Supervisory Approval of Penalties: The Opening of a Graev Pandora's Box

Abstract

Section 6751(b) of the Internal Revenue Code requires supervisory approval in writing prior to assessment of certain penalties. Enacted in 1998 as part of the Internal Revenue Service (“IRS”) Restructuring and Reform Act, the statute’s purpose was to prevent IRS agents from using penalties as bargaining chips. The section remained essentially dormant for over 20 years, with both the IRS and taxpayers accepting the position that approval needed to be obtained only prior to assessment. The trilogy of Graev cases and a decision of the Second Circuit Court of Appeals in Chai v. Commissioner changed the § 6751(b) landscape completely, opening a Pandora’s box of taxpayers using § 6751(b) to avoid penalties on the technicality of no-written-supervisory approval. Hundreds of court cases have followed, resulting in cases inconsistently interpreting § 6751(b) and well-counseled taxpayers avoiding tax penalties.

This article examines the enactment of § 6751(b) and explores in detail the Graev and Chai decisions. Tax Court cases decided since those decisions were issued are analyzed to determine the present state of the law. Without a change of course, the current situation of conflicting court decisions that have allowed well-deserved penalties not to be imposed will continue. Although there is more certainty as to the meaning of § 6751(b) than there was prior to these cases, different results for taxpayers may occur depending on which circuit has venue over any ensuing appeal.

Solutions to the § 6751(b) problem are analyzed—issuance of Treasury and IRS guidance, amendment of the statute, and outright repeal of the statute. The article concludes by recommending that the statute be repealed. Internal IRS procedures can address issues with the conduct of IRS employees, while not opening the door to taxpayers using a technicality to avoid penalties and IRS employees overbroadly imposing penalties.

Keywords: IRC § 6751(b), IRC § 7491(c), Graev, Chai, supervisory approval

JEL Classification: K34, K19, M49