Update on New Court-Approved Way to Defeat IRS Penalties

Like you, we at Hinrichs+Pesavento don’t like IRS penalties. That’s why we keep you up to date on new ways you can beat the IRS at its penalty game.

Section 6751(b) Overview

Tax code Section 6751(b) says that the IRS cannot assess a penalty unless an IRS supervisor or higher-level official designated by the Treasury secretary personally approves the initial determination in writing.

If the IRS does not follow this administrative requirement, then the IRS erroneously assessed the penalty and you can have it abated. But this abatement law does not apply to everything. For example, it does not apply to

  • individual and C corporation late-filing and late-payment penalties,
  • individual and C corporation estimated tax payment penalties, or
  • any other penalty automatically calculated through electronic means.

Tax Court Weighs In

Since this is a brand-new area of the tax law, we knew the Tax Court would flesh it out in future decisions. Here’s what we learned from the Tax Court over the past year about tax code Section 6751(b):

  • Palmolive case. The IRS does not have to make the initial determination of all penalties at the same time, and it does not have to make supervisory approval on any particular form.
  • Walquist case. Accuracy-related penalties for a substantial understatement of tax automatically generated by the IRS computer without any human review do not require supervisory approval.
  • ATL case. S corporation late-filing penalties automatically generated by the IRS computer without any human review do not require supervisory approval.

Well, the above cases may clarify the statute, but they do not make you jump up and down with joy. Nope. But another recent court case does make us jump up and down with joy, as we report below. With the strategies from this case, you’ll find it easier to attack and defeat IRS penalties.

Big Win

James Clay and Audrey Osceola, a married couple, received Native American casino revenue distributions (as members of the Miccosukee Tribe) that they believed were nontaxable to them, so they didn’t report those distributions as income. The IRS examined their tax returns for tax years 2004 and 2005 and asserted that the distributions were taxable.

On September 13, 2010, the IRS revenue agent sent the taxpayers a revenue agent report containing the proposed income tax adjustments and accuracy-related penalties, along with a 30-day letter allowing them to file a protest with the IRS appeals office. On October 18, 2010, the supervisory revenue agent received the examining revenue agent’s case file, and she approved the assertion of the penalties that day.

The taxpayers took their case to the Tax Court, where

  • the taxpayers lost on the income tax issues, and
  • the IRS lost on the penalty issues.

The Tax Court ruled that when the revenue agent communicates proposed adjustments to the taxpayer formally, as part of communication advising the taxpayer that penalties will be proposed and giving the taxpayer the right to appeal them (via a 30-day letter), the issue of penalties is officially on the table.

Based on this, the court concluded that the initial determination of penalties for purposes of Section 6751(b) was made no later than September 13, 2010, when the revenue agent issued the report of examination to the taxpayers, proposing adjustments including penalties and giving them the right to protest those proposed adjustments.

The court noted next that the supervisor approved the penalty on October 18, 2010, after the initial communication and in violation of Section 6751(b). Accordingly, the court in this April 24, 2019, case ruled that because of the Section 6751(b) violation, it could not assess penalties in this case.

We think this helps you in two ways:

  • You can challenge penalties using tax code Section 6751(b) pre-assessment in the IRS Appeals Office.
  • There are greater odds that the IRS could make a mistake on the approval because, as this case confirms, approval is necessary early in the audit communication when the IRS mentions penalties.

IRS Weighs In

Here’s another new development since our December 2017 article. It comes directly from the IRS. In June 2018, the IRS issued internal guidance to its attorneys on its tax code Section 6751(b) litigation position.

Here are the key points from this litigation guidance that you need to know:

  • The IRS accepts that it loses on the penalty issue if it can’t show it complied with tax code Section 6751(b).
  • IRS attorneys should concede the penalty as early as possible in the Tax Court process if there is no compliance with code Section 6751(b).
  • As the taxpayer, you generally can challenge a penalty under code Section 6751(b) in a collection due process (CDP) hearing. Here, in a CDP hearing either (a) the challenge is part of the Appeals Office’s responsibility to verify that the IRS followed all required administrative procedures, or (b) your liability for the penalty is at issue in the hearing.

Takeaways

Tax code Section 6751(b) is your friend in the battle against the IRS penalty machine. For the IRS to assess any penalty against you, the supervisor of the IRS employee proposing the penalty must personally approve the initial determination in writing. Here are the key points that we’ve learned since our original December 2017 article that will further assist you in attacking IRS penalties:

  • The IRS accepts that it loses on the penalty issue if it can’t show it complied with tax code Section 6751(b).
  • If you are in an IRS audit, the approval of the penalty assertion must come before you receive notice of the penalty in a revenue agent report containing a 30-day letter.
  • Penalties generated by the IRS computer without any human review do not require supervisory approval.

Here’s Rule 1 on tax code Section 6751(b): Don’t just accept that the IRS has followed its own procedures. During this time of fewer IRS staff and smaller budgets, it’s absolutely possible the required approval is missing.

Don’t overlook the possibility of using Section 6751(b) to eliminate IRS penalties.