The IRS and the courts have invalidated penalties where the IRS fails to obtain IRS manager approval before assessing the penalty. It has done so in cases where the penalties are manually assessed by IRS personnel. But what about penalties that are automatically assessed by the IRS’s computers? The court addresses this in Atl & Sons Holdings, Inc. v. Commissioner, 152 T.C. 8.
Facts & Procedural History
The taxpayer is an Subchapter S corporation. It has two shareholders. The taxpayer failed to file its Form 1120S, U.S. Income Tax Return for an S Corporation. The IRS assessed a late filing penalty under Sec. 6699.
The taxpayer challenged the penalty, arguing that the IRS had to obtain manager approval before assessing the penalty.
This dispute stems from Graev v. Commissioner, 147 T.C. 16, wherein the court invalidated a penalty when manager approval was not obtained.Graev involved a Sec. 6662(h) 40% gross valuation misstatement penalty. The penalty was assessed after an IRS audit. It was computed by an IRS agent and reported on a statutory notice of deficiency issued to the taxpayer.
In the current case, the IRS argued that the exception for penalties calculated by electronic means applies. The Code provides an exception for the manager approval requirement for “any other penalty automatically calculated through electronic means.” Thus, the question for the court is whether the Sec. 6699 penalty is an “other penalty” and whether it was automatically calculated through electronic means.
Calculated by Electronic Means
The court considered the electronic means requirement.
Unlike the manual process whereby an IRS agent assessed the penalty in Graev, the penalty here was assessed automatically by the IRS’s computer system. It is based on two inputs, namely, the number of shareholders and the number of months the return is filed late. This is why the IRS computer system can automatically assess the penalty.
The court noted this and held that the Sec. 6699 penalty is automatically calculated by electronic means.
What is an “Other Penalty”
The court also addressed the “other penalty” requirement. The Code doesn’t explain what the phrase “other penalty” includes. Given the absence of an express answer in the Code, the court construed the language of the statute.
The court compared the Sec. 6699 penalty to the penalties that are specifically identified in the Code as requiring manager approval.
The closest type of tax penalty that is similar to the Sec. 6699 penalty is the standard failure to file penalty under Sec. 6651(a)(1). The Sec. 6651(a)(1) penalty is computed by the amount of tax reported on a late filed return and the time period that has elapsed before the return was filed. No manager approval is required for this penalty as it is automatically calculated by the IRS’s computer.
By comparing the Sec. 6699 penalty to the Sec. 6651(a)(1), the court concluded that the penalty was an “other penalty” that does not require manager approval before assessment.
But What About Reasonable Cause?
The taxpayer also argued that the penalty was not automatically calculated as there is a reasonable cause defense available for the penalty.
The court concluded that the availability of a reasonable cause defense does not negate that the penalty was automatically calculated. Reasonable cause is a defense the taxpayer raises after the penalty is assessed or as part of the assessment.
This case provides some limits on the Graev case. Penalties that are automatically assessed by the IRS’s computer system are not subject to manager approval before assessment.
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