Although the government bears the burden of production for penalties, this often involves nothing more than showing that the penalties were properly assessed. Penalty relief is usually only given when the taxpayer can marshal their best facts and make a persuasive argument for leniency. This is because the focus is usually on the actions of the taxpayer in properly reporting amounts on the tax return and not the procedures followed by the IRS. However, recent litigation surrounding Code Sec. 6751 has turned added focus onto the IRS procedures for assessing penalties. This focus has resulted in numerous taxpayers having the opportunity to challenge penalties on technical grounds without delving into the actions of the taxpayer’s tax reporting. In some cases, the IRS has even conceded penalties when faced with their own lack of evidence regarding the proper approval procedures.
Procedural Requirements for Imposing Penalties on Taxpayers
Section 6751 is not a new provision of the Internal Revenue Code, it was adopted in 1998 and became law in 2001. This provision requires the IRS to follow two procedural requirements when imposing penalties on taxpayers. First, a taxpayer must receive notice of the penalty, the section of the Internal Revenue Code that imposes the penalty, and how the penalty is computed. This requirement is usually easily satisfied. Second, the “initial determination” to assess the penalty must be approved “in writing” by the “immediate supervisor” or an approved higher official. It is this second requirement that has resulted in the flurry of litigation over penalties. It is also the subject of Chief Counsel Advice issued on January 28, 2022 (CCA 202204008).
Exceptions to Procedural Requirements
According to Code Sec. 6751(b), all penalties must comply with the procedural requirements unless they meet the specific exceptions listed. Those specific exceptions include failure to file and failure to pay penalties as well as failure to make required estimated tax payments. They also include “any other penalty automatically calculated through electronic means.” According to the IRS, this means “no Service human employee makes an independent judgment with respect to the applicability of the penalty.” Essentially, if a computer makes the determination, then the supervisory approval probably isn’t required. The courts, interpreting the legislative history, have indicated that the purpose of Code Sec. 6751(b) was to prevent the IRS from threatening unjustified penalties without the proper supervisory determination and consideration.
Defining “Written” Approval
The IRS uses several forms when determining and imposing penalties, however, the courts have indicated that a particular form of “written” approval is not necessary to satisfy Code Sec. 6751(b). Therefore, approval of the “initial determination” must be “personally approved (in writing)” but this does not mean that it requires a signature or particular form. When verifying approval, the evidence the IRS may rely on could be a note, email, or any other written form so long as it shows written approval of the penalty at issue. The Internal Revenue Manual (IRM) instructs that the approval must be “dated, and retained in the case file … on a penalty approval form, in the form of an email, memo to the file, or electronically.” Even if a signature is used, it doesn’t need to be a specific type or placed in a specific place to qualify. For example, in one case the court found supervisory approval sufficient even though the signature was on the cover page and not the report outlining the penalty. This any-form-qualifies standard is the subject of the recent guidance by IRS Chief Counsel in CCA 202204008.
The taxpayer argued that the IRS had failed to follow the methods specifically outlined in the IRM for supervisory approval of penalties. IRS Chief Counsel indicated that although the IRM provides a “preferred method” it is not required and cites several cases indicating that the approval can takes “any particular form.” The IRS, and several courts, have been very lenient is allowing the IRS to point to virtually anything indicating supervisory approval to satisfy the requirements. An official procedure exists in the IRM, most likely to try and prevent future failures, but failure to follow the specific procedure will not defeat the penalties alone. Technicalities can still occur that will defeat penalties such as when penalties are approved by someone other than the immediate supervisor or when penalties are asserted early and then later with the proper approval. The details matter in these types of challenges so tax advisors should request documents proving the procedures were followed and ask questions about the documents they receive.