Today’s lesson involves yet more litigation over IRS compliance with the penalty approval process required by the formerly toothless §6751(b)(1). In Sand Investment Co., LLC, et al. v. Commissioner, 157 T.C. No. 11 (Nov. 23, 2021) (Judge Lauber), the Tax Court continues teaching us the scope and operation §6751(b), a series of lessons it started back in 2017 when its decision in Graev v. Commissioner, 149 T.C. 485 (2017), gave the statute sharp teeth. Among other requirements, the statute says approval must come from an IRS employee's “immediate supervisor.” In today’s case, the IRS employee who proposed a bunch of penalties had two supervisors but only one definitely signed timely. Judge Lauber finds that function trumps form in identifying which of the two supervisors was the right one to approve the proposed penalties. This is a short lesson, and also one that will may be rendered moot. Legislation passed by the House and now before the Senate de-fangs §6751(b). Details below the fold.
Law: The Nonsensical Language of §6751(b)(1)
Section 6751(b)(1) provides the general rule 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.”
Section 6751(b)(2) then lists the following exceptions: the additions to tax for failure to file or pay per §§6651, §6654, §6655; and the penalty in §6662(b)(9) for messing up the special above-the-line charitable deduction permitted by §170(p).
Most of the interpretive focus has been on the timing requirement: by when must the “the immediate supervisor” approve “the initial determination”? As to that the Tax Court has taken a largely practical approach to interpreting what the Service must do to comply with §6751(b). See Lesson From the Tax Court: A Practical Interpretation of the Penalty Approval Statute §6751, TaxProf Blog (Jan. 13, 2020). However, sometimes that practical approach ends up leaving the IRS vulnerable to Monday morning quarterbacking. See Lesson From The Tax Court: New 'Consequential Moment' Rule For §6751 Supervisory Approval, TaxProf Blog (March 8, 2021). Culpable but lucky taxpayers escape penalty while equally culpable but unlucky taxpayers pay. Not an ideal design.
Today’s lesson gives us the Tax Court’s first major interpretation of the supervisor requirement. Once again we see the Court taking a practical approach to statutory interpretation. Let’s take a look.
Today’s lesson arises out of a conservation easement controversy. The taxpayer is Sand Investment Co. LLC, a South Carolina limited liability company that was audited under the former TEFRA audit procedures. Sand had bought about 1,000 acres of land and was attempting to take a $80 million charitable contribution deduction for a conservation easement it granted to The Southeast Regional Land Conservancy in 2015. This is the same charity that apparently messed up the documents in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. No. 10 (2020)(currently on appeal to the 6th Circuit Court of Appeals. So if those documents had not changed from when Oakbrook made its donation in 2008, the taxpayers here are in for a world of hurt.
But today’s lesson is not about the donation of easements. It’s about the proper penalty approval process.
Sand’s 2015 return was selected for examination. The examination was assigned to “Team 1124 in the IRS Large Business & International Division.” Op. at 5. A Revenue Agent (RA) named Cooper was the team member who examined the return. The team was supervised and managed by a Supervisory Revenue Agent (SRA) named Burris. For details on the structure of teams and managers, see IRM 4.46.1.
Well, audits take time. On September 2, 2018, before this one was finished, RA Cooper received a promotion to a higher-paid RA position in a different examination team. That meant RA Cooper now had a new boss, one SRA Wilson. However, because the Sand examination was almost done, RA Cooper retained the lead and SRA Burris continued to be the case manager for that examination. See IRM 126.96.36.199.3.1 (“Case Manager Roles and Responsibilities”). Meanwhile, SRA Burris became RA Cooper’s supervisor for all other work, and was RA supervisor for all other purposes, such as approving RA Cooper’s timesheets, leave requests, etc.
RA Cooper completed the Sands examination and recommended assertion of various penalties under §6662 and §6662A. Now, pay attention to the following sequence of events:
On September 27, 2018, RA Cooper prepared a “Penalties Lead Sheet” and a “Supplemental Civil Penalty Approval Form” both reflecting her “initial determination” to assert penalties.
On November 20, SRA Burris signed both forms.
On November 21, RA Cooper sent Sand a preliminary package of documents that summarized RA Cooper’s position on each issue under audit, explained that RA Cooper was recommending penalties, and invited the taxpayer to a closing conference.
On November 23, SRA Wilson signed the penalty approval form, but not the penalties lead sheet.
In late December, RA Cooper held a closing conference with Sand’s representative, which apparently went the way these conferences often go: nowhere. RA Cooper then closed the case.
On February 8, 2019, the IRS issued the Final Partnership Administrative Adjustment. See IRM 8.19.12 (“Final Partnership Administrative Adjustment”).
Sand petitioned the Tax Court for review and both parties moved for partial Summary Judgement on whether the IRS complied with §6751(b)(1).
Lesson: The Meaning of “Immediate Supervisor”
Sand argued that RA Cooper violated the statute because she had not obtained the approval of her “immediate supervisor” before sending out her preliminary report on November 21st. Sand contended that because of her transfer, RA Cooper’s immediate supervisor had become SRA Wilson. It said RA Cooper knew that because she had submitted the Supplemental Penalty Approval Form to SRA Wilson to sign. But SRA Wilson did not sign it until November 23rd. That was after RA Cooper had sent the preliminary report out on November 21st. And the preliminary report was, argued Sand, the relevant “initial determination” for §6751(b)(1) approval purposes.
The IRS argued that (1) RA Cooper’s immediate supervisor for penalty purposes was SRA Burris, not SRA Wilson, and anyway (2) November 21st was not the relevant date; SRA Wilson just needed to sign off before the FPAA was sent out, which he did.
Judge Lauber agreed with the IRS’s first argument and thus did not address the second one.
Judge Lauber takes a very practical approach to figuring out why SRA Burris was the immediate supervisor for penalty purposes. I break his logic down into three steps.
First, the term “immediate supervisor” is nowhere defined in the statute, but as the statute speaks in the singular, there just needs to be one signature.
Second, he notes that RA Cooper had two different supervisors and “they oversaw distinct aspects of her day-to-day work.” Op. at 10. SRA Burris was responsible for how RA Cooper completed the audit of Sands. SRA Wilson was responsible for all other aspects of RA Cooper’s work. So the question presented was which of these two supervisors was the right one to sign off on the penalty approval form.
Third, the purpose of the statute was to prevent over-enthusiastic RA’s from making careless or scurrilous assertions of penalties. “Given this legislative purpose, an agent’s “immediate supervisor” is most logically viewed as the person who supervises the agent’s substantive work on an examination. *** That person is thus in the best position to supply the approval that Congress believed desirable.” Op. at 11.
Bottom Line: SRA Burris was RA Cooper’s immediate supervisor for penalty purposes on the Sand examination. Because SRA Burris gave approval before the November 21st transmittal to the taxpayer, the IRS had complied with §6751(b)(1) regardless of whether that transmittal was or was not the relevant contact with the taxpayer.
Coda: Escaping the Graev?
The Tax Court has done an admirable job in trying to make sense of the nonsense Congress wrote in §6751(b). However, the inherent instability of the provision---especially the ceaseless litigation over “initial determination”---will continue to allow some lucky taxpayers to avoid deserved penalties. However....
....Buried on page 2294 of the Reconciliation Bill, recently passed by the House of Representatives and now pending in the Senate is this: “§138404. Modification of Procedural Requirements Relating to Assessment of Penalties.” Keith Fogg blogged on this over at Proceduraly Taxing back in September. The proposal would do away entirely with the individualized supervisory approval requirement and would re-write §6741(b) to read: “Each appropriate supervisor of employees of the Internal Revenue Service shall certify quarterly by letter to the Commissioner of Internal Revenue whether or not the requirements of subsection (a) have been met with respect to notices of penalty issued by such employees.’’ Subsection (a) is simply the requirement that each notice of penalty has to tell the taxpayer the name of the penalty, the code section under which the penalty is imposed, and a computation of the penalty.
If that re-write becomes law, the IRS may or may not return to the pre-Graev penalty assertion process. After all, it takes considerable effort to change a bureaucratic process. And the while the post-Graev processes are awkward, they are not broken. But if Congress does nuke the current supervisory approval requirement, at least the IRS won’t be punished, and culpable taxpayers unjustly rewarded, for procedural foot-faults. The upside will be to force taxpayers to engage on the merits of a proposed penalty.
If that re-write does not become law, however, Congress has also created another exception to the subsection (b)(1) approval requirement. And it has to do with conservation easements. Over on page 2285 of the Bill as passed by the House is a provision that creates more rules on qualified conservation easements. For example, it creates a general limit on the amount of a deduction taken by a partnership to "2.5 times the sum of each partner’s relevant basis in such partnership." Oh boy, more litigation opportunities! Even better, Congress attempts to set up a reporting regime similar to the tax shelter reporting regime to allow the IRS to spot illegit easements. Yes, even more litigation opportunities ! Gosh someone really needs to tell Congress that the Administrative Procedure Act has been elevated to constitutional status, so that Congress simply cannot enact specific legislation for a specific agency to do something the agency specifically needs to do if that is arguably contrary to the grand general commands of the APA. But perhaps what some so cutely term "Tax Exceptionalism" is, really, legit? At any rate, the Reconciliation Bill basically creates a new substantial understatement penalty to support these new conservation easement requirements, and then excepts that penalty from the supervisory approval requirements...if they do not get removed by that other part of the Reconciliation Bill.
Bryan Camp is the George H. Mahon Processor of Law at Texas Tech University School of Law. Yes, that was not a typo. But it was cute, so I left it. He invites readers to return each week to TaxProf blog for another Lesson From The Tax Court.