The Tax Court has attempted to create a bright line test to deal with the issue of how to handle the requirement under IRC §6751(b) that supervisory approval must be obtained before the “initial determination of a penalty assessment” in the case of Belair Woods LLC et al. v. Commissioner, 154 TC No. 1.[1]

IRC §6751(b) reads as follows:

(b) Approval of assessment

(1) In general

No 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 or such higher level official as the Secretary may designate.

(2) Exceptions Paragraph (1) shall not apply to—

(A) any addition to tax under section 6651, 6654, or 6655; or

(B) any other penalty automatically calculated through electronic means.

In this case the IRS had sent the taxpayer a Letter 1807 in December of 2012 inviting the tax matters partner and other partners to a closing conference to discuss the IRS’s proposed adjustments. The summary report enclosed with the letter proposed to deny a $4.778 million charitable deduction and proposed either a gross overvaluation penalty under §6662(h) or the penalties for negligence and substantial understatement of income tax under IRC §§6662(c) and (d). The report did contain information on potential defenses against the penalty.[2]

Later the agent prepared a Civil Penalty Approval Form. That form contained boxes for the agent’s supervisor to indicate her approval or lack of approval for each proposed penalty. The agent indicated she was in favor of imposing the gross overvaluation penalty under §6662(h) as the “primary position,” as well as penalties under §§6662(c) and (d) as an “alternative.” In August of 2014 the agent forwarded the case file to Cheryl Mixon, her then-supervisor. Ms. Mixon signed the form indicating her approval of the penalty.[3]

Ms. Mixon had not been the agent’s supervisor at the start of the exam. In fact, the agent had a discussion regarding the penalties with her previous supervisor in late 2012, but that supervisor was not involved in the final approval.[4]

Following Ms. Mixon’s approval, the IRS sent the taxpayer a “TMP 60-Day Letter” (60-day letter). The letter indicated the IRS planned to assert the penalties listed on the Civil Penalty Approval Form along with the tax assessment. The letter indicated the taxpayer could accept the adjustments or appeal them to the IRS Appeals Office.[5]

The taxpayer argued that the initial determination of assessment of the penalty contemplated by the statute took place when the Letter 1807 was issued indicating the IRS was proposing penalties as their position entering the conference. At that time there had been no approval by a supervisor of the penalties and, thus, the penalties now could not be asserted by the IRS.[6]

The IRS contended that no such approval was needed prior to the 60-day letter, as that should be held to be the initial determination of the assessment of the penalty. As the approval was received before that date, the IRS argued that they were not barred from asserting the penalties that Ms. Mixon had approved.

The majority opinion begins by noting the phrase “initial determination of an assessment” is not completely clear:

The phrase “initial determination of * * * [an] assessment” appears nowhere else in the Code. It is what scholars of ancient Greek call a “hapax legomenon,” a word or phrase that occurs only once in a document or corpus. Graev v. Commissioner, 149 T.C. 485, 500 (2017) (Lauber, J., concurring), supplementing and overruling in part 147 T.C. 460 (2016). And the phrase has no ordinary meaning, at least not in tax law, because the words “determine” and “assessment” are not normally joined together. See Chai v. Commissioner, 851 F.3d 190, 218-219 (2d Cir. 2017) (“[O]ne can determine a deficiency * * * and whether to make an assessment, but one cannot determine an assessment.” (internal citations and quotation marks omitted)), aff’g in part, rev’g in part T.C. Memo. 2015-42.

Confronted with this ambiguity, this Court and others have looked to the statute’s legislative history as a possible guide to its interpretation. See id. at 219; Clay, 152 T.C. at 248; Williams v. Commissioner, 151 T.C. 1, 8-10 (2018). The Senate Finance Committee stated Congress’ belief that penalties should not be used to gain inappropriate leverage over taxpayers, but “should only be imposed where appropriate and not as a bargaining chip.” S. Rept. No. 105-174, at 65 (1998), 1998-3 C.B. 537, 601.

Given this legislative purpose, the Second Circuit reasoned in Chai that managerial approval would not be meaningful if deferred until after the taxpayer’s liability had been determined, e.g., by a decision of this Court. To be meaningful, supervisory approval must be secured at a time “when the supervisor has the discretion to give or withhold it.” Chai, 851 F.3d at 220. The Second Circuit accordingly interpreted section 6751(b)(1) to “require[ ] 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.” Id. at 221. In partnership cases, we have ruled similarly that supervisory approval must be obtained no later than the date on which the IRS issues the FPAA. See Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. 75, 89 (2019); Sugarloaf Fund, LLC v. Commissioner, T.C. Memo. 2018-181, at *22; Endeavor Partners Fund, LLC v. Commissioner, T.C. Memo. 2018-96, at *65, aff’d, 943 F.3d 464 (D.C. Cir. 2019).[7]

The majority concludes that in this case the 60-day letter is the appropriate point at which to force the IRS to have met the supervisory approval standard.

In Clay the penalties were formally communicated to the taxpayers in a revenue agent report (RAR) accompanied by a 30-day letter, which entitled them to appeal by filing a protest with the Appeals Office. We concluded that the “initial determination for purposes of section 6751(b) was made no later than * * * when * * * [the Commissioner] issued the RAR * * * proposing adjustments including penalties and gave * * * [the taxpayers] the right to protest those proposed adjustments.” Ibid. Because the IRS agent neglected to secure supervisory approval for the penalties before the Examination Division, by issuing a 30-day letter, formally communicated to the taxpayers its definite decision to assert penalties, we held that the Commissioner had failed to show compliance with section 6751(b)(1).

In the instant case the 60-day letter determining penalties under section 6662(b), (c), and (h) was issued on March 9, 2015. That letter, like the 30-day letter in Clay, formally communicated to Belair the Examination Division’s definite decision to assert those penalties, thus concluding the Examination Division’s consideration of the case. See Internal Revenue Manual (IRM) pt. 8.19.1.6.8.4(3) (Oct. 1, 2013) (“The 60-day letter is the equivalent of a 30-day letter in deficiency proceedings. It gives the partners the opportunity to appeal the findings of the examiner.”).

Group Manager Mixon, RA Pennington’s immediate supervisor, signed a Civil Penalty Approval Form approving assertion of the first three penalties on September 2, 2014. That date was more than six months before the 60-day letter was issued. The IRS thus secured supervisory approval for those penalties before formally communicating to Belair the Examination Division’s definite decision to assert the penalties. Respondent accordingly contends that, with respect to those penalties, he has shown compliance with section 6751(b)(1).[8]

But what about the initial IRS proposal before the conference where the agency indicated it intended to propose penalties? The majority found that no decision had been made at that point:

But the summary report did not notify petitioner of a definite decision to assert penalties. Rather, it set forth the exam team’s tentative proposals and invited Belair’s partners to a conference to discuss them. See IRM pt. 8.19.1.6.8.4(2) (Dec. 1, 2006). The Letter 1807 launched a lengthy communication and fact-gathering process during which Belair had the opportunity to present its side of the story. Only after that process concluded did the Examination Division finalize its penalty determination by issuing the 60-day letter.

The statute requires approval for the initial determination of a penalty assessment, not for a tentative proposal or hypothesis. As the Second Circuit noted in Chai, a “determination” denotes a “consequential moment” of IRS action. See Chai, 851 F.3d at 220-221 (analogizing the “initial determination” of a penalty to the “first determination made by the Social Security Administration of a person’s eligibility for benefits” (quoting Black’s Law Dictionary 460 (7th ed. 1999))). The natural place to look for an initial “determination” of a penalty assessment is a document that formally communicates to the taxpayer a definite decision to assert penalties.[9]

However, this case split the court. Eight judges joined in the majority opinion, while one concurred in result. There were two dissenting opinions in which the other judges joined. The dissenters generally found that the majority had pushed the approval far too late into the process to do much to discourage the IRS from using the threat of penalties as a bargaining chip.

That is, the fact that the IRS indicated they were considering asserting penalties prior to the initial conference could easily be read by a taxpayer that if the taxpayer is “cooperative” and consents to the tax assessment that the penalties might go away—the very bargaining chip the statute looked to prevent.

Given the close decision, as well as the fact that one judge agreed in result only, it isn’t clear that this case, despite being a published decision, actually will do a lot to clarify ultimately how this provision is applied in other cases—or even this one if the taxpayer decides to pursue an appeal.

[1] Belair Woods LLC et al. v. Commissioner, 154 TC No. 1, January 6, 2020, https://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=12159 (retrieved January 7, 2020)

[2] Belair Woods LLC et al. v. Commissioner, pp. 6-7

[3] Belair Woods LLC et al. v. Commissioner, pp. 8-9

[4] Belair Woods LLC et al. v. Commissioner, p. 6

[5] Belair Woods LLC et al. v. Commissioner, p. 9

[6] Belair Woods LLC et al. v. Commissioner, p. 14

[7] Belair Woods LLC et al. v. Commissioner, pp. 11-12

[8] Belair Woods LLC et al. v. Commissioner, pp. 12-13

[9] Belair Woods LLC et al. v. Commissioner, pp. 14-15