Second Circuit Decision in Chai v. Commissioner Says No Penalties When the IRS Failed to Obtain Written Approval
By Joel N. Crouch on March 30, 2017
On March 20th the U.S. Court of Appeals for the Second Circuit issued an opinion in Chai v. Commissioner that could impact every taxpayer who is disputing IRS penalties. A copy of the decision is here. Taxpayers with penalty cases pending in Tax Court should review the Chai decision as soon as possible and determine its application to their case.
In Chai, the IRS issued a notice of deficiency claiming that Jason Chai had underreported his income on his 2003 tax return by $2 million and proposing a 20% accuracy-related penalty. Chai challenged the IRS notice in Tax Court, which ultimately ruled for the IRS on all issues, including the imposition of the 20% accuracy-related penalty. In upholding the penalty, the Tax Court rejected as untimely Chai’s argument, raised for the first time in post-trial briefing, that the IRS failed to carry its burden to show compliance the statutory written-approval requirements of IRC Section 6751(b).
Section 6751(b) states that “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”. Chai argued to the Tax Court in his post-trial brief and to the Second Circuit on appeal that because the IRS had failed to produce any evidence at the trial that it had complied with Section 6751(b), the 20% accuracy related penalty could not apply.
The Second Circuit reversed the Tax Court on the penalty, holding that Section 6751(b)(1) requires 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 the penalty. The Second Circuit also held that compliance with Section 6751(b) is part of the IRS’ burden of production and proof in a deficiency case in which a penalty is asserted. The Second Circuit explicitly rejected recent Tax Court holdings on this matter, including Graev v. Commissioner (here)
The impact of the Second Circuit decision is already being felt. In Graev v. Commissioner, the IRS, which prevailed, took the very unusual step of filing a motion for reconsideration in light of the Chai decision. In its motion, the IRS asked the Tax Court to vacate its decision and order additional briefing on what steps the Court should take in light of the Chai opinion. In Henderson v. Commissioner, Tax Court Judge Mary Ann Cohen, citing to Chai, entered an order requiring the IRS to address the requirements of IRC Section 6751(b). Specifically, she ordered “on or before April 10, 2017, respondent may supplement the motion for summary judgment with any additional affidavit or argument concerning compliance with the law and administrative procedures supporting the notice of determination in this case, specifically with respect to compliance with Internal Revenue Code Section 6751(b)…”
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