Real Estate Company Targets Proposed Supervisory Approval Regs

July 10, 2023

The Honorable Lily Batchelder
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Daniel Werfel
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Proposed Regulations Under I.R.C. Section 6751
(REG-121709-19)

Dear Assistant Secretary Batchelder and Commissioner Werfel:

GBX is a real estate company focused on the acquisition, rehabilitation, and preservation of historic buildings across the country. We use a variety of federal, state, and local incentives to make these projects economically viable, including the historic preservation easement allowed pursuant to Section 170(h)(4)(A)(iv) of the Internal Revenue Code (the “Code”). We welcome the opportunity to provide comments to the Department of Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) on the proposed regulations under Code Section 6751.

These comments are chiefly geared toward the IRS's definitions of the persons involved in asserting a penalty as well as the definition of an “initial determination”.

I. Comments

The Proposed Regulations define a number of terms that are not defined in the statute, including “immediate supervisor”, “higher level official”, and “individual making the initial determination”.

Section 6751 was added to the Code by section 3306 of the Internal Revenue Service Restructuring and Reform Act of 1998. The preamble appropriately notes that Section 6751(b) was added to ensure that penalties are only imposed “where appropriate”. To ensure that penalties were only imposed in these limited circumstances, Section 6751(b) requires approval of penalties in writing “by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate”. There are thus three categories of people mentioned in this one sentence: (i) the individual making the initial determination, (ii) that individual's immediate supervisor, and (iii) such higher level official as designated by the Secretary. The statute does not expand on the definitions of these categories of persons, but the regulations endeavor to do so. By and large, the definitions of the key components of Section 6751 align with the IRS's interests, not those of taxpayers'.

Section 6751(b) also specifies that the penalty approval must be applied to the “initial determination” of the “assessment” but does not further elaborate on what these terms mean. The preamble accurately notes the development of case law surrounding this clause and its subsequent lack of clarity for taxpayers and the IRS. However, the regulations also adopt a regime that is intended to shield the IRS from attacks on supervisory approval rather than shielding taxpayers from inappropriate penalties, as Congress intended.

i. Individual Making the Initial Determination

Proposed reg. §301.6751(b)-1(a)(3)(ii) states that the individual making the determination is “the individual who first proposed the penalty”. The proposal can be made to the taxpayer, the taxpayer's representative, or the individual's supervisor or designated higher level official. The proposed regulation then expands the category of individuals referenced in Section 6751(b)(1) to be not “the individual who first proposed the penalty” if “the assessment of the penalty is attributable to an independent proposal made by a different individual”.

The proposed regulation does not clarify the inherent conflict in these two definitions, but Example 4 provides some explanation, positing a situation where a Revenue Agent concludes a penalty is appropriate, but her immediate supervisor disagrees, and the penalty is later re-proposed by an attorney after the case has been docketed in Tax Court. In the IRS's view, the “initial determination” is made not by the revenue agent who developed the case, but by the IRS attorney charged with litigating the case in Tax Court. But given that “initial” usually means “first”, it is unclear how the second of two individuals can make the “first” determination of whether a penalty is appropriate when the first individual tasked with determining the application of the penalty determined it to be appropriate, and her immediate supervisor declined to approve the penalty. Under this set of circumstances, the “initial determination” is clearly made by the first individual — the Revenue Agent — who was unable to obtain supervisory approval from her immediate supervisor. The proposed regulation is at odds with the statute, because it allows for a second “initial” determination. The final regulation should remove this second clause that references “a different individual.”

ii. Immediate Supervisor

Proposed regulation §301.6751(b)-1(a)(3)(iii) defines an immediate supervisor as “any individual with responsibility to approve another individual's proposal of penalties without the proposal being subject to an intermediary's approval.” This definition is so expansive as to be almost farcical, as it would categorize as the “immediate supervisor” any person with supervisory powers within the IRS. Just as “initial” has a discrete meaning, so too does “immediate”. In the context of a managerial workplace, “immediate” typically means “direct”, as in someone who supervises a direct report.

It is clear that this section is intended to allow the IRS maximum flexibility such that if, for example, a Revenue Agent's immediate supervisor is unable to approve penalties, any other person who is considered a “supervisor” can approve the agent's imposition of penalties. The preamble states so upfront: “the proposed rule does not limit the term immediate supervisor to a single individual”. The preamble rationalizes this expansion of the statutory language based on operational conveniences: “To limit the term to a single individual within the IRS would restrict section 6751(b)(1) in a way that does not reflect how the IRS operates.” To rephrase this sentence, the IRS has inconsistently applied Section 6751(b) — which requires approval by an individual's immediate supervisor — and wants to continue doing so. The Tax Court has consistently noted that Section 6751(b) does not contemplate a detailed review or justification for penalty approval — merely that the supervisor must approve a penalty in writing. However, the statutory text is set up such that the person approving the penalty should have some familiarity with the facts of each case by virtue of supervising the work of the individual imposing the penalty. The proposed regulation improperly expands the category of “immediate supervisor” to include people who have no knowledge of the underlying case or penalty, and who may thus approve penalties even when inappropriate, in contravention of Congress' intent in enacting Section 6751(b). The proposed regulation should be revised to a straightforward definition encompassed within the statute; only the immediate supervisor — meaning manager — may approve penalties.

iii. Higher Level Official

Proposed regulation §301.6751(b)-1(a)(3)(iv) defines “higher level official” as “any person designated under paragraph (a)(4) of this section as a higher level official authorized to approve a penalty for purposes of section 6751(b)(1).” Paragraph (a)(4) further defines “higher level official” as “any person who has been directed by the Internal Revenue Manual or other assigned job duties to approve another individual's proposal of penalties before they are included in a pre-assessment notice prerequisite to United States Tax Court (Tax Court) jurisdiction, an answer, amended answer, or amendment to the answer to a Tax Court petition, or are assessed without need for such inclusion”.

Like the definition of “immediate supervisor”, the definition of “higher level official” in the regulations is untethered from the statutory text, which states that the higher level official must be designated by the Secretary, not “the Internal Revenue Manual or other assigned job duties”. Thus, the final regulation should be revised to state that a higher level official must receive formal designation from the Secretary to approve penalties, and because of Congress' concern over inappropriate penalties, the higher level official should have some familiarity with the case and the individual making the initial determination.

iv. “Initial Determination”

Citing Chai, the preamble accurately notes that the individual making the determination “can determine a deficiency and whether to make an assessment, but * * * cannot 'determine' an assessment” and therefore, approval of a penalty after Tax Court review would undercut the Court's statutory review of penalties. There is thus ambiguity built into the statute of what constitutes an “initial determination of such assessment”. However, “initial determination” is not, in and of itself, ambiguous. As noted above, “initial” means “first”. In the context of a typical audit or Tax Court case, this should thus mean the very first piece of paper on which the IRS determines a penalty.

The proposed regulations exploit the statute's ambiguous reference to “assessment” to essentially mean that the penalty may be approved at any time — contrary to the statute's text. This glaring inconsistency is illustrated in Example 1, where the IRS would permit approval not of the initial determination, but of a subsequent determination following the taxpayer's failed efforts to prevent the penalty's imposition. In fact, many of the Examples follow a pattern, where an agent or attorney makes an initial determination, but penalty approval comes much later. The final regulation should be revised to eliminate this inconsistency and align with the statutory text.

II. Recommendations and Conclusion

The final regulations should be revised to take into account the recommendations encompassed above. Chiefly, the IRS should give words their plain meaning. “Initial” means “first”, “immediate supervisor” should mean an individual's direct manager, and “higher level official as the Secretary may designate” should mean someone actually designated by the Secretary, not the Internal Revenue Manual.

If you have any questions, please reach out to me. My contact information can be found at https://gbxgroup.com/team.

Respectfully submitted,

Katherine Schadler Jordan
Director of Tax Controversy, GBX Group LLC
Cleveland, OH