Many people, myself included, can sometimes be accused of poor penmanship. As our paperwork becomes more and more electronic, we write less and less down with pen and paper. However, a recent decision from the tax court may be sending more supervisors at the IRS to penmanship classes. The taxpayers, Gregory and Simone Colbert, were assessed income tax deficiencies and associated accuracy related penalties. The Colberts admitted the deficiencies but disputed the interest and penalties.
The Process of Penalties
The IRS bears an initial burden of production with respect to a taxpayer’s liability for accuracy related and other types of penalties. This requires the IRS to make an initial showing that there is sufficient evidence that penalties are appropriate. Once the IRS meets this initial showing, which is usually quite easy, the burden shifts to the taxpayer to show that the penalty determination is correct. However, there are also required procedural requirements the IRS must show indicating that the assertion of the penalty was done properly. These procedural requirements have been the subject of a lot of recent litigation and the IRS has lost many cases for not following them exactly. The relevant procedural requirements are listed in the Internal Revenue Code in Section 6751.
IRC Section 6751
Section 6751 requires that no penalty be assessed unless “the initial determination” is “personally approved by the immediate supervisor of the individual making such determination.” The rule exists to prevent over-eager revenue agents from using penalties as a bargaining chip against taxpayers without a supervisor approving, in writing, that the penalty is appropriate beforehand. Essentially, you cannot threaten penalties without having your supervisor agree that penalties are appropriate beforehand. The written supervisory approval must be obtained no later than the issuance of a notice of deficiency or other assertion of the penalty.
The tax court notes that the evidence included copies of the IRS “Civil Penalty Approval Form” and that such forms are signed by the immediate supervisor of the revenue agent examining the returns approving the penalties. However, the tax court also notes that the date on the forms is “illegible.” Therefore, the court held that “we cannot reliably conclude on the bases of the penalty approval forms that [the IRS] satisfied the requirements of section 6751(b)(1).” Because the IRS could not satisfy its burden to show that procedural requirements were followed, the taxpayers were found “not liable for accuracy-related penalties.”
The IRS is generally very careful regarding the statutory procedural requirements for making its assessments and asserting penalties. The procedures exist to provide important protections against abuse by revenue agents that wield a lot of power to disrupt the lives or business of taxpayers under audit. Taxpayers and their advisors are well advised to check all procedural requirements involved in their cases. Not only because it may win the argument for their clients, but because it also protects the integrity of the tax system.