Supervisory penalty approval must only precede assessment, not first formal notice

The Ninth Circuit, in a 2-1 decision, held that the IRS had properly obtained written managerial approval of a penalty imposed on the taxpayer, reversing a Tax Court decision.

Facts: The taxpayer, a C corporation, participated in a purported welfare benefit plan that was a listed transaction, and it failed to disclose that participation to the IRS, as required by Sec. 6011, on its fiscal 2008 Form 1120, U.S. Corporation Income Tax Return. When the IRS examined the taxpayer’s 2008 return, the revenue agent issued a 30-day letter to the taxpayer, which proposed to assert a penalty under Sec. 6707A for failing to disclose a reportable transaction. The 30-day letter was the first formal communication to the taxpayer of the IRS’s determination to assess a Sec. 6707A penalty. Some three months after the 30-day letter was sent, the revenue agent’s immediate supervisor approved the penalty assertion and signed a Form 300, Civil Penalty Approval Form.

After Appeals sustained the penalty proposal, the taxpayer filed a Tax Court petition, challenging the IRS’s notice of determination for failing to comply with the written supervisory approval requirement of Sec. 6751(b)(1). Under Sec. 6751(b)(1), the IRS generally cannot assess a penalty unless the initial determination of the assessment is “personally approved (in writing) by the immediate supervisor of the individual making such determination.”

The Tax Court held that the Sec. 6751(b)(1) written supervisory approval requirement applies to the Sec. 6707A penalty. It also held that the proposal of a penalty assessment in the 30-day letter was an “initial determination” for purposes of Sec. 6751(b)(1) that required written supervisory approval. Because the IRS obtained written supervisory approval after the 30-day letter was sent, the Tax Court held that it had failed to comply with Sec. 6751(b)(1), and the court granted the taxpayer’s motion for summary judgment (Laidlaw’s Harley Davidson Sales, Inc., 154 T.C. No. 4 (2020)). The IRS appealed to the Ninth Circuit.

Issues: The question before the appeals court was whether the IRS had complied with Sec. 6751(b)(1) written supervisory approval requirement. The IRS argued that Sec. 6751(b)(1) requires that it secure supervisory approval only before the assessment of a penalty. The taxpayer, on the other hand, pointed to Tax Court precedent (Clay, 152 T.C. 223 (2019)) holding that supervisory approval is required before the IRS “formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty” and argued that the 30-day letter embodied that first formal communication.

Holding: The Ninth Circuit held (with one judge dissenting) that Sec. 6751(b) requires written supervisory approval only before assessment of the penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment. It rejected the Tax Court’s holding that Sec. 6751(b)(1) requires supervisory approval before the IRS formally communicates a proposed penalty to a taxpayer because the statute does not make any reference to the communication of a proposed penalty to the taxpayer, much less a “formal” communication; it merely says “No penalty . . . shall be assessed” without written approval by a supervisor.

In this case, the court found, the supervisor gave written approval of the initial penalty determination before the penalty was assessed and while she still had discretion to withhold approval. The court held that, while the 30-day letter threatened assessment of the penalty, it did not assess a penalty; the penalty was not actually assessed until after the taxpayer’s administrative appeal was unsuccessful — some two years after the supervisor had signed the Form 300, providing written approval.

The Ninth Circuit concluded that the IRS had therefore satisfied Sec. 6751(b). Accordingly, the appeals court reversed the Tax Court’s grant of the taxpayer’s motion for summary judgment and remanded the case for further proceedings.

• Laidlaw’s Harley Davidson Sales, Inc., No. 20-73420 (9th Cir. 3/25/22)

— Alistair M. Nevius, J.D., is the JofA‘s editor-in-chief, tax.