Procedural Oversight by IRS Turns Out to Be a Good Weapon for Taxpayers

Good news for taxpayers: a procedural requirement on the IRS’s part that historically had not been strictly enforced has recently risen above the surface. Taxpayers under audit, in particular those litigating in Tax Court, might be able to use this as an additional weapon to protect their rights against the IRS.

Pursuant to section 6751(b) of the Internal Revenue Code, the IRS may not assess any penalty “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.” In other words, the IRS is required to provide written managerial approval before making a determination of tax penalties. The timing of this written approval requirement has been litigated over the last couple of years.  

Here is how the IRS generally assesses penalties: first, before a penalty can be assessed, the IRS must determine that the taxpayer has a tax deficiency; second, the IRS then issues a notice of deficiency asserting its intent to assess that tax deficiency; third, the taxpayer has 90 days to file a petition in Tax Court to petition against the deficiency. If the taxpayer does not file the petition, then the tax deficiency is assessed.

In Graev v. Commissioner, 147 T.C. No. 16, No. 30638-08, 2016 WL 6996650 (2016), the Tax Court seemed to believe that the written approval of the initial penalty determination could be provided at any time prior to the Tax Court’s decision on the penalty became final and the IRS assessed the penalty. However, the U.S. Court of Appeals for the Second Circuit disagreed in Chai v. Commissioner, No. 15-1653 (L), 2017 BL 85570 (2d Cir. Mar. 20, 2017), and held that the written approval of the initial penalty determination must be provided no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty. 

The Second Circuit’s holding applies to all kinds of penalties under Title 26 of the U.S. Code, which is the Internal Revenue Code, such as the accuracy-related penalty, the civil fraud penalty asserted against income tax or penalties for failure to file certain information returns, etc. However, since FBAR penalties are U.S. Code Title 31 penalties, the written approval requirement does not apply.

Therefore for taxpayers, in particular those in Tax Court litigation who have been assessed penalties by the IRS, it is important to review the files to locate the managerial approval the IRS was supposed to obtain prior to making its initial determination of the penalty. If the written approval is missing, then it is important to consult with legal counsel to know what rights and claims the taxpayer has against the IRS for its failure to comply with this procedural requirement.