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Patel v. Commissioner (T.C. Memo. 2020-133)

On September 22, 2020, the Tax Court issued a Memorandum Opinion in the case of Patel v. Commissioner (T.C. Memo. 2020-133). The primary issue before the court in Patel was whether the IRS secured timely prior written supervisory approval for the penalties at issue as required by IRC § 6751(b)(1).

The (Purported) Background

I enter this case with a fair bit of skepticism, due in toto to Judge Jones’ use of the word “purported” in two of the first three sentences.  This reminds me a bit too much of a criminal defense attorney interjecting “allegedly” when the prosecutor is saying that his clients stole a bag of cash from a bank, the ink stains and powder burns still remaining on the defendant’s hands from the exploding dye pack being Exhibit A of said theft.  Sorry…”alleged” theft.

Allegedly, the petitioner-husband was an ophthalmologist and sole owner of an LLC, who engaged in a “purported” microcaptive insurance arrangement for the LLC, and who formed several related entities through which petitioners deducted “purported” insurance premiums as business expenses during the years at issue.  What makes Judge Jones’ “purported” need for using the word purported so utterly disillusioning is that no less than one sentence above, he notes that there is “no dispute as to the following facts.”  Purportedly.

In May 2017, the IRS sent the petitioners a Letter 5153 and an accompanying RAR, which proposed changes to the petitioners’ income tax for 2013 – including an adjustment to the amount of income reported for that year and the imposition of accuracy-related penalties under IRC §§ 6662(a), (b)(2), (b)(6), and (i). Like a choose your own adventure book, the petitioners were given four options to respond to the RAR. First, capitulate and full pay; second, call the IRS to discuss payment options; third, agreed to extend the period for assessment to allow Appeals to consider the case; and, fourth, do nothing, come what may (i.e., a notice of deficiency). Feeling quite roguish, the petitioners opted for option four, responding to the Letter 5153 that they were disinclined to acquiesce to the IRS’s request for extension of the period of limitations on assessment.

Seventeen days later, the RA assigned to the case submitted the first civil penalty approval form to his then-immediate supervisor, who signed the form that day. In August 2017, the IRS issued a notice of deficiency determining accuracy-related penalties under IRC § 6662(b)(6) (penalties on disallowance of claimed tax benefits by reason of a transaction lacking economic substance) and IRC § 6662(i) (penalties for underpayments attributable to a non-disclosed, noneconomic substance transaction). Importantly, the IRS also asserted IRC § 6662(b)(1) and (b)(2) penalties for the first time as alternative positions in the notice of deficiency.

Somewhat anomalously, although the IRS had expanded the examination to include the petitioners’ 2014 tax year in March 2017, no information was entered into the report generation software until June 2017, subsequent to receiving penalty approval.  In January 2018, the IRS sent the petitioners another Letter 5153 and an accompanying RAR for the 2014 tax year. As with the 2013 tax year, the RAR included imposition of accuracy-related penalties under IRC §§ 6662(a), (b)(2), (b)(6), and (i). In equally dilatory fashion, the revenue agent did not seek penalty approval from his supervisor until the day after the Letter 5153 and RAR were issued. However, the penalty approval form signed in late January 2018 included penalties for tax years 2015 and 2016. The notice of deficiency with respect to 2014 determined accuracy-related penalties under IRC §§ 6662(a), (b)(2), and (b)(6). The petitioners filed a petition for redetermination in June 2018.

In March 2019, the IRS filed an amended answer in which it asserted an accuracy-related penalty under IRC § 6662(i) for the first time. The initial determination to assert the penalty under IRC § 6662(i) was “purportedly” made by Chief Counsel, whose immediate supervisor had signed the First Amendment to the answer in February 2019 (thereby approving the assertion of the penalty under IRC § 6662(i) prior to the filing of the amended answer).

For tax years 2015 and 2016, the IRS asserted penalties under IRC § 6662(a), (b)(1), (b)(2), (b)(6), and (i) in Letter 950 and the accompanying RAR, which the RA mailed to petitioners in April 2018. The IRS did not determine the penalty under section 6662(i) in the September 2018, notice of deficiency but did assert it in its March 19, 2019, answer the petitioners’ petition to redetermine the 2015 and 2016 deficiencies.

The (Actual) Application of IRC § 6751(b)(1)

IRC § 6751(b)(1) requires the IRS to secure prior written approval by the immediate supervisor of the individual making the determination to assess the penalty against the taxpayer. The Tax Court has interpreted IRC § 6751(b)(1) to require such supervisory approval before the first formal communication to the taxpayer that demonstrates that an initial determination has been made. See, e.g., Belair Woods, LLC v. Commissioner, 154 T.C. No. 1, *24-*25 (Jan. 6, 2020); Clay v. Commissioner, 152 T.C. 223, 249 (2019); Carter v. Commissioner, T.C. Memo. 2020-21, *27.

The Tax Court will not “conduct inquiries” into whether the IRS gave sufficient consideration to the penalties proposed. Raifman v. Commissioner, T.C. Memo. 2018-101, *61. Stated differently, a stinking signature is all that is needed, so long as that signature is from the individual’s supervisor (or someone higher up on the supervisory food chain) and is obtained prior to the initial determination. As the Tax Court so eloquently put in Raifman, the “written supervisory approval requirement…requires just that: written supervisory approval.” Nothing more, nothing less.

The Initial Determination in General

The “initial determination” of a penalty, for purposes of IRC § 6751(b)(1), must be a “formal act” that resembles a determination. Belair Woods, LLC, 154 T.C. No. 1, at *15. In a deficiency context the document by which Exam formally notifies the taxpayer, in writing, that it has “completed its work and made an unequivocal decision to assert penalties” would embody the initial determination of those penalties. Id. at *24-*25; see Clay v. Commissioner, 152 T.C. at 249.  A Letter 5153 with an accompanying RAR clearly reflects the IRS’s conclusion that the taxpayers should be subject to the penalties proposed in the RAR.  Carter, T.C. Memo. 2020-121, at *30; Belair Woods, LLC, 154 T.C. No. 1, at *24-*25. The Tax Court has also rejected the argument that a “communication” cannot be an initial determination unless it provides appeal rights. Carter, T.C. Memo. 2020-121, at *29.

The Initial Determinations in Patel

Unlike the Letter 5153 and accompanying RAR, which proposed penalties under IRC § 6662(a), (b)(2), (b)(6), and (i), it was the notice of determination for 2013 and 2014 (obtained after supervisory approval was obtained) that first proposed IRC § 6662(b)(1) and (b)(2) penalties for that year.  As such, the Tax Court sustained penalties under these latter two Code sections for 2013 and 2014. Similarly, the amended answer to the petition, which first asserted additional penalties, constituted “initial determinations,” and since the IRS received prior written supervisory approval (by Chief Counsel’s supervising attorney) before amending the answer to include such penalties, these penalties passed muster as well. Purportedly.

(T.C. Memo. 2020-133) Patel v. Commissioner

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