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Tax Court Throws Out Fraud Penalty Because IRS Agent Did Not Obtain Proper Management Approval
Former IRS Tax Attorneys Discuss Recent Cases Of Tax Court Tackling Supervisory Approval of Penalties
Congress approved Internal Revenue Code section 6751 as part of the Internal Revenue Service Restructuring and Reform Act of 1998. It protects taxpayers by requiring that IRS employees obtain approval from their immediate supervisor before asserting most penalties against taxpayers. Specifically, Congress believed that penalties should not be used to gain leverage over taxpayers and should only be imposed where appropriate and not as a bargaining chip. In other words, section 6751 was enacted to prevent agents from asserting arbitrary penalties to get a taxpayer to agree to an increase in tax.
Generally, section 6751 requires that penalty approval come before a penalty determination is initially communicated to the taxpayer. Hence, before IRS sends a written determination that it intends to impose a penalty, the agent must obtain written approval from his or her supervisor and this penalty approval form then becomes part of the IRS’ exam file. If a taxpayer’s dispute ends up in Tax Court, the IRS has the burden of production to show that the agent obtained the required approval. This is important because even if a taxpayer “loses” an audit by owing additional tax, IRS must still show the Tax Court that penalties were approved to “win” on its penalties.
Because IRS sends a number of different notices to a taxpayer in the course of an audit, there has been an extraordinary amount of litigation on the topic of when the penalty determination is “initially” communicated to the taxpayer. It is now clear that the agent must obtain approval before sending the taxpayer a notice of deficiency. But there are numerous notices that occur before the notice of deficiency.
On March 1, 2021, the Tax Court handed the taxpayers a win on IRS’ 75% fraud penalty. While the agent obtained her manager’s approval before she sent taxpayers a notice of deficiency, this approval did not occur before she met with the taxpayers in a closing conference and presented them with her revenue agent report. Beland v. Commissioner, 156 T.C. No. 5 (2021). In another recent case, the Tax Court threw out a fraud penalty because the agent had not obtained management approval before meeting with the taxpayer in prison (for tax evasion) and presenting him with a similar revenue agent report. Minemyer v. Commissioner, T.C. Memo. 2020-99. It is important to note that civil fraud penalties are almost always assessed against a taxpayer who is either convicted of or pleads guilty to tax evasion.
The bottom line is that penalties can be a significant issue in any IRS audit and taxpayers are protected by section 6751. However, because of the significant amount of litigation related to penalty approvals, the legal requirements are actively changing.
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