Tyler J. Bowman[*]
In September of 2022, the Eleventh Circuit took a side in a developing circuit split in Kroner v. Commissioner after rejecting the Second Circuit’s interpretation of 26 U.S.C. § 6751(b).[1] The Eleventh Circuit’s decision marks the third edition in the § 6751(b) saga. Because of the profound impact of differing statutory interpretations of § 6751(b) on IRS officials and taxpayers, the United States Supreme Court should grant certiorari, assuming they are presented with a petition, to resolve the conflict to ensure uniformity and clarity in the tax law.
To understand the confusion surrounding § 6751, a brief background about the IRS deficiency assessment procedure is necessary. Suppose an IRS agent conducts an audit of an individual’s income tax return. During the examination process, the IRS agent will issue a Notice of Proposed Adjustments, which the taxpayer can choose to respond to.[2] Eventually, if there are unresolved issues, the IRS will issue a “30-day letter” to inform the taxpayer of their right to appeal the agent’s proposed adjustments in an administrative proceeding. If the issue is not settled, the IRS will then issue a Notice of Deficiency, which serves as the “golden ticket” into the Tax Court.[3] If the taxpayer fails to file a petition with the Tax Court within 90 days, the “deficiency . . . shall be assessed, and shall be paid . . . .”[4] If the taxpayer files a “petition for a ‘redetermination of the deficiency’ within the 90-day period . . . , the IRS is restricted from assessing the deficiency ‘until the decision of the Tax Court has become final.’”[5] The Tax Court has the ability to “redetermine the correct amount of the deficiency even if the amount” is more than the amount specified in the statutory notice.[6] The Tax Court may also determine “penalties” if the IRS wishes to assert them.[7] However, the IRS may assess various penalties against the taxpayer, but only if “the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the [IRS case agent] or such higher level official as the Secretary may designate.”[8] When Congress passed this pre-approval requirement in 1998, they claimed that this would ensure “that penalties [w]ould only be imposed where appropriate and not as a bargaining chip.”[9]
When exactly does such supervisory approval need to be given? Is pre-approval required when the IRS first formally communicates their intention to assert penalties to the taxpayer? Or is it required when penalties are assessed? Until September, only two circuit courts had addressed this precise question. First, in Chai v. Commissioner, the Second Circuit held “that § 6751(b)(1) requires written [supervisory] approval of the initial penalty determination no later than the date the IRS issues the notice of deficiency (or files an answer or amended answer) asserting such penalty.”[10] The court reasoned that if approval is given at any time after the statutory notice or the amended answer is issued, then the supervisor can no longer exercise discretion to assert the penalty because the Tax Court’s decision will be final.[11] In other words, the approval must be given before the Tax Court proceeding begins because the supervisor must approve “the initial determination of such assessment.”[12] The court concluded that this interpretation aligned with Congress’s intent to preclude IRS agents from threatening bogus penalties to pressure settlement.[13] Put simply, under Chai, the supervisor must approve the assertion of penalties before the statutory notice of deficiency is issued or the answer is filed.
In the Spring of 2022, the Ninth Circuit rejected Chai, holding that § 6751(b) demands “written supervisory approval before the assessment of the penalty or, if earlier, before the relevant supervisor loses discretion whether to approve the penalty assessment.”[14] In other words, supervisor approval simply needs to occur prior to the assessment, which is “the formal recording of the taxpayer’s tax liability.”[15]
Recently, the Eleventh Circuit in Kroner followed the Ninth Circuit’s interpretation. In Kroner, the taxpayer underreported almost $25 million in taxable income between 2005 and 2007.[16] On August 6, 2012, the IRS agent provided Kroner with proposed changes that included almost $2 million in accuracy-related penalties.[17] Kroner responded and was issued a 30-day letter and an updated report that was signed by the IRS agent’s supervisor.[18] One year after the mailing of the 30-day letter and unsuccessful negotiations, the IRS issued a statutory notice of deficiency, and Kroner petitioned the Tax Court.[19] The Tax Court held that the August 6 letter was the “initial determination” of the penalty assessment.[20] Consequently, following Chai, the Tax Court disallowed the penalties because the supervisor did not sign off on the penalties on or before August 6.[21]
The Eleventh Circuit reversed, holding “that the IRS satisfies Section 6751(b) so long as a supervisor approves an initial determination of a penalty assessment before it assesses those penalties.”[22] The court rejected the Second Circuit’s contention that the “initial determination” equates to the first formal communication about penalties to the taxpayer, noting that “initial determination” has “nothing to do with communication and everything to do with the formal process of calculating and recording an obligation on the IRS’s books.”[23] As for legislative history, the Eleventh Circuit critiqued the Chai court for focusing on “policing pre-assessment settlement negotiations” only.[24] Instead, the Eleventh Circuit argued that the Chai court overlooked the fact that settlement negotiations may continue after the penalty is assessed.[25]
In sum, § 6751(b) provides that the IRS may assess penalties against a taxpayer only if the initial determination of the assessment is approved in writing by the IRS agent’s supervisor.[26] The Second Circuit has adopted a bright-line rule that requires supervisory approval of any penalties when the IRS first formally communicates the possibility of a penalty to the taxpayer.[27] Under this rule, the IRS does not even mention the “P word” (penalties) to the taxpayer until they have obtained supervisory approval. On the other hand, the Ninth and Eleventh Circuits have construed § 6751(b) to simply require supervisory approval prior to the assessment.[28]
So, who cares? We deal with circuit splits all the time, right? Congress or the Supreme Court need to resolve this issue immediately. From the government’s perspective, the Treasury risks conceding millions of dollars in penalties for failing to adhere to § 6751(b)’s procedural requirements if the taxpayer is in a jurisdiction that will follow the Second Circuit’s bright-line rule. Conversely, the taxpayers in jurisdictions that follow the Ninth and Eleventh Circuit’s IRS-friendly interpretation could face millions of dollars in penalties. When it comes to taxes, I doubt most taxpayers would want to be subject to different procedural rules that could cost them millions of dollars simply because they live in the “wrong” jurisdiction. Even if IRS officials “play it safe” in practice by avoiding using the “P word” until supervisory approval is given, these costly cases will keep coming up for two reasons. First, mistakes happen. Whether in emails, conversations, or letters, IRS officials will inevitably let the “P word” slip on accident. Second, it sometimes is unclear of when exactly the initial penalty determination occurs. Bottom line, both the Treasury and the taxpayers stand to gain or lose millions of dollars, and these issues will keep making their way into the courts. Therefore, we should all welcome a Supreme Court decision resolving the matter with open arms.
[*] Tyler J. Bowman, J.D. Candidate, University of St. Thomas School of Law Class of 2024, Associate Editor of the St. Thomas Law Journal.
[1] Kroner v. Comm’r of Internal Revenue, 48 F.4th 1272 (11th Cir. 2022).
[2] Jaime Vasquez & Zhanna Ziering, The Nuts and Bolts of Deficiency Cases: From Examination to the Tax Court, 27 Prac. Tax L. 25, 27 (2012).
[3] 26 U.S.C. § 6212.
[4] 26 U.S.C. § 6213(c).
[5] Chai v. Comm’r of Internal Revenue, 851 F.3d 190, 219 (2d Cir. 2017) (quoting 26 U.S.C. § 6213(a)).
[6] 26 U.S.C. § 6214(a).
[7] Id.
[8] 26 U.S.C. § 6751(b)(1) (emphasis added).
[9] S. Rep. No. 105-174, at 65 (1998).
[10] Chai, 851 F.3d at 221.
[11] Id. at 220.
[12] Id. (quoting 26 U.S.C. § 6751(b)).
[13] Id. at 219.
[14] Laidlaw’s Harley Davidson Sales, Inc. v. Comm’r of Internal Revenue, 29 F.4th 1066, 1074 (9th Cir. 2022).
[15] Id. at 1071.
[16] Kroner v. Comm’r of Internal Revenue, 48 F.4th 1272, 1275 (11th Cir. 2022).
[17] Id.
[18] Id.
[19] Id.
[20] Id. While the Chai court held that supervisory approval must be given prior to the statutory notice of deficiency or the amended answer, note that the Tax Court in Kroner extended the holding in Chai to conclude that the initial determination occurred almost two years before the statutory notice of deficiency, which was issued on July 10, 2014. Kroner v. Comm’r of Internal Revenue, 119 T.C.M. (CCH) 1507, at *1 (2020).
[21] Kroner, 48 F.4th at 1275.
[22] Id. at 1276.
[23] Id. at 1278.
[24] Id. at 1280.
[25] Id. This argument is questionable. In Kroner, the Court stated that “the IRS’s probable next steps, issuing a tax lien, and collecting via levy, provide taxpayers access to administrative and judicial remedies that may encourage the parties to continue negotiating long after assessment.” Id.While the taxpayer may elect to pay the assessed penalty and sue for a refund, which may result another set of negotiations, this in no way changes the fact that the penalty has already been assessed. That is, the taxpayer’s liability is on the IRS’s books. Put simply, the Eleventh Circuit’s critique of the Chai court’s legislative history analysis ends up reinforcing the Chai court’s goal of ensuring that IRS agents are precluded from using penalties as “bargaining chips” prior to assessment.
[26] 26 U.S.C. § 6751(b).
[27] Chai, 851 F.3d at 221.
[28] Laidlaw’s, 29 F.4th at 1074; Kroner, 48 F.4th at 1276.
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