Written supervisory approval is not required under Sec. 6751(b) for the initial assessment of the Sec. 72(t) additional tax on early distributions because it is not a penalty, addition to tax, or additional amount.
Background
In 2015, Kirgizia Grajales took loans from her New York state pension plan. Although she received a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reporting gross distributions of $9,026, she did not report the distributions as income on her 2015 tax return.
The IRS did not agree with her tax treatment of the distributions and issued her a notice of deficiency in which it determined the full amount of the distributions reported on the Form 1099-R were includible in income and were subject to a Sec. 72(t) 10% additional tax on early distributions.
Grajales petitioned the Tax Court to review the IRS's determination. Before trial, the IRS conceded that only $908.62 of Grajales' 2015 pension plan distributions were taxable early distributions but maintained that they were subject to the Sec. 72(t) additional tax on early distributions. Grajales argued that these early distributions were not subject to the Sec. 72(t) additional tax because the IRS had not obtained written supervisory approval for its initial determination to assess the tax as required under Sec. 6751(b)(1) for penalties as defined under Sec. 6751(c). The IRS admitted that it had not obtained written supervisory approval but argued that none was required because the Sec. 72(t) additional tax is not a penalty as defined in Sec. 6751(c).
Secs. 72(t), 7491, and 6751
Sec. 72(t) is titled "10-Percent Additional Tax on Early Distributions From Qualified Retirement Plans." Sec. 72(t)(1) is titled "Imposition of Additional Tax." It provides that if a taxpayer receives a distribution from a qualified retirement plan, the taxpayer's tax for the year of receipt is increased by 10% of the portion of the distribution that is includible in gross income.
Under Sec. 7491(c) the IRS bears the burden of production with respect to "any penalty, addition to tax, or additional amount," including the burden of producing evidence establishing that the initial determination of an assessment of any penalty was approved as required under Sec. 6751(b). Under Sec. 6751(b), an initial penalty determination by the IRS must be personally approved in writing by the immediate supervisor of the individual making the initial determination, unless an exception applies. Sec. 6751(c) defines a penalty for these purposes to include "any addition to tax or any additional amount."
The Tax Court's decision
The Tax Court held that the Sec. 72(t) additional tax on early distributions applied to Grajales' taxable early distributions from her pension plan. The court found that the Sec. 72(t) additional tax was a tax, not a penalty as defined in Sec. 6751(c), so the Sec. 6751(b) written supervisory approval requirement did not apply.
The Tax Court noted that it has held repeatedly in the context of Code sections other than Sec. 6751(b)(1) that the Sec. 72(t) additional tax on early distributions is a tax and not a penalty, addition to tax, or additional amount. Citing its decision in El, 144 T.C. 140 (2015), the court explained its three reasons for holding the Sec. 72(t) exaction is a tax. First, Sec. 72(t) calls the exaction that it imposes a tax. Second, a number of Code sections (e.g., Sec. 26(b)(2) and Sec. 401(k)(8)(D)) refer to Sec. 72(t) using the unmodified term "tax." Third, Sec. 72(t) is in Subtitle A, Chapter 1 (Normal Taxes and Surtaxes), of the Code, which includes several income taxes, and not in Subtitle F, Chapter 68 (Additions to the Tax, Additional Amounts, and Assessable Penalties), of the Code, which contains most penalties and additions to tax.
Grajales argued in particular that the additional tax imposed by Sec. 72(t) was an additional amount within the meaning of Sec. 6751(c) and therefore a penalty. The Tax Court pointed out, however, that it has "consistently held that 'additional amounts,' particularly when it appears in a series that also includes 'tax' and 'additions to tax,' is a term of art that refers exclusively to the civil penalties enumerated in chapter 68, subchapter A." Accordingly, this argument failed because the Sec. 72(t) additional tax is not a civil penalty enumerated in Chapter 68.
Finally, Grajales argued that under the Supreme Court's opinion in National Federation of Independent Business (NFIB) v. Sebelius, 567 U.S. 519 (2012), the Tax Court was required to revisit the question of whether the Sec. 72(t) additional tax was a tax or a penalty and, in its analysis, employ the functional approach the Supreme Court applied in the constitutional analysis in NFIB. However, observing that neither Grajales nor the IRS had contended that Sec. 72(t) was unconstitutional, the Tax Court found that the case raised no constitutional issues. Therefore, it determined that the functional approach to constitutional analysis used in NFIB was not appropriate.
Rather, the Tax Court found that in its NFIB decision, the Supreme Court stated that in a case like Grajales', where the issue was one of statutory construction, a court should look to the statutory text as the best evidence of Congress's intent. Furthermore, again citing the Supreme Court in NFIB, the court concluded that it made sense to be guided by Congress's choice of label in this regard.
Reflections
Grajales can be forgiven for thinking that she could win on this issue, as in practice the Sec. 72(t) additional tax on early distributions is often, if not usually, called a penalty and characterized as such (i.e., a punitive extra exaction imposed to deter taxpayers from taking early distributions). However, it can just as easily be characterized in a nonpunitive fashion, as a tax imposed when a taxpayer takes an early distribution. In isolation, the characterization is meaningless to taxpayers, but as this case demonstrates, in the larger tax regime the characterization may have significant effects.
Grajales, 156 T.C. No. 3 (2021)
