Definition of ‘immediate supervisor’ clarified for penalty purposes

For purposes of the Sec. 6751(b) supervisory approval requirement for penalties, the immediate supervisor who must approve the penalties is the person who directly supervises the work in an examination of the examining agent who makes the initial determination to assert the penalties.

Background

Sand Investment Co. LLC is a South Carolina limited liability company that was treated as a partnership for its short tax year beginning Dec. 9, 2015, and ending Dec. 31, 2015. Sand is subject to the TEFRA unified audit and litigation procedures.

In May 2014, Sand acquired land in Jasper County, S.C. On Dec. 28, 2015, Sand granted the Southeast Regional Land Conservancy a conservation easement over a portion of that land. Sand timely filed Form 1065, U.S. Return of Partnership Income, for its short 2015 tax year on which it claimed a charitable contribution deduction of $80,150,000 for the donation of the easement.

Sand’s return was selected for examination, and the IRS assigned the case to Revenue Agent Adrienne Cooper, a member of Team 1124 in the IRS Large Business & International Division (LB&I). Supervisory Revenue Agent Gregory Burris supervised all cases assigned to Team 1124, and he served as both the “case manager” and the “issue manager” for the examination of Sand’s return. In these capacities, he supervised all aspects of the examination of Sand’s return.

Near the end of the exam, Cooper was promoted to senior revenue agent. As a result, she was transferred to a different team in LB&I, and William Wilson became her new immediate supervisor. For the ongoing Sand examination, the IRS authorized Cooper to continue working with Team 1124 until the examination was finished. Although Wilson, as Cooper’s new supervisor, was responsible for approving Cooper’s time sheets, leave requests, and other routine administrative matters, Burris remained the case and issue manager of the Sand examination and continued to oversee all of Cooper’s work on that examination.

Proceeding with the Sand examination after her promotion, Cooper determined that Sand’s charitable contribution deduction for its contribution of the conservation easement should be disallowed. Without that deduction, Sand had a large understatement of tax and, accordingly, on Sept. 27, 2018, Cooper decided to assert accuracy-related penalties under Sec. 6662A and Sec. 6662(a) for 2015. She set out her penalty recommendations in a “Penalties Lead Sheet.” Burris, as her supervisor on the Sand examination, digitally signed this document on Nov. 20, 2018, as the “Case/Issue Manager.”

Cooper at the same time also prepared a Supplemental Civil Penalty Approval Form, which stated that she “made the initial determination to assert … penalties.” Cooper signed that form on Nov. 20, 2018, and Burris digitally signed it the same day as the “Case & Issue Supervisor.” Cooper also sent a copy of the penalty approval form to Wilson, who signed on Nov. 23 as the “Immediate Supervisor.”

On Nov. 21, 2018, Cooper sent Sand a packet of documents including a Form 5701, Notice of Proposed Adjustment, and a Letter 1807, TEFRA Partnership Cover Letter for Summary Report, which summarized Cooper’s positions in the case, including the possible imposition of penalties. One month later Cooper held a closing conference, after which she proceeded to close Sand’s case. The IRS issued a final partnership administrative adjustment (FPAA) to Sand, disallowing its charitable contribution deduction and determining penalties.

Sand filed a petition in Tax Court. It argued that it was not liable for the penalties because the IRS had not met the Sec. 6751(b) supervisory approval requirement for the penalties. In Tax Court, the parties filed cross-motions for summary judgment on the penalty issue.

The Tax Court’s decision

The Tax Court held that the supervisory approval requirement had been met for the penalties and upheld them. It found that the proper person for the requirement was the person who supervises the substantive work of the examining agent who asserts the penalties.

Under Sec. 6751(b)(1), the IRS generally cannot assess a penalty unless the initial determination of the assessment is “personally approved (in writing) by the immediate supervisor of the individual making such determination.” In a TEFRA case, supervisory approval for penalties generally must be obtained before the FPAA is issued to the partnership. If supervisory approval was obtained by the FPAA issue date, the partnership must establish “that there was a formal communication of the penalty before the proffered approval” was secured to benefit from the supervisory approval requirement.

The IRS asserted that a penalty approval form was signed by both of Cooper’s supervisors, Burris and Wilson, more than two months before the definite decision to impose the penalties was communicated to Sand in the FPAA. Thus, the approval of the penalties was timely.

Sand advanced a two-step argument that the penalty approval was not timely. First, Sand asserted that the penalties were formally communicated to the LLC on Nov. 21, 2018, when Cooper transmitted a packet of documents including a Letter 1807 and Form 5701 that mentioned the penalties. Second, Sand asserted that since Cooper’s “immediate supervisor” on that date was Wilson, and Wilson did not sign the penalty approval form until Nov. 23, 2018, his approval of the penalty was late.

The Tax Court found that because it rejected the second step of Sand’s argument, it did not have to address the merits of the first argument. It began its analysis of the second step by examining the text of the statute.

The Tax Court noted that the term “immediate supervisor” is not defined in the Code. Based on examples from the Internal Revenue Manual, it further found that the IRS did not employ the term uniformly in its personnel practices. Thus, the Tax Court relied on the “well-established” rule of construction that that if a statute does not define a term, the term is given its ordinary meaning. It determined in this context that “immediate” meant “with no intermediary,” and that “supervisor” meant a person who oversees, directs, or manages work, workers, projects, etc.

Applying these definitions to Sand’s situation, in which two different supervisors oversaw different aspects of her work as an IRS agent, the court concluded, given that Sec. 6751(b) deals with the approval of penalties, that the relevant work for purposes of the supervisory approval requirement was the work on the Sand examination, which generated the penalties. Because Burris supervised Cooper on that examination, the Tax Court held that he was the immediate supervisor for purposes of Sec. 6751(b).

The Tax Court further found that the legislative history supported its position. The legislative history indicated that Congress enacted Sec. 6751(b) to prevent IRS agents from coercing settlements from taxpayers by threatening unjustified penalties or using penalties as a bargaining chip in settlement negotiations. In the court’s view, with this legislative purpose, an examining agent’s immediate supervisor most logically would be seen as the person who supervised the agent’s substantive examination work. That person would presumably, besides the agent, have the most knowledge about the facts and legal issues in the case, making him or her the best person to review whether a proposed penalty is justified.

Sand argued that for Sec. 6751(b) purposes, the immediate supervisor is the direct superior, in a hierarchical sense, of the agent asserting the penalties. That person, Sand contended, is the one who handles the agents’ work assignments, performance reviews, leave requests, and similar administrative tasks. The Tax Court rejected this argument because it reasoned this interpretation did not align with the statutory context, which was penalty approval, or Congress’s intent behind the statute.

Sand also observed that the statute identifies the immediate supervisor as being the person who supervises the individual making the penalty determination, not the person who supervises the conduct of an audit. The Tax Court found this reasoning flawed because Burris supervised all of Cooper’s work during the examination, so he necessarily supervised the individual making the determination.

Finally, Sand argued that Wilson must have been Cooper’s immediate supervisor because she asked him to sign the penalty approval form and he did sign it. The Tax Court disagreed and refused to penalize Cooper for doing more than the statute intended, stating that due to evolving judicial decisions of the ambiguous Sec. 6751(b), “Cooper evidently took a belt-and-suspenders approach” in having both supervisors sign the form.

Reflections

Sec. 6751(b) should not be a terribly hard statute for the IRS to comply with; however, in the past, IRS agents have often failed to obtain the required penalty approval from the right person at the right time, which has allowed many taxpayers to avoid paying well-deserved penalties. This has not gone unnoticed, and the current administration is seeking to solve this problem by eliminating the supervisory approval requirement in a provision of the Build Back Better Act (H.R. 5376). Whether this attempt will be successful remains to be seen.

Sand Investment Co., LLC, 157 T.C. No. 11 (2021)