A hearing is scheduled for September 11, 2023 for interested persons and organizations to provide testimony on proposed regulations on the timing and approval process for penalties. Section 6751(b) provides that:
No penalty under this title 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 or such higher level official as the Secretary may designate.
The timing of when the approval is required by Section 6751(b) has been the subject of significant litigation. The Second Circuit in Chai v. Commissioner concluded that Congress enacted section 6751(b) to “prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle.” This has caused a lot of litigation in both the Tax Court and U.S. District Courts such that there are currently two different standards on timing of when such supervisory approval is required. If supervisory approval is to meet the goal of not being used as an unfair “bargaining chip” it must be required before such unwanted behavior can occur. Many groups have submitted comments asking for supervisory approval to be done earlier in the examination process than the proposed regulations require and that approval be done by a direct supervisor and not just anyone with penalty approval rights within the IRS.
Against this backdrop, the U.S. Tax Court has been handling allegations from a taxpayer that the IRS backdated supervisory approval and then misrepresented those facts to the court. According to the Court, the parties agree that the Revenue Agent prepared a penalty consideration “Lead Sheet” on July 15, 2016 that was amended in February 2017 to include additional penalties and signed by the Revenue Agent on February 10, 2017 but backdated by the Revenue Agent by writing in a date of July 16, 2016. The Court had previously granted a motion for partial summary judgment to the IRS on the issue but noted in its recent opinion that “it is not apparent that our ruling was predicated on facts that were not true.” The IRS abandoned its previous argument and tried to point to a different document, presumably not backdated, as the required written supervisory approval. The Court decided that was insufficient to support its previous ruling in their favor and a genuine dispute of material fact exists now over whether the IRS complied with Section 6751(b).
The taxpayer also sought sanctions against the IRS for its misrepresentations requesting that the Section 6751(b) approval issue be resolved against the IRS and attorney’s fees awarded for the misconduct. The IRS attempted to distinguish its actions from “fraud or bad faith” required for sanctions and indicated that it brought the misrepresentation to the Tax Court’s attention as soon as possible. The Tax Court disagreed and said that the IRS actions fell short of the obligations to the Court. Specifically, the IRS received an email on November 2, 2022 from the Revenue Agent that the date could be inaccurate but filed several subsequent pleadings and discovery documents maintaining that the date was correct. The Tax Court noted that this multiplied the proceedings “unreasonably and vexatiously” and resulting in the taxpayer retaining additional counsel and substantially increasing the discovery and motions practice required. The Court refused to grant the adverse ruling against the IRS on the issue but did indicate that excess costs and fees was “appropriate” but it did not have sufficient information at this time to determine the amount.
Section 6751(b)(1) requires that the immediate supervisor or higher-level official “personally approve (in writing)” the initial determination to assert a penalty. Proposed regulations § 301.6751(b)-1(a)(3)(v) provides that “personally approved (in writing)” means any writing, including in electronic form, that is made by the writer to signify the writer’s asset and that reflects that it was intended as approval.” Courts have allowed for a liberal standard for what constitutes a “writing” but this case illustrates the problems with an unverifiable standard that allows for backdating. The IRS can fix this problem in the final regulations by requiring approval in a form that clearly shows that the date, time, and authority of the individual approving the penalty. Digital signatures, for example, when properly used can avoid confusion and inappropriate backdating caused by typed signatures and dates on forms. Therefore, the definition of “personally approved (in writing)” should include a provision that approval is shown through a digital signature including a software-generated timestamp indicating precisely when and who signed the document.
Further, this emphasizes the importance of supervisory approval requirements to prevent abuse. A standard that can be easily manipulated and costly to prove manipulation does not promote faith in the system or encourage voluntary compliance – it does the opposite.