“With every move he makes, another chance he takes”
Today we have the pleasure of looking at an IRC 6751(b) opinion written by Judge Holmes. For long time readers of this blog, the link between Judge Holmes and Graev consequences of not following the statutory language requiring approval of the immediate supervisor are well known. His warning of Chai ghouls continues to haunt the IRS as different scenarios regarding the imposition of various penalties arise. In CFM Insurance, Inc. v. Commissioner, Dk. No. 10703-19 (Order entered June 16, 2021), a case involving a microcaptive insurance company the IRS has targeted as abusive, he issues an order denying the IRS motion seeking summary judgment on the issue of penalty approval. As with many of the cases seeking to interpret IRC 6751, the facts in CFM do not follow a straight line. The title of the blog comes from a line in the footnote by Judge Holmes citing to the famous, for those of us of a certain age, recording by Johnny Rivers entitled “Secret Agent Man”. Use the link to listen to the song if you are not familiar with it or if you have curiosity about vintage recordings.
So, from the many prior rulings on the issue of proper imposition of a penalty we have learned that the IRS needs the immediate supervisor of the agent imposing the penalty to personally approve in writing the penalty before the IRS first formally notifies the taxpayer of a proposed penalty. If the IRS fails to obtain the written approval in time, then it loses the right to impose the penalty, as has occurred in many cases. That’s why the IRS files a motion for summary judgement on this issue before trial in order to lock down the fact that it has followed the correct procedural steps before it gets to the merits of the penalty. In some ways, this motion for summary judgment seems like a motion in limine.
Here, the IRS asserts in the Tax Court case that CFM owes a 20% accuracy related penalty created in IRC 6662(a) for negligence. The Court looks to see when it notified CFM of this penalty and what steps the IRS had taken before notification. The first issue the Court addresses concerns the notification. It notes that a couple possibilities exist for when this occurred. The IRS sent a 30-day letter which in prior cases the Court has treated as the official notification. This letter tells the taxpayer of the examination division’s position and offers the taxpayer a chance to file a protest and go to the Independent Office of Appeals to discuss the matter. The 30-day letter was signed by the revenue agent’s immediate supervisor which would seem to end the inquiry on the point of notification, except for one small problem. The 30-day letter proposes the imposition of a 40% penalty, not the 20% penalty included in the notice of deficiency. So, correct notification form but a shift in penalty before issuance of the notice of deficiency. How does that impact satisfaction of the statutory requirement?
The Court looks for approval of the 20% penalty as well as prior case law in situations in which the penalty shifted. The Court describes its inquiry:
Our caselaw tells us to focus on the formal notice that a taxpayer gets. Did any of these documents give formal notice to CFM of the 20% penalty? Ordinarily, an Examination Report and 30-day letter is sufficient to clear the 6751(b)(1) hurdle. See, e.g., Thoma v. Commissioner, 119 T.C.M. (CCH) 1447, 1472 n.34 (2020). But in this case, there was no mention of a 20% penalty’s being asserted in the 30-day letter or any of the documents listed as enclosures; the Examination Report and Agreement Form both mention 40% penalties for each year pursuant to section 6662, but section 6662 allows for 40% penalties in only three instances: when an underpayment is due to a “gross misvaluation misstatement,” § 6662(h), a “nondisclosed noneconomic substance transaction,” § 6662(i), or an “undisclosed foreign financial asset understatement,” § 6662(j). The 20% penalties under section 6662(b)(1) for negligence or disregard of rules or regulations (or substantial understatement) are distinct from each of these 40% penalties and must receive separate supervisory approval to cross over the section 6751(b) threshold. See Sells v. Commissioner, 121 T.C.M. (CCH) 1072 (2021), T.C. Memo. 2021-12, at *11. “Formal notice” requires that the penalty be described with sufficient particularity so a taxpayer knows what he is accused of. See Legg v. Commissioner, 145 T.C. 344, 350 (2015) (“Congress enacted section 6751(b) to ensure that taxpayers understood the penalties that the IRS imposed upon them”). An Examination Report and 30-day letter that mention only a 40% penalty do not provide notice of a 20% penalty. See Oropeza v. Commissioner, 120 T.C.M. (CCH) 71, 72 (2020). As a matter of law, then, neither the 30-day letter nor any of the documents listed as enclosures provided CFM with formal notice of the 20% penalties under section 6662(b)(1).
The Court notes that at this point the outcome looks bad for the IRS but goes on to discuss a stuffer in the envelope transmitting the 30-day letter. The stuffer, Form 886-A does mention a 20% penalty; however, the stuffer has problems:
That document correctly identifies the reasons for and subsections under which the penalties were being asserted, but incorrectly identifies the amount. And that’s not the only irregularity. An initial glance reveals that the text of the Form is shrunk so that each page only takes up about half the area of the paper it’s printed on. Closer inspection shows that it includes errors (e.g., the phrase “Error! Bookmark not defined” appears several times in the Form’s table of contents) and what appear to be highlights and comments made by someone reviewing the report using a “track changes” function. So, is this “formal notice?”
The Court finds that the Form 886-A was incomplete and that the record is incomplete whether or not the supervisor of the agent approved stuffing this form in the letter with the 30-day letter. Among other things, the supervisor at the time of sending the letter is unknown, and the signature of that supervisor is not clearly identified in the material before the Court, causing the reference to the “Secret Agent Man.” In the end, the Court denies the motion for summary judgment but does not toss out the penalty. The IRS has a roadmap for what it needs to prove and it remains to be seen if it can prove it.
Another Chai ghoul appears as the stuffer saves the IRS to fight another day but does not insure that it will win the fight. This case was docketed in 2019. By that time, the Tax Court had provided the IRS with notice of the importance of IRC 6751(b). This is not a case like some described in earlier posts where the case sat so long in the Tax Court that the knowledge and interpretation of the law shifted dramatically between the time of the penalty imposition and the decision.