Section 6751(b)(1) causes no end of interpretive trouble for the Tax Court, no end of administrative difficulties for the IRS, and no end of windfalls for those lucky taxpayers who get to avoid penalties because the Tax Court later decides the IRS committed procedural errors.
In Brian D. Beland and Denae A. Beland v. Commissioner, 156 T.C. No. 5 (Mar. 1, 2021) (Judge Greaves), the Court has once again changed how it interprets §6751(b)(1). It now says written supervisory approval must be made before an ill-defined “consequential moment.” Here, that moment came when the Revenue Agent (RA) and her immediate supervisor met in person with the taxpayers to discuss a proposed Revenue Agent Report (RAR). Contained in the RAR was a proposed fraud penalty. But the supervisor—sitting next to the RA—had not given written approval for the fraud penalty before the meeting. Too late! The lucky taxpayer was thus able to avoid contesting the merits of a fraud penalty. There is also a lesson here about administrative summonses, but may be more a lesson for the Tax Court than from the Tax Court because this opinion appears to rest, in part, on a misunderstanding of summons law. Details below the fold.
To understand today’s lesson you need a short background in §6751 and in summons law. If you are good with both, just skip on down. Otherwise, here’s what you need to know.
Law: The §6751 Horse and Barn Rule
Section 6751(b)(1) says that “[n]o 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.”
Interpreting §6751(b)(1) has become difficult for the Tax Court since it decided to rewrite the statute in Graev v. Commissioner, 149 T.C. 485 (2017). I summarized why in Lesson From the Tax Court: A Practical Interpretation of the Penalty Approval Statute §6751, TaxProf Blog (Jan. 13, 2020). It boils down to timing: by when must the “the immediate supervisor” approve “the initial determination”? For decades the answer had been: anytime before assessment. In Graev, the Tax Court re-wrote the text of the statute from “unless the initial determination of such assessment is personally approved by...” to this: “unless the initial determination of such penalty is personally approved, before such penalty is first officially communicated to the taxpayer, by....”
The Tax Court grounded its revision by applying “the mischief rule,” a hoary rule of statutory interpretation. That is, the Tax Court grounded its interpretation in its understanding of the mischief Congress intended this statute to prevent: misuse of penalties. The perceived misuse was that IRS employees were stuffing penalties into proposed deficiencies simply to create a bargaining chip for when taxpayer went to the Office of Appeals. See Senate Finance Committee Report, S. Rep. No. 105-174, at 65 (1998) ("The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.")
Graev has forced the Tax Court to wrestle with timing. When does the requisite “initial determination" of a penalty take place such as to trigger the approval requirement? At what step in the penalty determination process is the penalty being communicated to the taxpayer such as to require the required magic written approval? Just over a year ago, the Court seemed to settle on what I call the Horse and Barn rule. Belair Woods, LLC, et al v. Commissioner, 154 T.C. No. 1 (Jan. 6, 2020).
In Belair, the RA had sent a document (Letter 1807) to the taxpayer proposing to meet at closing conference. Attached to the Letter 1807 was the RA’s summary report which proposed multiple penalties. When the case eventually reached Tax Court, the taxpayer argued that §6751 required the RA to have obtained supervisory approval before proposing those penalties. The Tax Court rejected that argument in an opinion authored by Judge Lauber and joined by eight other judges. The Court held that supervisory approval must be made “at a time when the supervisor has the discretion to give or withhold it.” Belair at 12. That idea traces back to Judge Gustafson’s dissent in the initial Graev opinion. See 147 T.C. at 508. (“The statute can be construed only to require supervisory approval at a time when the supervisor has the ability to approve or disapprove the penalty—and no later.”)
This is the Horse and Barn rule. So long as the matter is still being worked within the Examination Division Barn, supervisors have meaningful opportunity to approve proposed penalties. Only once Exam has, as an office, officially committed to the proposed adjustments—such as through a 30-day letter or an NOD or a FPAA—has the matter moved beyond the point where the supervisor has discretion. The matter is now off to other functions within the IRS, notably the Appeals function. Those other functions might alter the penalties, but by that point the evil which the statute seeks to prevent—the unconstrained actions of low-level employees threatening penalties as bargaining chips—will have already possibly occurred. Put another way, the supervisor of the individual who first proposes the penalties needs to be able to act to constrain the low-level employee. By the time the Exam function has crystalized its position in a formal document, it is generally too late for the supervisor to make a difference. The horse has left that barn.
Law: Administrative Summons Are Not Compulsory
An IRS administrative summons is not self-enforcing. That is, the IRS cannot itself compel obedience. It must first go to court and seek to enforce the summons in a § 7604 proceeding. See Schulz v. IRS, 395 F.3d 463 (2nd Cir. 2005) (collecting cases). That is why a taxpayer who receives a summons cannot go running to court to enjoin the enforcement of that summons. See Reisman v. Caplin, 375 U.S. 440, 447-50 (1964) (denying injunctive relief from IRS summonses because §7604 gave “full opportunity for judicial review before any coercive sanctions may be imposed.")
There, that was easy! And it’s useful to remember too. Naturally, there are very good reasons to obey an IRS administrative summons, such as not pissing off the RA! But if the RA is issuing your clients a summons, that can be a pretty strong signal that relationships between the the RA have deteriorated. But not always. Sometimes RAs issue summonses as informal accommodations to shift cost of document production to the government. They are not supposed to, but they do.
The point is that sometimes you may want to advise your clients to blow off a summons, such as when the RA is already so committed that complying with the summons has a low probability of resolving the matter in your client’s favor, but has a high probability of doing further damage. Remember that cardinal rule of representation: don't let your clients do the talking! In such cases you can always assure your clients that whatever other consequences may attend, they face no legal jeopardy (fines, imprisonment, etc.) unless and until the IRS goes to court to enforce the summons.
In such cases, there is no downside to forcing the IRS to enforce the summons which, actually, it may not. Remember that the IRS itself cannot go to court. It must instead write a beg letter to the DOJ Tax Division to file the summons enforcement suit. That means, as a practical matter, the RA has to justify the summons and the RA may decide to bag it, assume the worst about the missing information, and move forward with the examination, leaving the taxpayer to produce the information when later contesting the proposed assessment.
The IRS selected Mr. and Ms. Beland’s 2011 return for examination in late October 2014.
In January 2015, shortly after a couple of meetings with taxpayers and their CPA, the RA referred the case to an IRS fraud technical advisor (FTA). Such a referral is a rather laborious and complex process, described in detail in IRM 25.1.2. What is important to understand here is that the fraud examination process requires multiple sign-offs at multiple steps by supervisors of both the RA and the FTA. This is not a process that can be engaged in whimsically by some evil-minded rogue RA.
In this case, the FTA was concerned enough to involve the Criminal Investigation division (CI). That process also adds delay. Normally, assuming timely filing, the §6501(a) assessment statute expiration date (ASED) would be April 16, 2015 (April 15, 2012 was a Sunday). However, for reasons unexplained in the opinion, the ASED here had extended beyond April 15, 2015 to a time not specified in the opinion. The opinion does tell us that by August 2015 there were “fewer than 240 days left on the limitations period.” Op. at 5. That fact is important because, as Judge Greaves explains in footnote 5, when less than 240 days remain on the ASED, it changes the document that the examination function issues when it completes its work. When there is time enough, Exam issues a 30-day letter, which explains the examination result and offers the taxpayer an opportunity to protest the result to the Office of Appeals. When only 240 days are left on the clock, however, Exam just issues the NOD, giving the taxpayer a ticket to the Tax Court. IRM 220.127.116.11.1
On June 5, 2015, because of the apparently looming ASED, the RA issued what appears to have been a testimonial summons, with a June 30 return date. A week before the return date, the taxpayers “sent a letter...requesting a postponement of the summons interview because petitioner wife had just given birth to petitioners’ second child.” Op. at 3-4. Either the RA agreed or else the taxpayers just blew off the summons because the next event, according to the opinion, was a July 24 letter from IRS Chief Counsel resetting the summons return date for August 19th. The letter contained boilerplate language explaining (or threatening, depending on your point of view) that the IRS could start legal proceedings to enforce the summons if the taxpayers did not show up.
The taxpayers showed up with their representative.
At the August 19th meeting the RA was accompanied by her supervisor. She first asked a variety of questions. The opinion is silent on what they were. She then presented the taxpayers with an RAR which proposed various changes including a proposed fraud penalty. The RA asked the taxpayers to either: (1) agree to the proposed changes, including the fraud penalty; (2) disagree with the proposed changes, in which case Exam would close the case and issue an NOD enabling them to go to Tax Court; or (3) agree to extend the ASED and provide additional information to help the RA adjust the proposed changes, including the fraud penalty.
The taxpayers chose option 2. Exam sent out the NOD. The taxpayer’s timely petitioned the Tax Court (in 2015, remember, long before Graev) where they eventually moved for partial summary judgment to dismiss the fraud penalty for failure to comply with §6751. They argued that the IRS violated §6751 because the RA had not obtained her supervisor’s approval to include the fraud penalty before showing the taxpayers the RAR. Judge Greaves agreed. That’s a big win for these taxpayers and more than justifies whatever fees their attorney Matthew D. Carlson charged them.
Lesson: Look For The “Consequential Moment”
The IRS raised two arguments for why the RA was not required to have obtained supervisory approval for the fraud penalty before meeting with the taxpayers and showing them the RAR.
First, it invoked the Horse and Barn rule to argue that the relevant “horse” was the NOD that resulted from the RAR. Because the August 19th meeting with the taxpayers was not the end of the examination process, no supervisory approval was required.
Judge Greaves rejects the argument. He reads the ever-expanding list of TC opinions as supporting a rule that the “initial determination” for which approval is required is the first “communication with a high degree of concreteness and formality [that] represents a consequential moment of IRS action.” Op. at 8 (internal quotations and citations omitted).
I will call that the “consequential moment” rule.
Applying that rule here, Judge Greaves found that the August 19th meeting was the “consequential moment.” What appears to have made it so was (1) the degree of formality surrounding the meeting; and (2) the offering of three choices on how to proceed, two of which required accepting the proposed penalty and only one of which would avoid the penalty being proposed at that time. As to the first Judge Greaves finds it important that (i) the meeting resulted from a summons, (ii) it happened at what turned out to be the end of the RA’s examination, and (iii) the RA had signed the RAR before showing it to the taxpayers. As to the second, Judge Greaves finds it important that “[p]resenting petitioners with the RAR at the closing conference for an opportunity, if not expectation, to legally bind petitioners to that assessment sufficiently denoted a consequential moment in which RA Raymond had made the initial determination to impose the fraud penalty.”
Second, the IRS argued that only those documents (horses) giving taxpayers Appeal rights (i.g. galloping from Exam over to Appeals) were subject to the supervisory approval requirement. Judge Greaves makes an ipse dixit rejection of that argument, writing: “appeal rights form no basis of the plain text of section 6751(b)(1) and are not the sine qua non of an initial determination.” Op. ag 14. What matters instead is finding that “consequential moment” where an IRS employee tells the taxpayer (with the requisite degree of formality) that one of the consequences of how the taxpayer chooses to proceed will be a penalty recommendation. The idea seems to be that a moment becomes a “consequential” moment when the taxpayer is given a choice to accept a penalty. Here, for example, the taxpayers had three choices, two of which involved accepting a penalty. While the taxpayers could have chosen to extend the ASED to give the RA longer to do a more thorough job and to guarantee a visit to the Office of Appeals, that choice was irrelevant because “petitioners had no reason to expect RA Raymond to change the penalty she proposed on the RAR.” Op at 16.
Comment 1: Shifting the Line
This opinion seems to shift the 6751(b)(1) line from the barn door to inside the barn. In doing so, the opinion abandons the Belair Woods idea that the approval occur before the relevant office of the IRS (here, Exam) communicates the penalty to the taxpayer. Instead, the approval must occur before the individual IRS employee tells the taxpayer of that employee’s decision to propose a penalty.
In this case, the horse had not left the barn, but the Court finds that horse was pretty much all saddled up and ready to go. I think it was critical to this decision that if the taxpayers had agreed to the proposed RAR, then that horse would be gone before the written supervisory approval! Sure, the supervisor would then approve the agreement, but that supervisory approval would not have been made “at a time when the supervisor has the discretion to give or withhold it.” Belair at 12.
Judge Greaves notes that the IRS has apparently accepted this line-shifting. It has modified the IRM to require supervisory approval be made before “issuing any written communication of penalties to a taxpayer that offers the taxpayer an opportunity to sign an agreement or consent to assessment or proposal of the penalty.” Op. at 10, note 7, citing to IRS Memo Control #SBSE-20-0520-0029 (May 20, 2020).
Comment 2: The Role of Formality
Judge Greaves places a great deal of weight on looking for a sufficiently “formal” consequential moment. I am not sure that is consistent with either the text of purpose of the statute.
As to text, I think we are long past the point of pretending that the text does any real work. It’s an incoherent statute which has required significant judicial revision to make any sense.
As to purpose, look at the result in this case and tell me, with a straight face, these taxpayers were saved from abuse. The Tax Court seems to be concerned that the taxpayers were here “cornered” or “forced” into an unpleasant choice. Yes, yes they were. But it did not result from rogue employee action. It resulted from how the system is designed: you get caught on audit and there are consequences, most of them unpleasant. The point of the statute is not to save taxpayers from unpleasant choices. The point is to save them from having inappropriate choices forced upon them by unrestrained Jack Bauer wanna-bes. The mischief to be remedied is unsupervised assertions of penalties. But that is not what was going on here with these fraud penalties. That is because every move here was fenced with supervisory approval requirements. Go read the IRM I cite above. All the transmittals between Exam and the FTA require supervisory approval.
And I cannot help but come back to the thought that the RA’s supervisor was sitting right there in the meeting! Apparently Judge Greaves thought the Group Manager's name was Chopped Liver. Sure, the supervisor did not give "written" approval until after the meeting. But there were many other written approvals in the fraud determination process. I would also think the Tax Court should be consistent: if is going to rely on Congressional intent (the Mischief Rule) to read the word "assessment" out of the statute and read the word "penalty" into it, then it seems weird to suddenly ignore that very intent and suddenly give uncritical weight and scope to the word "written."
As a practical consequence this new rule requires much more attention to detail---the inside of the barn is dark and mysterious for most of us. It requires careful evaluation of the degree of formality of any communication that you think constitutes the “initial determination.” Judge Greaves’ opinion gives some good guidance but also raises some questions. For example, Judge Greaves thought it mattered that the RA signed the RAR. So if the document had a big old “DRAFT” stamp on it, that might have changed the outcome here? If the taxpayers had attended the meeting without a summons, would that have made a difference? What about if it was a Zoom meeting? And the RA did a screen share of the proposed RAR?
Comment 3: The Role of A Summons
What confuses me most about this opinion is the weight it gives to the administrative summons. The opinion mentions the summons at least seven times and the summons figures prominently in the opinion’s formality analysis. In note 2 on page 3 of the Opinion Judge Greaves implies that the summons was issued to coerce the taxpayers. He write that the summons “did not specify the purpose of the meeting but internal e-mail correspondence between respondent’s counsel and GM Pardo shows that the summons was issued at least in part to obtain information concerning petitioners’ knowledge as to bank information and third party records.” The “least in part” language implies that the RA had a different, perhaps even insidious, motive for issuing the summons...like coercing these taxpayers into accepting a fraud penalty....
That is a very confusing footnote to me. Summonses are not used to coerce taxpayers into accepting penalties. Summons are always issued to obtain information. It says so right on the Summons. There is no “at least in part” about it. The first page of a Summons Form 2039 tells the summoned party to show up and be prepared to give testimony and perhaps documents in the matter captioned in the summons. So when Judge Greaves writes that the summons did not specify the purpose of the meeting, that is very confusing to me. There are other summons forms as well, some used simply to obtain documents and not testimony. But they all tell the summoned party "the purpose of the meeting." True, sometimes you see what is called a “dual purpose” summons where the summoned party is ostensibly the subject of the summons but the IRS is really seeking information about third parties. But there is no indication that was going on here.
The point is that summons are used to obtain information. The Summons Handbook tells IRS employees to have specified reasons to issue a summons. See 18.104.22.168 (“Factors to Consider Before Issuing a Summons”). Those reasons are all about gathering information. Particularly in cases like this one, when CI is involved, the RA must also obtain permission from Counsel before issuing a summons. See 22.214.171.124.3 (09-10-2014)(“Considerations and Limitations on Issuance of a Summons”).
Equally importantly, a summons is generally not used unless other methods have failed. Id. RAs generally use summonses against recalcitrant, non-cooperative taxpayers. That is what seems to be going on here. The point of the summons here was not to drag the taxpayers into a personal meeting to present them with the official decision of Exam. It was for the RA to get a chance to discover more information to help conclude the examination.
Finally, as I noted above, a summons is not compulsory process. While you do not lightly want to blow off a summons, there is generally room to negotiate the terms and setting. Ironically enough, if the taxpayers here had not shown up, then the RA would have likely prepared the NOD, gotten supervisory approval, and sent it off. So by showing up, they actually ended up escaping the fraud penalty!
Comment 3: IRS Response
I suspect the IRS will adjust to this “Consequential Moment” rule. But precisely because the opinion calls for an ad-hoc search for some you'll-know-it-when-you-see-it consequential moment, the IRS will never be able to write sufficient guidance to cover all the permutations of IRS employee interactions with taxpayers.
I do wonder why the IRS does not put out regulations interpreting §6751, perhaps incorporating the Horse and Barn rule or the Appeals rule and thus avoiding this amorphous Consequential Moment rule. After all, it is standard administrative law (controversial, yes, but still standard), that an agency can, by regulation, overturn a lower court’s interpretation of a statute the agency is charged with administering. See National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967 (2005). The answer, I expect, ties to resource constraints.
Bryan Camp has many inconsequential moments in his life as the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return to TaxProf Blog each Monday for a new Lesson From The Tax Court.