We all know that the IRS is quick to pull the trigger on penalties, especially trust fund penalties, which the IRS rightfully views as Uncle Sam’s money. But the Tax Court’s January 21st decision in Chadwick vs. Commissioner makes clear that even trust fund penalties must be approved by a supervisor when proposed; otherwise, the penalties are invalid.
Under Section 6751(b), the IRS may not assess a penalty unless the initial determination is approved in writing by the immediate supervisor of the person making the determination. This sneaky little provision has garnered much attention since the Tax Court’s 2017 decision in Graev v. Commissioner, wherein the Tax Court held that the written approval requirement of Code Section 6751(b) is an element of the penalty claim and is properly before the Tax Court in a deficiency proceeding; and further, that the IRS has the burden of proving it complied with that requirement as part of its prima facie penalty case. If it cannot, the proposed penalty against the taxpayer can not be sustained. Since that time taxpayers have put the IRS to the task of meeting this burden of production, and where it is not met, even in abusive tax shelter cases, the courts have refused to sustain penalties.
It was only a matter of time before the Tax Court reached this issue in the context of a trust fund penalty assessment. As a brief refresher, under Code Section 6672, if an employer fails to properly pay over its payroll taxes, the IRS can seek to collect a trust fund recovery penalty equal to 100% of the unpaid taxes from a "responsible person," i.e., a person who: (a) is responsible for collecting, accounting for, and paying over payroll taxes; and (b) willfully fails to perform this responsibility.
In Chadwick, the taxpayer, David Chadwick, operated two LLCs that failed to timely pay their payroll taxes. Two IRS revenue officers separately determined that Mr. Chadwick was both a responsible person and willful in failing to pay the payroll taxes of the LLCs. Each revenue officer issued a Letter 1153, proposing trust fund penalty assessments under Section 6672. Mr. Chadwick did not challenge the assessments, and the IRS shortly thereafter sought to collect by proposed levy. Mr. Chadwick appealed the proposed levy to IRS Appeals and later petitioned the Tax Court for review of the IRS’ adverse determination. Although the IRS filed a motion for summary judgment, to which Mr. Chadwick did not respond, the Tax Court faced a threshold issue: Was the trust fund penalty subject to the supervisory requirement of Code Section 6751(b); and if so, was that approval properly secured? After all, the IRS initially bears the burden of proving that a penalty is validly assessed.
Although the IRS argued that the Section 6672 penalty is really a tax and not a penalty and therefore not subject to supervisory requirement, the Tax Court was not convinced. The Court acknowledged that Section 6672 functions to transfer liability for the payroll taxes from the employer to the responsible person, but the Court found that such transfer does not mean that Section 6672 assessments are not penalties. The Court found that from the standpoint of the person sanctioned, “they are penalties both as denominated by the Code and in the ordinary sense of the word,” and therefore the Court found that the penalties were subject to the supervisory requirement of Section 6751(b). Unfortunately for the taxpayer, the Court went on to find that the necessary approval had been secured in the proposed assessments at issue in that case. A copy of the full decision is linked here.
As most tax practitioners know, the IRS aggressively enforces payroll taxes and has never met a business owner or executive that was not a responsible person and acted willfully. The Chadwick decision gives taxpayers yet another complete defense to a proposed trust fund penalty assessment that requires no additional action or places no burden on the taxpayer. The issue should be raised in every trust fund penalty case, and is timely raised at virtually any time following the IRS’ initial proposal of trust fund penalties.
If you have any questions about the Chadwick decision, or trust fund penalty matters, please do not hesitate to contact me at (214) 749-2464 or firstname.lastname@example.org.