Tax Penalty May Be Communicated to Taxpayer Prior to Required Supervisory Approval

In Kroner v. Commissioner, 2022 U.S. App. LEXIS 25650 (11th Cir. Sept. 13, 2022), the court reversed a U.S. Tax Court decision to hold that the Internal Revenue Service (“IRS”) did not violate section 6751(b) of the Internal Revenue Code when it obtained supervisory approval prior to the assessment of a tax penalty, even though the penalty was communicated to the taxpayer prior to supervisory approval.

Between 2005 and 2007, Kroner received nearly $25 million in wire transfers from a business partner, which he believed to be excludable from income as gifts for tax purposes.  He did not report any of the $25 million on his federal income tax returns for those years.  The IRS selected his returns for examination.  On August 6, 2012, the IRS delivered a form letter to Kroner proposing to increase his income by the amount of the wire transfers and to impose the accuracy related penalty.  However, the IRS revenue agent did not obtain the signature of his supervisor on the Civil Penalty Approval Form until October 31, 2012.  On that same day, the revenue agent mailed Kroner a second letter, also asserting the penalty.  The IRS issued a statutory notice of deficiency in 2014, and Kroner petitioned the Tax Court, asserting (among other things) that the failure to obtain supervisory approval violated section 6751(b).

Section 6751(b) provides that no penalty 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.  The Tax Court, consistent with its prior decisions, held that because the August 6, 2012 letter had provided Kroner with the ability to appeal to the IRS Independent Office of Appeals, the letter was “the initial determination of such assessment,” prior supervisory approval was required, and the taxpayer was not liable for the accuracy-related penalty.  The IRS appealed the Tax Court’s decision to the Eleventh Circuit.  (Kroner did not appeal the Tax Court’s holding that the $25 million transfer was not a gift and therefore was subject to tax.)

The Eleventh Circuit, in an opinion written by Judge Brasher and joined by Judge Newsom and Judge Branch, reversed.  Relying on the text of section 6751(b), which it found to be clear and unambiguous, the Eleventh Circuit held that the IRS satisfies section 6751(b) so long as a supervisor approves an initial determination of a penalty assessment before it actually assesses the penalties.  The court’s interpretation of section 6751(b) is consistent with the Ninth Circuit’s interpretation of the same provision.  See Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29 F.4th 1066 (9th Cir. 2022). 

Because Kroner petitioned the Tax Court, assessment of any tax and penalties is postponed under section 6213(a) until all appeals of the Tax Court’s decision are exhausted.  Because no assessment has yet occurred, the supervisory approval on October 31, 2012 necessarily occurred prior to the assessment. 

The Eleventh Circuit rejected the reasoning of Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017), which had relied on the legislative history indicating that the statute reflected a purpose to prevent IRS agents from using penalties as a bargaining chip during pre-assessment negotiations to impose a pre-assessment deadline for supervisory approval.  The Eleventh Circuit noted that the Tax Court’s rule requiring early supervisory approval prevents the IRS from assessing penalties that the Tax Court itself has otherwise found to be warranted.  The court was not persuaded that the statute required this anomalous result.

Posted by Mary E. Monahan.

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