On December 20, the Tax Court issued a supplemental opinion in Graev v. Commissioner (here), in which it reversed its prior position on I.R.C. Section 6751(b) and agreed with the Second Circuit’s decision in Chai v. Commissioner. In Chai, the Second Circuit held that Section 6751(b)(1) requires the IRS to obtain written supervisory approval of an initial penalty determination no later than the date the IRS issues the notice of deficiency or files an answer asserting the penalty. A previous blog post (here) discussed the Chai decision and its impact on pending Tax Court cases.
The Tax Court’s recent decision in Graev is significant because it is the first time the Tax Court has enforced the 6751(b) requirement. In Graev, the Tax Court held the IRS must comply with Section 6751(b) before asserting penalties in a notice of deficiency and that the Government bears the burden of production that it complied with Section 6751(b) under Section 7491(c).
Before the Second Circuit’s decision in Chai, the Tax Court had generally disregarded Section 6751(b) as a paper tiger that imposed no hard deadlines or requirements on the IRS. In Chai, however, the Second Circuit overruled the Tax Court’s decision to uphold penalties despite the Government’s failure to establish compliance with Section 6751(b). Since then, tax practitioners have eagerly awaited a post-Chai Tax Court decision regarding the Section 6751(b) requirement. The Tax Court’s recent decision in Graev is the first indication it will follow Chai and enforce the Section 6751(b) procedural requirement going forward.
Graev v. Commissioner
In the Graev supplemental opinion, the Tax Court reversed its initial opinion regarding the 6751(b) penalty approval requirement. In its initial opinion issued in November 2016, the Tax Court sustained accuracy-related penalties against the taxpayer, holding in part that the taxpayer’s argument that the Government failed to comply with Section 6751(b)(1) was premature. The Tax Court determined the taxpayer’s 6751(b) argument was premature because the IRS could comply with the 6751(b) approval requirement any time before the Tax Court issued a final determination on the deficiency (the Tax Court said a penalty is not “assessed” until there is a final detemination of a deficiency). Thus, the Tax Court did not consider the merits of the taxpayer’s 6751(b) argument.
After Tax Court’s initial opinion in Graev, the Second Circuit issued its opinion in Chai v. Commissioner in March 2017. In Chai, the Second Circuit held that the IRS must comply with the Section 6751(b) written approval requirement no later than the date the IRS issues a notice of deficiency (or files an answer or amended answer) asserting such penalties. Because Graev was appealable to the Second Circuit, the Tax Court vacated its initial decision in Graev that the taxpayer’s 6751(b) argument was premature. The parties then submitted supplemental briefs to the Tax Court arguing the merits of the 6751(b) issue.
In light of Chai, the Tax Court issued its supplemental opinion in Graev last month. In the opinion, the Tax Court reversed its initial determination that the taxpayer’s 6751(b) argument was premature and adopted the Second Circuit’s ruling in Chai. The Tax Court held (1) taxpayers may challenge the IRS’s failure to comply with 6751(b) before the Tax Court issues a final decision on a deficiency (because the IRS must comply with the 6751(b) written approval requirement before first asserting penalties in the notice of deficiency (or in an answer)), and (2) the Government bears the burden of production that it complied with Section 6751(b) under Section 7491(c).
Despite upholding the Section 6751(b) procedural requirements, the taxpayer still lost on the merits of the 6751(b) issue. The Tax Court found that an IRS Counsel memorandum recommending that the examining agent assert a 20% accuracy-related penalty in the notice of deficiency, as an alternative to the examiner’s proposed 40% misstatement penalty, constituted an “initial determination” under Section 6751(b).
Takeaway for Taxpayers and Practitioners
The takeaway from Graev is the Tax Court acknowledged for the first time that the IRS must comply with the Section 6751(b)(1) written approval requirement before asserting discretionary penalties against taxpayers. Notably, the IRS also bears the burden of production that it timely complied with Section 6751(b) to assert discretionary penalties. Thus, where the IRS asserts discretionary penalties (e.g., Section 6662 accuracy-related penalties) against taxpayers in a notice of deficiency, taxpayers and practitioners should affirmatively place the burden of production on the IRS by requesting its production of the initial penalty determination and a supervisor’s written approval of such penalty determination.
Because Graev was appealable to the Second Circuit, Chai was binding on the Tax Court decision. Thus, it remains to be seen whether the Tax Court will enforce the Section 6751(b) requirement in cases not appealable to the Second Circuit.
The Tax Court’s language in Graev’s majority and concurring opinions, however, strongly suggests the Tax Court agrees with the Second Circuit’s interpretation of 6751(b) and will apply its ruling in Graev to other Tax Court cases outside the Second Circuit. (See, e.g., the Graev majority opinion, “Having considered the [Chai opinion] . . . and in the interest of repose and uniformity on an issue that touches many cases before us, we reverse those portions of Graev which held that it was premature to consider section 6751(b) issues in this deficiency proceeding.” See also Justice Buch’s concurrence and partial dissent stating, “the two main points over which the vast majority of the Court now agrees. We agree that, in a deficiency proceeding, we may consider whether the Commissioner complied with section 6751(b)(1). And we agree that under 7491(c), the Commissioner has the burden to established compliance with section 6751(b)(1).”)
Justice Holmes was the only Tax Court judge who outright said he would not follow Chai in Tax Court cases that are not appealable to the Second Circuit. Justice Holmes concurred in the result only because of Chai’s binding authority on the Tax Court in Graev.
Potential Consequences on IRS Examinations and Penalty Determinations
In his concurring opinion, Justice Holmes raised the question of how IRS examinations may respond to a windfall of Section 6751(b) challenges after Chai. Holmes said the IRS might respond by recommending discretionary penalties in nearly all deficiency cases. To avoid 6751(b) challenges, the IRS could streamline its penalty determination and approval process in the I.R.M, tweak penalty-approval forms, and “crank out a Chief Counsel memorandum or two” for every penalty determination. Thus, taxpayers subject to IRS examinations should be wary of baseless penalty assertions by the IRS. Sufficient paperwork alone cannot justify discretionary penalties. Regardless of 6751(b) compliance, the IRS still bears the burden of proving a sufficient basis to assert discretionary penalties against taxpayers.
If you have any questions regarding the Tax Court's recent decision or other tax matters, please feel free to contact Paul Budd at (214) 749-2442 or by email at firstname.lastname@example.org.