Paul L. Caron

Monday, October 30, 2023

Lesson From The Tax Court: The Rules For Penalty Approval Depend On Geography

Camp (2021)Tax law is supposed to be uniform.  The thousands of pages of statutes and regulations are supposed to be applied to taxpayers living in Texas in the same way as taxpayers living in California.  The IRS is a single federal agency charged with applying the law uniformly.  And the Tax Court is a single national trial court that can and does travel to every corner of the United States to resolve most disputes that arise between taxpayers and the IRS.

But tax law is not uniform.  One reason is because there are 11 geographic Circuit Courts of Appeals (Circuits 1-11 plus the D.C. Circuit) in the federal system.  Their decisions are binding within the geographic boundaries of the Circuit, but are not binding on the other Circuits.  So when one Circuit Court of Appeals disagrees with another on how to interpret a tax statute, the law is not uniform.  Under what is known as the “Golsen rule” the Tax Court will generally follow the law of the Circuit to which a taxpayer would take an appeal.

Today we learn another reason tax law is not uniform: the Tax Court itself.  In Wolfgang Frederick Kraske v. Commissioner, 161 T.C. No. 7 (Oct. 26, 2023) (Judge Gale), the taxpayer was arguing that the IRS could not assert penalties because the penalties were not properly approved under §6751(b).  That argument was a winner under the Tax Court’s interpretation of that statute, but was a loser under the interpretation given by every one of the four Circuit Courts of Appeals to interpret the statute, including the Circuit to which the taxpayer would take an appeal.  This might have been a good case for the Tax Court to change its interpretation and bring uniformity to tax administration.  Sadly, that did not happen.  Instead Judge Gale applied the Golsen rule, which teaches us another good lesson: the Golsen rule is not automatic!

Details, as usual, below the fold.

Law: The Golsen Rule
The job of trial courts is to apply the law to the case before them.  An important job of the Circuit Courts of Appeals is to ensure that the law is uniform within the geographic area of the Court.  And when the U.S. Supreme Court decides a case, creating a uniform rule of law throughout the entire United States is an important part of its job as well.

Given this general structure of litigation, federal trial courts need to pay close attention to the decisions of their Circuit Court of Appeals because those decisions are binding on them.

But the structure of tax litigation is different.  One might even say “exceptional!”  The Tax Court is unlike any other trial court in the United States.  That is because its decisions are subject to review by all 12 of the geographic Circuit Courts of Appeals.

This structure of tax litigation creates a problem.  When one Court of Appeals reverses the Tax Court on a legal issue and then the legal issue comes up again, what should the Tax Court do?  When it first confronted this problem the Tax Court got all bold and brassy.  It concluded that it should decide all cases as it thought right. It decided that it would treat all Courts of Appeals decisions as merely persuasive and none as binding. Heck, it was the Tax Court!  It was a national court!  Unlike all those other trial courts, it was responsible for ensuring the uniform application of the tax laws across the country!!  No higher court could bind it except SCOTUS!!!  Judge Murdock explained the idea in Lawrence v. Commissioner, 27 T.C. 713, 716-17 (1957).  He did not use exclamation points, but don’t let that lull you into ignoring the boldness of the idea:

“One of the difficult problems which confronted the Tax Court, soon after it was created in 1926 as the Board of Tax Appeals, was what to do when an issue came before it again after a Court of Appeals had reversed its prior decision on that point. Clearly, it must thoroughly reconsider the problem in the light of the reasoning of the reversing appellate court and, if convinced thereby, the obvious procedure is to follow the higher court. But if still of the opinion that its original result was right, a court of national jurisdiction to avoid confusion should follow its own honest beliefs until the Supreme Court decides the point.”

This seemed backwards. Here was a trial court saying that it would follow a Court of Appeals opinion only “if convinced thereby.” Wow. If there had been social media in the 1950’s it would have erupted.  As it was, there was plenty of criticism in academe and plenty of grumbling in law offices.

The issue did not really come back up until 13 years later in a 1970 case called Golsen v. Commissioner, 54 T.C. 742.  By then the conversation between academics and practitioners had convinced the court to modify its position.  In Golsen Judge Raum wrote that “it is our best judgment that better judicial administration requires us to follow a Court of Appeals decision which is squarely in point where appeal from our decision lies to that Court of Appeals and to that court alone.” 54 T.C. at 757. But when an appeal would go to a different Court of Appeals, Judge Raum said, the Tax Court would still follow the Lawrence approach and treat the contrary appellate opinion as merely advisory. In this way, the Tax Court still claimed to be able to exercise its responsibility as “the” national court:

“[T]he practice we are adopting does not jeopardize the Federal interest in uniform application of the internal revenue laws which we emphasized in Lawrence. We shall remain able to foster uniformity by giving effect to our own views in cases appealable to courts whose views have not yet been expressed, and, even where the relevant Court of Appeals has already made its views known, by explaining why we agree or disagree with the precedent that we feel constrained to follow.”

Here's the point about Golsen that many folks overlook.  It was the Tax Court reversing its own policy.  It’s a rule created by the Tax Court itself.  No higher Court has ever told the Tax Court that it is bound by any Circuit Court of Appeals decision.  And, as it often does, the Tax Court gives a very practical, rather than theoretical, reason for the rule. As Judge Raum explained: “we think that where the Court of Appeals to which appeal lies has already passed upon the issue before us, efficient and harmonious judicial administration calls for us to follow the decision of that court.” This leaves open the possibility that someday, perhaps, the Tax Court might decide that a Court of Appeals opinion was just so incredibly wrong that it should not be followed even in cases appealable to that Circuit. That would give the Court of Appeals an opportunity to correct its error.

This practical approach also means that the Tax Court will not automatically apply the Golsen rule but will basically decide the likelihood that the Circuit Court of Appeals would reverse the Tax Court in the case at hand.

Law: 6751(b) — Horse-And-Barn Rule v. Consequential Moment Rule
Section 6751 was a sleepy little statute for the first 20 years after its enactment.  But in 2017 the Tax Court elevated a snippet of a legislative committee reports into statutory text, a decision that has caused no end of headaches for taxpayers, the IRS and the courts.  I give some of that history in Lesson From The Tax Court: A Practical Interpretation Of The Penalty Approval Statute § 6751, TaxProf Blog (Jan. 30, 2020).

Importantly, there is no Circuit Court split on the interpretation of this statute.  Four Circuit Courts of Appeals have uniformly agreed that supervisory approval is timely so long as it “is obtained when the supervisor has the discretion to give or withhold it.” Chai v. Commissioner, 851 F.3d 190, 220 (2d Cir. 2017).  I call that the horse-and-barn rule: only once the horse has left the barn is it too late to approve what the horse is carrying.  Accord: Minemyer v. Commissioner, No. 21-9006 (10th Cir. 2023); Kroner v. Commissioner, 48 F.4th 1272 (11th Cir. 2022); Laidlaw Harley Davidson v. Commissioner, 29 F.4th 1066, 1071 (9th Cir. 2022).  All the cited cases involved horses that were in the form of a pre-assessment notice giving the taxpayer the right to petition the Tax Court, such as a Notice of Deficiency.  They all say that the supervisor needed to approves no later than when the IRS sent the taxpayer a pre-assessment notice that triggered the right to judicial review.

The proposed regulations also adopt this horse-and-barn idea.  See proposed 301.6751(b)–1(c) (“The requirements of section 6751(b)(1)...are satisfied for a penalty that is included in a pre-assessment notice that provides a basis for Tax Court jurisdiction upon timely petition if the immediate supervisor of the individual who first proposed the penalty personally approves the penalty in writing on or before the date the notice is mailed.”)

Again, the Circuit Courts are uniform in their interpretation.  The non-uniformity here comes from the Tax Court.  It sets an earlier deadline for supervisory approval: approval must come before the “consequential moment” that the IRS makes a sufficiently formal communication to the taxpayer of a sufficiently "initial determination” to assert a penalty.  See Lesson From The Tax Court: New 'Consequential Moment' Rule For §6751 Supervisory Approval, TaxProf Blog (Mar. 8, 2021); Lesson From The Tax Court: Penalty Approval In Conservation Easement Cases, TaxProf Blog (Apr. 4, 2022).

The Tax Court’s insistence on its interpretation means that taxpayers living in the geographic area of the four Circuit Courts of Appeals—as well as the IRS—are subject to a different rule of law is than are taxpayers living elsewhere.  The preamble to the proposed regulations does a good job in explaining the problem here with non-uniformity.

We can see the results of non-uniformity in this case.

The IRS examined Mr. Kraske’s 2011 and 2012 returns.  The IRS employee doing the review was a tax compliance officer (TCO).  TCO’s are a step below Revenue Agents and generally are assigned less complex matters.

Dates are important here, so pay attention.

On June 2, 2014 (a Monday), the TCO sent Mr. Kraske Letter 692 (15-day letter).  It proposed various adjustments but the important part for today’s lesson is that it also proposed penalties under §6662(a) and (b)(2).  The 15-day letter was not a ticket to the Tax Court.  It was one of those pre-pre-assessment letters (like the 30-day letter) and explained to Mr. Kraske that if he disagreed with the proposed adjustments, he should send the TCO a written protest explaining his disagreement and asking for the Office of Appeals to resolve the disagreement.

The TCO’s immediate supervisor did not sign off on the penalties proposed in the Letter 692.

On July 16th (Wednesday), Mr. Kraske mailed his protest and requested an Appeals hearing.  That’s a lot more than 15 days later.

Also on July 16th—having not received anything from Mr. Kraske as of that date, the TCO closed the case file and forwarded the file to her immediate supervisor.

On July 21st (Monday), the TCO’s immediate supervisor signed off on an approval of the §6662 penalties asserted as part of the process of approving the issuance of an NOD to the taxpayer.

On July 24th (Thursday), the TCO received Mr. Kraske’s protest.  So the TCO held off issuing an NOD and instead started the process for Mr. Kraske to be heard by Appeals.  That process ended about a year later with no resolution and on July 28, 2015 the IRS issued the NOD to Mr. Kraske.  He timely petitioned the Tax Court for review.

Lesson:  Tax Court Refuses to Change Its Position But Will Apply Golsen
In Tax Court Mr. Kraske lost on the merits (the issues concerned the §183 hobby loss rules, the §195 start-up expenses and the rules for home office deductions).  Judge Gale issued an opinion on the merits in T.C. Memo. 2023-128.

But Mr. Kraske thought he should win on the penalties because the TCO’s supervisor had not approved the penalties until after the TCO issued the 15-day letter which, under the Tax Court’s interpretation of §6751(b) was the sufficiently consequential moment where assertion of penalties was communicated to Mr. Kraske in a sufficiently formal communication.

Mr. Kraske lived in California and so was subject to the uniform law of the 9th Circuit.  The IRS invoked the Golsen rule to ask the Tax Court to use the 9th Circuit’s interpretation of §6751(b) given in the Laidlaw case, which is basically the horse-and-barn rule.

Judge Gale gives us a very nice explanation of why the Golsen rule is not automatic.  He explains that proper application of the Golsen rule requires the Tax Court to avoid mechanically following or refusing to follow a relevant Circuit Court precedent.  Instead, it requires “an analysis to determine the scope of the Ninth Circuit’s rationale in its holding.” Op. at 6.  He gives an example of one case where the Tax Court did not follow a Ninth Circuit opinion because the Circuit Court’s reasoning related to S Corporations and the Tax Court case involved a grantor trust and it was not clear that the scope of the Circuit Court’s opinion was broad enough to include grantor trusts.  Op. at 6, referencing Lardas v. Commissioner, 99 T.C. 490, 494 (1992) (Golsen rule applies on when the relevant Circuit Court precedent would lead to “inevitable reversal” on appeal).

Here, Judge Gale gives a careful review of Laidlaw and concludes that “given the Ninth Circuit’s rejection of our section 6751(b) interpretation...that measures timeliness on the basis of formal communications to the taxpayer, and its broadly phrased holding that approval is timely at any time before assessment so long as the supervisor retains discretion to approve, we conclude that its rationale is clear and extends to penalties subject to deficiency procedures.”

Applying the horse-and-barn rule, Judge Gale then determines that penalty determination horse had not left the Exam function barn at the time the 15-day letter was issued.  When that horse left the barn to go to Appeals, the TOC’s group manager had approved the entire NOD package, including penalties.  That met the 9th Circuit’s test for timely approval and thus the IRS complied with §6751(b).

Oh if only Mr. Kraske had lived in Texas!  Or Virginia!  He would have won!  That is because the relevant Circuit Courts (4th and 5th Circuits) have not yet ruled on what the IRS must do to comply with §6751(b).  Thus the Tax Court's continued application of its interpretation means the law is not uniform.  While the Tax Court’s interpretation is not illogical, it becomes increasingly  tenuous in light of the solid set of Circuit Court of Appeals holdings rejecting it.

I had thought that this case would be one where the Tax Court could reconsider and revise its interpretation of §6751(b) to once again bring the law into uniformity.  But maybe it is waiting for even more Circuit Court cases.  Or maybe it is waiting for the proposed regulations to become final.

While it waits, the law remains unevenly applied.  Different taxpayers are subject to different penalties and the IRS is subject to different rules depending only on where the taxpayer happens to live.  What a way to run a railroad. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.

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Good post, Bryan.

The problem of too many cooks in the kitchen (or making the broth)– not only12 geographic Circuit Courts of Appeals (Circuits 1-11 plus the D.C. and Federal Circuits that your mention but also all the Tax Court and district courts (with bankruptcy courts) all around the country interpreting tax laws potentially differently among themselves.

The only resolution of any differences for tax law which in theory should be uniform is for the Supreme Court to resolve the differences with one standard on the issues it takes for cert. But, not only is that inefficient because of the time it takes to get issues before the Supreme Court but the Supreme Court Justices evidence dislike for tax cases and, as I used to tell my class, tax cases are too important for the Supreme Court to decide (with a long list of examples).

Dean Griswold offered a solution many years ago to have a solution through a Court of Tax Appeals to handle tax issues decided by trial courts (including the Tax Court). Erwin N. Griswold, The Need for a Court of Tax Appeals, 57 Harv. L. Rev. 1153 (1944).

Another solution for most of the mischief of “the number of cooks who make the broth” [Robert Jackson, Equity in the Administration of Federal Taxes (i935) 13 Tax Mag 641 (1935)] is offered by Justice Jackson in Dobson v. Commissioner, 320 U.S. 489 (1943), reh. den., 321 U.S. 231 (1944). Dobson gave deference, perhaps some strong form of deference (maybe stronger than Chevron) to Tax Court interpretations of law except where contrary to the “clear-cut” interpretation of the statutory text. (As I will discuss in a soon to be released article Jackson’s “clear-cut” is basically the clear meaning in Chevron Step One (maybe even stronger than Chevron Step One).) Congress legislatively overruled Dobson’s holding of deference to Tax Court interpretations in 1948 in what is now § 7482(a)(1) (but those interested in whether that legislative fix actually does what it was intended to do, should dig a bit deeper into Dobson and § 7482(c)(1) the text of which was interpreted in Dobson to permit deference.)

In any event, I think your discussion fully illustrates the problem of our tax judicial review system having too many cooks making the broth, which I personally think is detrimental to a national tax system which should value uniform application across the country.

Finally, one comment on Dobson. Many comments on Dobson are superficial, starting with the common practice of omitting the rehearing denied opinion which adds nuance to Dobson. I go deeper in my draft article.

Posted by: Jack Townsend | Oct 30, 2023 9:44:35 AM

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