The Build Back Better Act, which has been passed by the House and awaits passage by the Senate, contains a provision that would give individual IRS agents more power and strip taxpayers of important protections that were enacted in 1998. Internal Revenue Code section 6751 currently provides that before the IRS can assess penalties against a taxpayer, the initial determination of that penalty must be approved in writing by the immediate supervisor of the agent who determined imposing the penalties is justified. That requirement, that managerial approval must be obtained in writing, was enacted in 1998 as part of a sweeping reform to give taxpayers a more level playing field with the IRS known as the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98). After 1998, the IRS was required to obtain written supervisory approval before imposing penalties on taxpayers. Did the IRS do this? No, it did not. And taxpayers noticed, sued the IRS, and won. Now Congress seeks to retroactively repeal 6751(b) and create a time-machine that would forgive the IRS for its failure to follow the law and provide the required protections to taxpayers against overzealous agents who impose penalties as a punishment or use them as a bargaining chip.
In 1998, the movie Titanic became the first movie to gross over a billion dollars. In that same year, Congress embarked on a titanic endeavor to restore taxpayer confidence in the Internal Revenue Service and to put taxpayers on a more level playing field with the IRS when dealing with examinations. Why did Congress do this? Senator Grassley put it this way during his opening statement at the hearings, “There are real problems dealing with the IRS and there are real problems at the IRS. In this committee’s hearings last fall, we heard horror stories about our government’s treatment of taxpayers. Every time I go home I hear constituents tell about these firsthand experiences, and rarely are these experiences good.”
What is so important about requiring managerial approval before imposing penalties?
Nina Olson, former National Taxpayer Advocate, explained in her recent blog post in Procedurally Taxing why 6751(b)’s protections are so important:
“Supervisor approval helps ensure consistent and equitable treatment for taxpayers…. [E]ach examiner approaches the job and issues with a little bit (or sometimes a lot) different mindset. What one thinks is negligent or fraudulent will be different from what another thinks. Laying a second set of eyes and judgement on the case can smooth out the edges of differing value systems and mindsets of examiners. If done correctly, the supervisor should ask a few questions which could reveal gaps in the examiner’s exam procedures (such as the examiner failing to ask a salient question that might have clarified why the taxpayer did what they did, which might show a penalty isn’t warranted). This process could eliminate some penalties but perhaps strengthen others where penalties are in order. In this way, supervisor review promotes good tax administration and reinforces effective exam procedures.”
As I recently explained in an article about a prior iteration of this proposed legislation, retroactively repealing 6751(b) would do nothing more than reward the IRS for bad behavior. In my career representing taxpayers before the IRS, I can unequivocally say that I think many (if not most) IRS agents try hard to do their job well. They are honest, hardworking men and women who want to do the right thing. But Congress’s decision to enact 6751 back in 1998 was a product of two things:
- Agents who try hard to do the right thing, but get it wrong, and
- Overzealous agents who go overboard and do not handle their cases properly.
Even one overzealous agent can erode taxpayer confidence in fair and equal administration of our tax system. Taxpayer confidence in fair and equal administration of our tax system is critical, because we have a self-reporting and self-paying system. If you think your neighbor Bob is getting away with not paying his taxes, it makes you not want to pay your taxes. If taxpayers believe that IRS agents are overzealous and go overboard, and inappropriately impose penalties, then confidence in the system – and as a result, compliance with the system – is eroded. When RRA 98 was passed, it was done to restore taxpayer confidence in a system that had eroded due to abuse. There are very few things that everyone in this country can agree on, but I think one of them is that a single IRS agent should not be able to impose penalties on a taxpayer without at least getting his boss to agree that penalties are appropriate.
To be sure, section 6751 is by no means a model of clarity. But rather than repealing it – let alone retroactively – Congress should work to clarify when written managerial approval must be obtained. After all, do we really want IRS agents to have unilateral authority to impose penalties on taxpayers? I sure don’t.
And if you think that the enactment of section 6751 and the subsequent litigation over it has lead to the IRS following the rules in all instances, think again. Someone representing themselves as an IRS agent recently left this comment on a social media post about the proposed repeal of 6751, “Ummm we still use penalties as bargaining chips. Its just creating less red tape.”
A Reluctant Proposal for Modification
I don’t think this proposed retroactive repeal of section 6751(b) should be passed in any form, but if it is passed at all, basic tenants of fundamental fairness suggest Congress should make clear that it would not apply to assessable penalties. I hesitate to even publish the rest of this article because I so fervently believe that section 6751’s protections are imperative for all taxpayer protection and fairness, but if Congress is bound and determined to repeal some part of section 6751, it should not – must not – apply to assessable penalties.
Why? Because when the IRS imposes assessable penalties, unlike deficiency penalties, the taxpayer can’t even begin to dispute whether those penalties should apply unless the penalty is paid in full.
In general, when the IRS examines a taxpayer, the examination can have four possible results:
- No Change. A civil tax dispute in which the IRS determines that no change is needed. This is the best possible outcome from an IRS exam, the taxpayer owes nothing.
- Deficiency Notice. A civil tax dispute in which the IRS determines that the taxpayer made an error or omission on an income tax return. This will result in a Notice of Deficiency. A Notice of Deficiency is sometimes called a “ticket to Tax Court.” You might be reading this thinking, no one wants to go to Tax Court, and I certainly don’t want a ticket to Tax Court. Yes, you do. If you have a dispute with the IRS, Tax Court provides the only pre-payment judicial forum to litigate your dispute. In addition, litigation in Tax Court is generally less expensive than in other federal courts. Taxpayers whose audits end in a Notice of Deficiency have 90 days to file a Tax Court Petition. If the taxpayer files a petition in 90 days, the IRS is prohibited from assessing the amount in dispute unless and until the Tax Court case is decided, and only if it is decided in the IRS’s favor. If the taxpayer does not file a timely petition, then the IRS will assess the whole amount in dispute. Then the taxpayer’s only recourse as to the liability is to pay the whole amount the IRS says is due in full, file a claim for refund with the IRS, and then file a lawsuit to enforce the refund claim after receiving a denial (or 6 months after filing the refund claim, whichever comes first). But in general, when the IRS conducts a civil tax examination that results in the IRS determining an additional amount is due, including taxes and penalties, taxpayers have a right to a trial in Tax Court before they have to pay anything.
- Referral to IRS Criminal Investigation. If the IRS civil examination division determines during the course of a civil examination that there may be criminal conduct at play, then the case will be referred to the criminal investigation division. If you have an IRS exam that suddenly goes quiet, it does not mean that the IRS agent forgot about you. It may mean that the IRS agent determined there was good cause to refer the case to IRS criminal division, and in those cases, the civil exam typically stops and is on hold while the criminal case proceeds.
- “Assessable penalties” are assessed. Not every IRS case is about taxes, believe it or not. Many cases focus purely on whether taxpayers failed to file a form that doesn’t even impose tax. Assessable penalties typically stem from the failure to file information returns, improper or incomplete filing of information returns, or certain conduct that is determined to be improper, such as promoting a tax shelter.
Why Assessable Penalties Be Excluded from Any Repeal of 6751(b), Retroactive or Not.
In the scenarios I have described above, in all cases but assessable penalties, taxpayers have absolute right to their day in court without paying the full amount the IRS says is due. If the IRS determines no tax or penalties are due, that is the end of the examination. In deficiency cases, the taxpayer is provided with a “ticket to Tax Court,” a pre-payment venue, and can litigate in front of an impartial judge who understands the tax code whether the tax and penalties are due prior to paying a dime. The taxpayer will not lose any refunds in the meantime, because the tax and penalties are prohibited by law from being assessed while the matter is being litigated. If a case is referred to the IRS Criminal Investigation unit, IRS civil will typically stop. Taxpayers who are charged with tax crimes have the right to contest those charges in court and they must be found guilty beyond a reasonable doubt before a conviction will be rendered.
Conversely, when the IRS determines that assessable penalties should be imposed, the taxpayer has almost no rights whatsoever. The assessable penalties are “assessed,” and so unlike when a taxpayer disputes a tax deficiency and penalties, the prohibition on assessment does not apply. Because the assessment is made, the taxpayer will not receive federal or state tax refunds that they are entitled to. Instead, those will be applied towards the balance of the civil penalty. The taxpayer is at risk of having their passport revoked because of the civil penalty. And the IRS has the right to proceed with enforced collection, including an IRS lien or levy. While taxpayers have important Collection Due Process rights to contest the IRS enforced collection process, rights to contest an IRS lien only arise after the lien is filed and encumbers a taxpayer’s property.
Because of an obscure and outdated Supreme Court case, Flora v. United States, 357 U.S. 63 (1958), taxpayers must pay any amount the IRS assesses in full in order to dispute the validity of the tax or penalty at all. Remember that taxpayers who are assessed assessable penalties don’t get a “ticket to Tax Court,” and their only avenue to contest the IRS determination is to pay and file a claim for refund. In Flora, the taxpayer suffered losses on commodity futures. He reported the losses as ordinary losses, but the IRS disagreed and determined that they were capital losses. A Notice of Deficiency was issued, but instead of going to Tax Court, the taxpayer elected to pay part of the balance the IRS said was due, file a claim for refund, and file a lawsuit in federal district court. The Supreme Court in Flora held that in order to obtain refund jurisdiction (or, in other words, to earn the right to sue the IRS in Federal Court for a refund), the taxpayer has to pay the amount the IRS says is due in full.
It is important to note that no law requires taxpayers to pay in full before suing for a refund in Federal Court. The only authority is Flora, a case that was decided in 1958, based on a taxpayer who received a ticket to Tax Court but decided to throw the ticket away. Since Flora was decided, Congress has enacted scores of civil penalties for which no ticket to Tax Court will ever be issued. And the IRS has similarly created scores of information reporting forms for which no tax is due, but information reporting civil penalties will be imposed for the failure to timely or accurately file those information reporting forms. (For an excellent overview of Flora and why Congress should overturn it, see Keith Fogg’s article in the ABA Tax Journal, Access to Judicial Review in Nondeficiency Tax Cases)
The practical implication of assessable penalties is that a rogue agent has a lot of power, and can literally ruin someone’s life by imposing that penalty. Think I’m being dramatic? Ask John Larson. The IRS agreed that the assessable penalty it imposed on him was wrong – to the tune of $67 million dollars. Yet because of Flora, Larson was not able to get his day in court on whether he owed the assessable penalty at all. Why? Because he could not pay in full to get that day in court. And remember, in the meantime, all of his refunds will be seized and applied towards the balance, a lien will be filed on his property, and his passport could be certified for revocation. All of this before he even gets the opportunity to contest the liability for the penalty. It makes you wonder what country we are living in.
It seems to me that applying Flora in today’s environment, in which obscure information reporting forms and civil penalties abound, amounts to no more than requiring taxpayers to buy their way into courts to get a fair shake at impartial review of whether they are even liable for the penalty or not. The only procedural tax rule Congress should be considering retroactively repealing is Flora and its outdated and unfair application to American taxpayers.
Who Benefits?
There is a sense that application of section 6751(b) and its ensuing litigation has benefitted only “well-heeled” taxpayers. This is not true. First, there is no better authority on this issue than Nina Olson, the former National Taxpayer Advocate, who has devoted her career to representing low-income taxpayers and is currently the Executive Director of the Center for Taxpayer Rights. According to Olson, “I suggest you review two research studies published in the National Taxpayer Advocate Annual Reports to Congress in 2013 and 2019. In these studies we looked at the IRS application of the IRC § 32(k) two-year ban of the Earned Income Tax Credit where the IRS made “a final determination that the taxpayer’s claim of credit was due to reckless or intentional disregard of rules and regulations. In 2013, the Taxpayer Advocate Service (TAS) reviewed a representative sample of the 32(k) cases and found:
- In almost 40% of the cases, the ban was imposed without the required “determination” of the taxpayer’s state of mind;
- In 69% of the cases IRS employees did not obtain required managerial approval before imposing the penalty; and
- In almost 90% of the cases, “neither IRS work papers nor communications to the taxpayer contained an adequate explanation of why the ban was being imposed.
Following our study, TAS negotiated with the IRS to update the Internal Revenue Manual provisions to include a requirement that auditors must note the reason for imposition in their workpapers. Both the 2013 and 2016 IRMs required supervisory approval of 32(k) penalty revision.”
In other words, taxpayers whose income is so low that they qualify for the Earned Income Tax Credit were significantly impacted by the IRS’s failure to obtain the requisite supervisory approval.
I recently presented at the Freeman Law Conference with Frank Agostino, the attorney who first litigated section 6751 compliance. In our presentation on IRS enforcement of International Information Reporting Penalties, Frank pointed out that the IRS’s aggressive and seemingly arbitrary enforcement of International Information Reporting Penalties was “clearly discriminatory against immigrants.” His point is well taken. The IRS is imposing these assessable international information reporting penalties without a cursory glance at the facts and circumstances of the individual taxpayers’ cases. Immigrants, who have the least knowledge and first-hand experience of our tax system, are paying a disproportionate price for reporting foot-faults.
Finally, as a tax controversy attorney, I am seeing the IRS impose assessable information reporting penalties over and over against small businesses who are least prepared and financial able to pay to contest them. Who among my readers has ever heard of IRS Form 1095-C? This is the form employers are supposed to file to report compliance with Obamacare requirements to offer health insurance coverage. The failure to file this form results in assessable IRS penalties that can triple if the IRS deems, in its wisdom, that the failure to file the form was intentional. Nevermind that the employers engaged professional payroll services to handle all tax matters – the IRS says that is not good enough, and the IRS agents decided to impose the applicable civil penalties. Small businesses face enough problems today without having overzealous IRS agents impose penalties for the failure to file information returns without managerial approval. Especially information forms that few have even heard of.
Because assessable penalties are so costly and so difficult to dispute in litigation, at a minimum, Congress should exempt them from any repeal of section 6751(b). But the better course would be to repeal Flora, and revise 6751(b) to clarify when and how written managerial approval must be obtained.