Supervisory Approval for IRS Penalties, Defenses & Exceptions

Can IRS Summons Taxpayer for Foreign Income or Asset Exams?

Supervisory-Approval Requirement for Penalties

When it comes to IRS penalties, one of the biggest issues in recent years has been whether the Internal Revenue Service went through the proper procedures to approve the penalties before putting the taxpayer on notice that penalties have been issued. Rule (26 U.S.C. 6751) requires the immediate supervisor of the person issuing the penalties to approve the penalty (in writing). However, not all penalties require supervisory approval, and circuits across the nation are split as to the timing of the approval. Moreover, depending on whether the penalties go through the deficiency procedures or not can impact the timing rules as well. In addition (and especially with foreign reporting penalties), the IRS uses various methods to side-step the supervisory approval requirements. Namely, the IRS relies on 6751(b)(2)(B), to circumvent the requirement to obtain supervisory approval in matters in which the penalty is automatically calculated. Since penalties such as Form 3520 foreign gift penalties are not based on income-related issues, but rather simply on the value of the gift and the number of months late, the penalties are considered automatically calculated and the IRS is not subject to 6751 Procedural Requirements. Let’s take a look at how this works.

26 U.S. Code § 6751 Procedural requirements

• • • (A) Computation of penalty included in notice

      • The Secretary shall include with each notice of penalty under this title information with respect to the name of the penalty, the section of this title under which the penalty is imposed, and a computation of the penalty.

    • (B) Approval of assessment

      • • (1) In general: No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.

        • (2) Exceptions Paragraph (1) shall not apply to—

          • (A) any addition to tax under section 6651, 6654, 6655, or 6662 (but only with respect to an addition to tax by reason of paragraph (9) or (10) of subsection (b) thereof); or

          • (B) any other penalty automatically calculated through electronic means.

    • (C) Penalties

      • • For purposes of this section, the term “penalty” includes any addition to tax or any additional amount.

When is the Supervisory Approval Necessary?

One of the key issues involving supervisory approval is ‘when’ the supervisory approval is required – in other words at what point during the penalty assessment process must the IRS gain supervisory approval. Unfortunately, courts are split as to when the penalty assessment must be made concerning the phrase ‘initial assessment.’ Courts are split on when supervisory approval is required. Some recent cases include Kraske, Graev, Laidlaw, and Clay. Some courts require it earlier in the penalty assessment process whereas others do not require the approval until later in the process.

Why this is a Problem for IRS International Return Penalties 

The reason why the supervisory approval issue is crucial for international information return penalties is that these types of penalties do not go through with typical deficiency procedures. Rather, taxpayers only learn that they have been assessed an international return penalty such as a Form 3520 penalty or Form 5471 penalty after they receive notice of the penalty assessment on the CP15 notice. While some taxpayers may try to use the defense that there was no supervisory approval before the penalty was issued, in practice these penalties are oftentimes automatically calculated based on whether the form was filed late or not and how many months later the form was filed — and thus the penalty assessment does not require supervisory approval. Especially in situations where the person receives a large gift on Form 3520, it is completely unfair that the taxpayer can get here with a six or seven-figure penalty automatically without going through deficiency procedures and without an IRS Supervisor reviewing the penalty facts and circumstances first.

Proposed Regulations

• • • “The proposed regulations would adopt three rules regarding the timing of supervisory approval of penalties under section 6751(b) that are based on objective and clear standards. One rule addresses penalties that are included in a pre-assessment notice that is subject to the Tax Court’s review, such as a statutory notice of deficiency. One rule is for penalties that the IRS raises in an answer, amended answer, or amendment to the answer to a Tax Court petition. And one rule is for penalties assessed without prior opportunity for review by the Tax Court.”

Penalties Subject to Pre-Assessment Review in the Tax Court

• • • “Proposed §?301.6751(b)–1(c) provides that, for penalties that are included in a pre-assessment notice issued to a taxpayer that provides the basis for jurisdiction in the Tax Court upon timely petition, supervisory approval may be obtained at any time before the notice is issued by the IRS. Section 6751(b) clearly provides that there be supervisory approval before the assessment of a penalty and contains no express requirement that the “written approval be obtained at any particular time prior to assessment.” Chai, 851 F.3d at 218.”

Penalties Raised in the Tax Court After a Petition

• • • “Proposed §?301.6751(b)–1(d) provides that, for penalties raised in the Tax Court after a petition, supervisory approval may be obtained at any time prior to the Commissioner requesting that the court determine the penalty. The proposed rule gives full effect to the language in both sections 6214 and 6751(b)(1) because once a penalty is raised, the Tax Court decision will control whether it is assessed. Section 6214(a) permits the Commissioner to raise penalties in an answer or amended answer that were not included in a notice that provides the basis for Tax Court jurisdiction upon timely petition.

    • The proposed rule allows the exercise of this statutory grant of independent judgment by the IRS Office of Chief Counsel (Counsel) attorney, while maintaining the intent of Congress that penalties be imposed only where appropriate, and with meaningful supervisory review. Any concern about a Counsel attorney using penalties raised in an answer or amended answer as a bargaining chip is mitigated by the requirement in proposed §?301.6751(b)–1(d) for supervisory approval within Counsel before the answer or amended answer is filed. Moreover, by raising a penalty on answer, amended answer, or amendment to the answer to, the Commissioner will likely bear the burden of proof at trial regarding the application of the penalty, thus reducing further the possibility that Counsel will attempt to use a penalty as a bargaining chip in a docketed case. See Tax Court Rule 142. Furthermore, Tax Court Rule 33(b) provides that signature of counsel on a pleading constitutes a certificate by the signer that the pleading is not interposed for any improper purpose, thus diminishing the potential for abuse. No case has found that a penalty raised on answer, amended answer, or amendment to the answer was untimely under section 6751(b).”

 Penalties Not Subject to Pre-Assessment Review in the Tax Court

• • • “Proposed §?301.6751(b)–1(b) provides that supervisory approval for penalties that are not subject to pre-assessment review in the Tax Court may be obtained at any time prior to assessment. This includes penalties that could have been included in a pre-assessment notice that provides the basis for Tax Court jurisdiction upon timely petition, but which were not included in such a notice because the taxpayer agreed to their immediate assessment.

    • Unlike penalties subject to deficiency procedures before assessment, there is no Tax Court or potential Tax Court decision that would make approval of an immediately assessable penalty by an IRS supervisor meaningless. Instead, consistent with the language of section 6751(b), supervisory approval can be made at any time before assessment without causing any tension in the statutory scheme for assessing penalties.

    • The proposed rule is also consistent with congressional intent that penalties not be used as a bargaining chip. Most penalties not subject to pre-assessment review in the Tax Court cannot be used as a bargaining chip because they are not in addition to a tax liability. Rather, the penalty is the sole liability at issue.”

Exceptions to the Rule Requiring Supervisory Approval of Penalties

• • • Proposed §?301.6751(b)–1(a)(2) provides a list of penalties excepted from the requirements of section 6751(b). Proposed §?301.6751(b)–1(a)(2) excepts those penalties listed in section 6751(b)(2)(A), along with penalties imposed under section 6673 of the Code. Penalties under section 6673 are imposed at the discretion of the court and are designed to deter bad behavior in litigation and conserve judicial resources. Section 6673 penalties are not determined by the Commissioner, and the applicable Federal court may impose them regardless of whether the Commissioner moves for their imposition. The proposed rule excepts penalties under section 6673 from the requirements of section 6751(b)(1) because section 6751(b)(1) was not intended as a mechanism to restrain Federal courts. This rule is consistent with the Tax Court’s holding in Williams Commissioner, 151 T.C. 1 (2018).”

Clarification of Definitions

Proposed regulations also intend to clarify/modify certain definitions such as

• • • Immediate Supervisor

    • Personally Approved (in Writing)

    • Automatically Calculated through Electronic Means

More information about the regulation and the definitions can be found in the Federal Register. 

2025 Green Book Revenue Proposal 

The 2025 Green Book proposal would allow supervisory approval to be done at any time prior to the issuance of the applicable notice — thus making it easier for the IRS to issue penalties and then have the supervisory approval later in the process. Let’s look at the proposed changes as outlined in the Treasury Department’s Green Book of Revenue Proposals.

Current Law Section

• • • 6751(b)(1) of the Internal Revenue Code (Code) provides that no penalty under Title 26 shall be assessed unless the initial determination of such assessment is personally approved in writing by the immediate supervisor of the individual making such determination or such higherlevel official as the Secretary or her delegate may designate.

  • • This section applies to all civil penalties imposed by the Code, except for penalties under section 6651 for failure to file tax returns or to pay tax; section 6654 for failure by individuals to pay estimated income tax; section 6655 for failure by corporations to pay estimated income tax; section 6662 with respect to an overstatement of certain qualified charitable contributions; and penalties that are automatically calculated through electronic means. With respect to individuals, the Internal Revenue Service (IRS) has the burden of production in a U.S. Tax Court proceeding challenging penalties to show the penalties are appropriate.

Reasons for Change

• • • Recent court decisions have led to uncertainty concerning, among other things, the requisite timing of the approval and qualified approvers. Judicial opinions have required supervisory approval of a penalty before the penalty is communicated to a taxpayer when a taxpayer still has the opportunity to raise defenses to the penalty. As a result, a supervisor may not have all the information relevant to deciding whether a penalty is appropriate by the deadline certain opinions have imposed. Many judicial opinions have barred penalties that a supervisor approved before assessment and before any opportunity for judicial review. When supervisory approval did not meet judicially-created deadlines, courts have bar red penalties without considering whether the penalties were appropriate under the facts of the particular case.

  • • These barred penalties have included accuracy-related penalties where the taxpayers did not show they acted with reasonable case for underpayments on their returns. Barred penalties have also included those arising from understatements attributable to reportable transactions that the IRS identified as tax avoidance transactions or that taxpayers entered into with a significant purpose of income tax avoidance or evasion. In some cases, barred penalties have even included civil fraud penalties where the IRS has met its burden of showing by clear and convincing evidence that an underpayment of tax was attributable to fraud. These cases undercut the purpose of penalties to deter taxpayer non-compliance with tax laws, based on unclear, hard to apply rules that often apply retroactively.

Proposal

• • • The proposal would clarify that a penalty can be approved at any time prior to the issuance of a notice from which the Tax Court can review the proposed penalty and, if the taxpayer petitions the court, the IRS may raise a penalty in the court if there is supervisory approval before doing so. For any penalty not subject to Tax Court review prior to assessment, under the proposal supervisory approval could occur at any time before assessment.

  • • In addition, the proposal would expand approval authority from an “immediate supervisor” to any supervisory official, including 176 General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals those that are at higher levels in the management chain or others responsible for review of a potential penalty.

  • • Finally, the proposal would eliminate the written approval requirement under section 6662 for underpayments of tax; section 6662A for understatements with respect to reportable transactions; and section 6663 for fraud penalties. The proposal would be effective upon enactment.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.