NTU Says Penalty Approval Regs Are Too Ambiguous

July 10, 2023

Internal Revenue Service
CC:PA:LPD:PR (REG–121709–19)
Room 5203, P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments and Request for Public Hearing on Proposed Rule for Supervisory Approval of Penalties, REG-121709-19

On behalf of National Taxpayers Union (NTU), the nation's oldest taxpayer advocacy organization, we write with comments on the Internal Revenue Service (IRS) notice of proposed rulemaking published in REG121709-19 entitled, Rules for Supervisory Approval of Penalties (proposed April 11, 2023). We also formally request the opportunity to speak at a public hearing.

I. Introduction

NTU is the nation's oldest taxpayer advocacy organization, founded in 1969 to achieve favorable policy outcomes for taxpayers with Congress and the executive branch. Our experts and advocates engage federal policymakers on important questions surrounding tax administration, taxpayer rights, and IRS services.

After organizing a coalition on behalf of taxpayer rights legislation contained in the 1988 Technical and Miscellaneous Revenue Act, NTU served on the National Commission on Restructuring the IRS in 1996 and 1997, helping to craft IRS policies and guidance, including what became the statute at issue, 26 U.S.C. §6751. Later, these efforts became the basis of the 1998 IRS Restructuring and Reform Act (RRA).

More recently, we provided technical assistance to Congress for what became the Taxpayer First Act of 2019, and worked with stakeholders across government to ensure its implementation. On May 16 of this year NTU testified before the U.S. Senate Finance Committee on the Service's Strategic Operating Plan outlining in limited detail the directions the Inflation Reduction Act's infusion of resources would allow.

II. Congress Wrote I.R.C. 6751(b) to Protect the Taxpayer

NTU strongly advocated for what became 26 U.S.C. §6751(b) for many years. We assisted in advising and crafting the RRA, which contained section 6751. As such, we are very familiar with the legislative history surrounding this statute, and believe a key factor to consider when interpreting section 6751(b) is the context and public understanding of the terms used which existed at the time the statute became law.

The committee report summarized it well:

Present law does not require the IRS to show how penalties are computed on the notice of penalty. In some cases, penalties may be imposed without supervisory approval.

. . .

The Committee believes that taxpayers are entitled to an explanation of the penalties imposed upon them. The Committee believes that penalties should only be imposed where appropriate and not as a bargaining chip.¹

The “Background” section of REG–121709–19 duly repeats part of the above quotation, as do other commenters, but the legislative pedigree of 26 U.S.C. §6751(b) stretched decades prior to RRA. Between 1954 and 1987, for example, the number of penalties provided in the U.S. Tax Code proliferated from 13 to some 150. In the space of a single decade — 1978 to 1988, the dollar amount of penalties increased ten-fold, leading even then-Commissioner Gibbs to express “concern” to Congress in 1988 hearings that the “rapid expansion of civil sanctions in the Internal Revenue Code was occurring on an ad hoc basis without a consistent rationale.”² That same year, Senator David Pryor (D-AR) summarized the assessment of many of his colleagues that the penalty system had become “a morass of inconsistency and irrationality.”³

Subsequent advisory bodies, some of them voluntarily constituted by the practitioner community, others mandated by Congress, attempted to offer suggestions to correct these undesirable traits. The Service even created its own “Executive Task Force for the Commissioner's Penalty Study,” culminating in a final 400-page report in 1989. The Task Force identified four criteria for sound penalty policy — fairness, effectiveness, comprehensibility, and administrability — and noted ongoing challenges of reliable data and philosophies of whether compliance depends solely on the so-called “audit lottery” attitude or something less sinister on the part of the taxpaying population.⁴ Unfortunately, more than 30 years later, the Service still struggles with these fundamental questions, despite some progress.

So has Congress, which has developed, through legislation, a suite of tools to help shape a system of backstops and guardrails for examination and collection due process. A significant part of this infrastructure concerns itself with protections against excessive, arbitrary, or incomprehensible penalties. From the RRA of 1998 through the Taxpayer First Act of 2019, such tools have included everything from improving the content of penalty notices, to expanding the National Taxpayer Advocate's Taxpayer Assistance Order authority, to creating “one-stop” customer service portals, to strengthening the Independent Office of Appeals. While these initiatives serve several purposes, all of them can be applicable to penalty activities.⁵

Yet, most of these reforms have been designed to provide remedies to penalties after they have been issued. Section 6751(b) was created to be a first line of defense against maladministration, before penalties become a problem of contention between the taxpayer and the government. That is why its importance cannot be overstated.

The purpose, and intended effect, of the statute was to protect taxpayers from systematic abuse and provide them with fair treatment from the IRS.⁶ As explained by Tyler Martinez of NTU's sister organization, National Taxpayers Union Foundation, the statute was enacted to make sure the IRS “carefully consider[s] the facts of each tax dispute. The IRS agents should weigh whether, and how much to, assess in each case. Requiring the supervisors to actively engage in the process is an important step in protecting taxpayers from abuse.”⁷

With this history in mind, and NTU's experience in shaping section 6751(b), we express some concerns with the IRS's proposed regulations.

Broadly, we are concerned the proposed regulation would greatly narrow the statute's original wide scope of supervisory approval of all penalties. Congress designed section 6751 to apply to nearly all penalties imposed by the IRS, except for those in specific, narrow categories outlined in the statute. The introduction of new categories of exceptions through regulation is therefore inappropriate as it is at odds with the statute's purpose and meaning. For example, the regulation proposes that supervisory approval of a penalty is not required where the penalty notice is not subject to pre-assessment review in the Tax Court. Along with expanded use of the statute's “automatically calculated through electronic penalties” exception where the taxpayer is the first human to see the penalty, the proposed regulation would reduce the number of penalties subject to section 6751. From nearly all penalties at the time of enactment, this regulation would reduce the number of penalties subject to supervisory approval to perhaps less than 15 percent of the total.

How would such a result comply with Congress's goal in enacting the statute? While the IRS may take the position that it takes less administrative effort to only provide one group of taxpayers with a supervisory approval, having different rules for different situations appears more cumbersome and prone to mistakes. A better approach, and one more protective of taxpayer rights, would be a broad standard that supervisory approval is the default in all cases, except for narrow exceptions. We believe this is also what the statute sets out, and that a proposed regulation should aim to treat all taxpayers who receive penalties equally when providing supervisory approval.

III. The First Line of Defense for an Error Resulting from an Automatically Calculated Penalty Should be the IRS, Not the Taxpayer

Congress permitted an exception to the supervisory approval requirement for penalties automatically calculated through automatic means, along with penalties for failure to file, failure to pay tax due, and failure to pay sufficient estimated tax. The IRS may choose to require supervisory approval in these cases; it is simply not statutorily required to do so. The IRS should seriously consider a default posture of supervisory approval even for automated notices as opposed to the direction it takes with this proposed regulation.

One reason to not rely more heavily on the automated calculation exception is that it puts the burden on the taxpayer to monitor for errors in IRS-created penalties. Sometimes computers are wrong, or at least the data that goes into them are. A human being taking the time to examine penalty notices for any obvious mistakes can save innocent taxpayers a lot of heartache and grief. Under the IRS proposal, the onus will be entirely on the taxpayer to spot these mistakes and convince the IRS to fix them. Instead, the IRS should be monitoring for errors before penalty notices are sent to taxpayers, and the supervisory approval process is an existing tool to enable that critical function.

We believe Congress meant for the “any other penalty automatically calculated through electronic means” exception to be limited in scope.⁸ The purpose of the exception is to make sure the IRS is not burdened to review a relatively indisputable automatically calculated “penalty determination . . . based on a 'true/false' analysis.”⁹ If the automatic calculation requires any analysis, then the statute meant for the IRS to obtain a supervisor's approval prior to communicating this penalty with the taxpayer.

The proposed regulation is at odds with this interpretation of the statute. The IRS currently allows its Automated Underreporter Program (AUR) “to propose the substantial understatement and negligence components of the accuracy-related penalty without human review.”¹⁰ Because negligence penalties depend on the taxpayer's specific facts and circumstances, they require a decision-making process more advanced than a true or false analysis. Such penalties should typically require a supervisor's approval in order to fall within the statute's automatically calculated through electronic means exception.

After all, computer programs cannot conduct a fact-specific inquiry and draw conclusions, and even if they could, that cannot be considered an automatically calculated penalty. The burden is then placed on the taxpayer to ensure these penalties are correct. Only if the taxpayer responds to the IRS's AUR-generated proposed assessment of penalties will the IRS personnel examine if the penalties were correct.¹¹ If that taxpayer does not respond on time, then the penalty is assessed.¹²

In short, the proposed regulation would result in the IRS further moving away from the statutory objective of having the IRS ensure the correctness of penalty imposition before it goes to taxpayers. Requiring a supervisor to review and sign off on these penalties could alleviate many of these errors. The IRS seems to understand this is not a truly automated process, assigning responsibility of reviewing penalties to the Office of Servicewide Penalties, who “does not consider it unfair to taxpayers for the IRS to assert penalties through a systemic process which applies distinct criteria to identify potential instances of noncompliance.”¹³

We are very concerned about the IRS's treatment of automatically calculated penalties. This potential for inaccurate penalties, and the ultimate assessment thereof upon the taxpayer, not only undermines the statute's broad goal, but also harms American taxpayers. The Service should consider an alternative regulation that develops and implements a system where only automatically calculated penalties resulting from a “true/false” analysis may qualify for the “automatically calculated through electronic means” exception and be communicated to taxpayers without a supervisor's approval. Any penalty which requires a factual analysis on a case-by-case basis should fall under the requirements of the statute to acquire a supervisor's approval prior to any notice being sent to a taxpayer.

IV. The Proposed Regulation Effectively Deletes the Phrase “Initial Determination” From the Statute

The proposed regulation heavily relies on the word “assessed” in the statute as the catalyzing event that triggers supervisory approval, but to such a degree that it improperly creates surplusage of the phrase “initial determination” in the statute. Such an interpretation would effectively rewrite the plain language of section 6751(b) and bring the proposed regulation outside of its scope.

A plain reading of section 6751(b)(1) is that supervisory approval of a penalty is generally required at the time the IRS first decides (“initial determination”) that it will ultimately impose (“assess”) a penalty. At several points, the proposed regulation instead interprets the statute as not requiring supervisory approval until assessment occurs or is about to occur:

In each of these instances, the proposed regulation would give the IRS leeway to obtain supervisory approval at some point after the initial communication is issued to the taxpayer. The regulations seemingly envision “assessment” as the trigger for the supervisory requirement rather than “initial determination” as the statute requires. One example even is backwards in envisioning the supervisor validly approving a proposed penalty only if and after a taxpayer has submitted an objection to it (“and an IRS employee considers the response,” which wrongly implies that the applicability of supervisory approval depends on the IRS reading something from the taxpayer). Instead of the statute's understanding of the steps of the process as (1) initial determination, (2) supervisory approval, and (3) communication with taxpayer, the proposed regulations suggest the process in many cases will be (1) communication with taxpayer, (2) supervisory approval, (3) assessment. Because this necessarily leaves “initial determination” as surplusage, this is not a natural reading of the statute. The process should be “ready, aim, fire,” not “fire, aim, ready.”

Allowing such a broad scope for supervisory approval would also defeat the purpose of the statute. As a basic matter, the term “initial” means “of or relating to the beginning. . . .”¹⁵ This common sense definition of “initial” as used in the statute means the IRS should obtain a supervisor's approval at the beginning of the penalty process before any communication is made to the taxpayer. The National Taxpayer Advocate agrees with this interpretation, observing in the 2022 Purple Book: “Where written supervisory approval is required, it should be required early enough in the process to ensure it is meaningful and not merely an after-the-fact rubber-stamp applied in the limited number of cases in which a taxpayer challenges a proposed penalty.”¹⁶ Allowing the IRS to acquire supervisory approval anytime prior to assessment “leave[s] open the possibility that IRS employees could use penalties as a bargaining chip — precisely what Congress sought to prevent by enacting IRC §6751(b).”¹⁷

In Chai v. Commissioner of Internal Revenue, the Second Circuit explained that “[t]he statute would make little sense if it permitted written approval of the 'initial determination' up until and even contemporaneously with the IRS's final determination.”¹⁸ The holding in Chai is yet more persuasive authority on how the statute's “initial determination” requirement should be applied. The IRS should consider an alternative that is in accord with this natural reading of the statute, rather than the proposed regulation.

The term “initial determination” can only mean the IRS must obtain a supervisor's approval prior to its first communication about a penalty to the taxpayer. This definition not only properly follows the natural reading of the statute and the purpose Congress had in enacting it, but benefits and protects the taxpayer. Accordingly, the proposed regulations' allowing supervisory approval to occur after communication to the taxpayer would undermine this plain language and purpose.

V. Clear Guidance is More Beneficial to the Government's and Taxpayer's Interests than Ambiguous Guidance

We agree on the importance of clarity and certainty for taxpayers and tax administrators alike, especially in the case where courts may have struggled to give consistent guidance. However, we are concerned that the proposed regulation introduces more ambiguity in several instances. In addition to our arguments made herein, we proffer definitions of terms that are clearer than those proposed in the regulation and ask that these be considered.

A. Recommendation: A Clearer, Common Sense Definition of “Supervisor” Should Be Adopted

The proposed regulation includes a convoluted and confusing definition of the statute's terms “immediate supervisor” and “higher level official.” When practically applied, the proposed regulation would allow anyone designated by the IRS to approve penalties by defining immediate supervisor as “any individual with responsibility to approve another individual's proposal of penalties” and higher level official as “[a]ny person who has been directed . . . to approve another individual's proposal of penalties.”

These definitions are circular (the person authorized to approve penalties is the person authorized to approve penalties) and improperly assume ambiguity about what the terms “immediate supervisor” and “higher level official” mean.

The proposed regulation's definition of “higher level official” essentially reads the words “higher” and “level” out of the statute, instead improperly allowing the IRS merely to designate multiple officials at whatever level. The proposed regulation should adhere to the statute and specify “higher level” means one person high in the IRS hierarchy, who can be an alternative when an immediate supervisor is not available.

We also recommend the IRS adopt a common-sense definition of “immediate supervisor.”

As one possibility, the National Labor Relations Act provides a clear definition of “supervisor” for the private sector:

The term “supervisor” means any individual having authority, in the interest of the employer, to hire, transfer, suspend, lay off, recall, promote, discharge, assign, reward, or discipline other employees, or responsibly to direct them, or to adjust their grievances, or effectively to recommend such action, if in connection with the foregoing the exercise of such authority is not of a merely routine or clerical nature, but requires the use of independent judgment.¹⁹

A similar definition is prescribed for most federal agencies (including the IRS) in 5 § U.S.C. 7103:

“[S]upervisor” means an individual employed by an agency having authority in the interest of the agency to hire, direct, assign, promote, reward, transfer, furlough, layoff, recall, suspend, discipline, or remove employees, to adjust their grievances, or to effectively recommend such action, if the exercise of the authority is not merely routine or clerical in nature but requires the consistent exercise of independent judgment, except that, with respect to any unit which includes firefighters or nurses, the term “supervisor” includes only those individuals who devote a preponderance of their employment time to exercising such authority.²⁰

Moreover, the Office of Personnel Management (OPM) highlights the importance of supervisory leadership development, and notes regulations that, “[a]ll agencies are required to provide training within one year of an employee's initial appointment to a supervisory position, as well as refresher training to all supervisors and managers at least every three years.”²¹ In addition, the Federal Workforce Flexibility Act provides additional training requirements. The Act requires agencies to provide training to supervisors and managers on actions, options, and strategies to:

• Mentor employees,

• Improve employee performance and productivity,

• Conduct employee performance appraisals, and

• Identify and assist employees with unacceptable performance.²²

“Immediate” means “not separated by other persons or things.”²³ So a common sense definition of immediate supervisor is the person with authority and responsibility to oversee an employee, with no intervening individuals. Practically, this is the person an employee goes to for work assignments, questions, or time off requests. Everyone at the IRS knows, or should know, who this is for themselves. The proposed regulation should reject an elastic definition of the term that is at odds with usage in the rest of the federal government and the private sector.

The clearer definition we propose will create clarity for the IRS internally and for the courts. The complex definition of supervisor promoted by the IRS would only further complicate the supervisory approval process and dilute the intended effect of the statute.

B. Recommendation: A Statement of Signing Should Be Adopted to Ensure the Penalty is Approved in Writing

NTU additionally recommends the IRS require a statement of signing accompany the request for a supervisor's approval of a penalty: “I declare and certify that I have examined this initial determination of assessment and personally approve it as proper.” This statement, similar to the statement taxpayers sign on their 1040 forms, would clearly establish the supervisor analyzed and approved the penalty prior to the IRS sending the first communication about the penalty to the taxpayer.²⁴ Such a statement would need to be accompanied by language or phrasing that makes clear the penalty for failing to do so. In most areas of law, this would be signified by requiring the signatory to declare and certify “under penalty of perjury.” Otherwise, an oath with notarization might be stipulated, which would be highly impractical. At the very least, some kind of affirmative electronic signature and date stamp, as recommended by one commenter, would be necessary. Without some type of binding process, communicating the importance to the supervisor of fulfilling their duty, we fear that 6751(b) could continue to be mired in obscurity and desuetude.

The goal we wish to achieve with a statement of signing is protection for taxpayers. Such a statement is not an additional burden to the IRS because the Internal Revenue Manual already requires IRS employees to note their approval of the penalty in some fashion: “Supervisory approval may be documented in the form of an e-mail, memo to file, or on a penalty approval form (e.g., Lead Sheet 300, Civil Penalty Approval Form, SAIN 011 Lead Sheet, Form 4700, signed comment on Form 5464, Form 8278, Form 5701).”²⁵

Our proposed statement of signing would reinforce the Internal Revenue Manual's guidance with a specific default rather than leaving supervisors with little clarity of what precisely they are supposed to do. We believe our recommendation will make sure the IRS's supervisors comply with the plain language of the statute and “personally approve[ ] in writing” all proposed penalties.²⁶ The statement of signing is a useful tool to make sure the IRS complies with the statute and the penalties communicated with taxpayers are correct.

VI. The Senate Recently Introduced a Bill to Clarify the Statute's Language, Which Would Be at Odds with This Proposal

The IRS should halt this notice and comment process due to pending legislation that would resolve any ambiguity about the statutory provision at issue here.

On April 20, 2023, Senator Tim Scott (R-SC) and nine other sponsors introduced a bill in the Senate, S. 1249, the IRS Accountability and Taxpayer Protection Act, to amend section 6751(b)(1).²⁷ The bill would add a clarifying sentence:

No penalty under this title shall be assessed unless the initial determination with respect to the application of such penalty 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. The approval required under the preceding sentence shall be given at a time in the pre-assessment process when such supervisory or higher level official has the discretion to give or withhold such approval.²⁸

The IRS should defer to this action Congress is taking instead of proceeding with a regulatory action that would, if both were adopted unchanged, conflict with this proposed language. Alternatively, the IRS should propose regulatory language that is in accord with this proposed statutory amendment.

VII. Conclusion

Any proposed regulation relating to section 6751 should reinforce the supervisory approval requirement under the statute and benefit American taxpayers by allowing penalties to be issued only with oversight by the IRS. Regulations should be truly clarifying and reduce any multiple standards or uncommon definitions in the supervisory approval process. We believe the recommendations we have offered will serve the goal of alleviating any ambiguity in the statute while protecting taxpayers.

NTU is grateful for your consideration. If you have any questions or concerns, please do not hesitate to contact us.