Recent Tax Court rulings may allow refunds of previously assessed penalties
By: Derek B. Wheeler, Esq. and Heather L. Marello, Esq.
As part of the Restructuring and Reform Act of 1998 (“RRA 98”), Congress enacted IRC §6751(b)(1), which requires written supervisory approval for certain penalties proposed by the IRS. Much of RRA 98 focused on legislative controls to prevent abusive practices by IRS personnel which had come to light in the years preceding the Act. This statute section was enacted to curtail the abusive practice whereby IRS examiners asserted unwarranted penalties that would be later used as bargaining chips in Appeals. The provision provides specific exceptions where supervisory approval is not required: failure to file, failure to pay, failure to pay estimated tax penalties, as well as penalties assessed through automatic means – i.e. directly by the Service Center and not by an IRS employee.
More than 20 years later, this statute has returned to the tax headlines. Since 2019, penalties assessed under IRC § 6751 have been the subject of careful scrutiny by the Tax Court. On April 24, 2019, the Tax Court issued its decision in Clay v. Commissioner, 152 T.C. No. 13 (appeal pending), which held that the mandated penalty approval must be made prior to the “initial determination” of a penalty, which could be as early as the 30-day Proposed Assessment Letter giving rise to Appeal rights.
Since the Clay decision, practitioners have been eager to apply this ruling not only to accuracy related penalties, but also to various other penalties such as IRC § 6707A reportable transaction penalties (determined to be a penalty subject to managerial approval by Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 154 T.C. No. 4 (Jan. 16, 2020)). And, most recently, on January 21st, Judge Lauber’s opinion in Chadwick v. Commissioner, 154 T.C. No. 5 (Jan. 21, 2020) finally answered the question as to whether the Trust Fund Recovery Penalty (TFRP) is a penalty or tax for purposes of IRC §6751(b). The fact that this is even a question should raise eyebrows, but the IRS had argued that this penalty is not really a penalty and so managerial approval is not necessary. And, fortunately for taxpayers, reason prevailed and the Tax Court held that TFRP liability under IRC § 6672 is indeed a penalty.
IRC §6672 imposes a penalty on any person who is required to collect, truthfully account for, and pay over any tax. The penalty is equal to the total amount of trust fund portion of the employment taxes (federal income tax withholding and employee contributions to Social Security and Medicare). The IRS can, and will, assess the penalty on as many people as possible that qualify as “responsible persons.” Imposition of TFRP can result in large liabilities being assessed on multiple persons involved in the financial operations of the business, and IRS can pursue collection against all of them up to the full amount of the actual trust fund tax owed.
The IRS has long argued, and will likely continue to argue, that the Trust Fund Recovery Penalty is not a penalty, but a tax, because it is (1) equal to the amount of unpaid trust fund taxes and (2) payment of the penalty reduces the tax liability of the employer. IRS has 90 days from the date of the decision to appeal the Chadwick decision to the 2nd Circuit. While decisions in Chai (2nd Cir.) and Graev III (T.C.) placed the administrative onus on the IRS to verify that written supervisory approval was secured timely, the 2nd Circuit has not yet opined on whether the TFRP is a penalty or a tax. Multiple district court decisions in the 2nd Circuit have held the TFRP to be a tax, yet, most of these decisions were prior to the implementation of IRC §6751. Judge Lauber rebuts many of these arguments head on, providing persuasive precedent to challenge any potential adverse decision at the district court level in the 2nd Circuit.
What does this mean for you or your clients?
Any taxpayer who has been assessed a penalty subject to IRC § 6751 or recently paid an assessment of those penalties, including a TFRP penalty, should seek verification that the IRS followed the penalty approval procedures laid out in IRC § 6751 prior to the “initial determination” of the penalty. This challenge can be made at the administrative, Tax Court, refund, or collection alternative phases. Taxpayers who successfully challenge such penalties can substantially reduce their outstanding liabilities or obtain refunds of amounts paid towards improperly-assessed penalties.
Andreozzi Bluestein has extensive experience representing taxpayers before the IRS in conjunction with audit defense and collection alternatives, including challenging penalties subject to IRC § 6751 managerial approval. If you or a client have been assessed a penalty or have received a notice regarding collection of the penalty, please call us at any time for a no-obligation consultation.
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