Litigating IRS Penalty Approval

• Published date: 18 November 2022
• Subject Matter: Accounting and Audit, Tax, Audit, Income Tax, Tax Authorities
• Law Firm: Morvillo Abramowitz Grand Iason & Anello
• Author: Mr Jeremy Temkin and Emily Smit

Each year the Internal Revenue Service assesses billions of dollars in civil penalties against taxpayers. In 1998, Congress adopted '6751(b) of the Internal Revenue Code, which imposes a procedural restriction on the IRS's ability to assess penalties. That section provides that "[n]o penalty ... 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."

For years the IRS's compliance with this statutory requirement went largely unquestioned by taxpayers. In Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), however, the U.S. Court of Appeals for the Second Circuit reversed the Tax Court and held that the IRS bears the burden of establishing that supervisory approval was given "no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty."

While Tax Court cases decided after Chai adopted and enlarged the Second Circuit's rule, the Ninth and Eleventh Circuits recently departed from Chai's reasoning and allowed for the approval of penalties much later in the administrative process. Given that the Tax Court applies the law as interpreted by the Court of Appeals in the Circuit where the taxpayer lives, the varying interpretations of the supervisory approval requirement mean that liability for substantial penalties may turn on where the taxpayer resides.

Procedural Context

The Internal Revenue Code contains over 150 types of civil penalties. Certain penalties, including accuracy-related penalties imposed for negligent mistakes on income tax returns and civil fraud penalties, are subject to "deficiency procedures" that provide taxpayers with the opportunity to challenge penalties in Tax Court prior to payment being due. In the deficiency regime, if the IRS concludes a taxpayer owes funds and the taxpayer either does not appeal the proposed adjustment to the IRS Independent Office of Appeals or the taxpayer's appeal is unsuccessful, the IRS will issue a "notice of deficiency." The taxpayer then has 90 days to file a petition in Tax Court. If the taxpayer fails to file a Tax Court petition, or if the Tax Court rejects the taxpayer's petition, the IRS will "assess" the deficiency, at which point the IRS can take steps to collect the amount owed.

By contrast, other penalties, including penalties for failure to file information returns, are "assessable penalties" that are due upon...