings opinion makes clear that the IRS is not limited to even the panoply of forms used by the IRS. See also CCA-2018-006.
Bright Line Rule
The term “determination,” as used in IRC § 6751(b)(1), is embodied in a written communication to the taxpayer that definitively notifies him of a final IRS decision. Belair Woods, LLC v. Commissioner, 154 T.C. No. 1, *15 (Jan. 6, 2020). Thus, the word “determination” is not a mere suggestion, proposal, or initial informal mention of the possibility of the assertion of a penalty; it is the first formal, definitive, and conclusive written communication to the taxpayer that the IRS has determined that it will impose a penalty, which communication is generally (though need not absolutely be) accompanied by a notice of appeal rights, that triggers the IRC § 6751(b)(1) prior written approval requirement.
Original opinion: (T.C. Memo. 2020-2) Chicago Baseball Holdings, LLC v. CommissionerAdd to favorites