The courts recently held that penalties have to be abated if the IRS does not obtain written manager approval for the penalties. The IRS has been abating penalties for this since the ruling.
But there is a question as to when does the IRS have to obtain manager approval? Is it sufficient that the IRS gets the approval before the IRS assesses or records the penalty on its books or is it before the IRS tells the taxpayer about the penalty?
The court addresses this in Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. 4 (2020).
About the 6707A Penalty
We have previously covered the 6707A penalty. In that post we described the penalty as follows:
The Section 6707A reportable transaction penalty applies if the taxpayer fails to report certain transactions to the IRS on a Form 8886, Reportable Transaction Disclosure Statement, with their tax return.
The IRS determines which transactions are reportable by identifying transactions and designating them as listed transactions.
Unlike most other tax penalties, the Section 6707A reportable transaction penalty is an assessable penalty. This means that the IRS can assess the penalty without going through the statutory notice procedures.
This also means that taxpayers generally cannot contest the penalty in U.S. Tax Court. So taxpayers have to pay the penalty, file a refund claim, wait for the refund claim to be denied, and then sue for a refund in U.S. District Court or the Federal Claims Court.
The intent of the penalty is to obligate taxpayers to report certain transactions or dealings that the IRS has an interest in reviewing. This includes things like contingent fees charged by tax pros for research tax credits.
About Manager Approval for Penalties
The Code has included language requiring manager approval in writing before penalties are assessed. It wasn’t until the Graev v. Commissioner, 149 T.C. 485, 493 (2017), line of cases that anyone ever challenged the IRS not getting manager approval. The court in that case removed the penalties due to the absence of written manager approval.
But Graev didn’t involve an assessable penalty. It involved a penalty that triggered a notice that could be appealed administratively and, if unsuccessful, appealed to the U.S. Tax Court without having first made payment.
The court has since considered another assessable penalty and concluded that the manager approval requirement applied to it. So the court was easily able to determine that this requirement applies to the Section 6707A penalty.
When Manager Approval Has to be Secured
But there is a question of when written approval has to be obtained. This case helps answer that question.
In this case, the the IRS revenue agent sent a 30-day letter to the taxpayer proposing the Section 6707A penalty. The IRS uses the 30-day letter to let the taxpayer know that it has 30-days to file a protest to ask the IRS Office of Appeals to consider the case.
The IRS revenue agent did not have written IRS manager approval at the time the 30-day letter was sent to the taxpayer. The IRS then secured written IRS manager approval for the penalty and assessed the penalty.
In the court case, the IRS argued that the approval only needed to be before the actual assessment. The taxpayer argued that the approval had to be obtained before the first communication to the taxpayer about penalties.
In reviewing the statutory language, the court had this to say:
we now hold that in the case of the assessable penalty of section 6707A here at issue, section 6751(b)(1) requires the IRS to obtain written supervisory approval before it formally communicates to the taxpayer its determination that the taxpayer is liable for the penalty.
This clarifies the timing for the Graev line of cases. The written IRS manager approval must proceed the issuance of a 30-day letter.
Those who are assessed penalties should continue to submit Freedom of Information Act Requests (FOIA requests) to determine whether the IRS obtained written manager approval. In doing so, they should check the timing to see if the written approval came before or after the issuance of a 30-day letter. If it is after the 30-day letter, the taxpayers should file a penalty abatement claim or refund claim for the penalties.