By: Patrick Riley Murray, Volume 105 Staff Member
The Internal Revenue Service (IRS) processes more than 250 million business and individual tax returns each year. The vast majority of these returns are correctly filed and end in either additional tax paid or a refund. When a taxpayer files a return with incorrect information, the IRS will typically assess a penalty. Naturally, the IRS must adhere to statutorily imposed procedural requirements when assessing these penalties.
For example, Code § 6751 requires supervisor approval before a penalty can be assessed against a taxpayer. But a significant exception to this rule exists: if a penalty is “automatically calculated through electronic means,” supervisory approval is not required. Given the modern processes of the IRS, many penalties—including those in audits concerning the Earned Income Tax Credit, a tax break for low- to middle-income taxpayers—are assessed via computer software. The IRS claims that these accuracy penalties are automatic. Meanwhile, taxpayer litigants, who are often wealthy, have been able to escape accuracy penalties by arguing that the IRS did not follow § 6751’s procedural requirements.
In short, § 6751’s application has become convoluted. The result: poor taxpayers must pay penalties that rich taxpayers can avoid through litigation. This Post discusses recent case law on the issue of supervisory approval for § 6662 penalties and argues that § 6751 should be amended to require all penalties to have supervisory approval.
I. CASE LAW SURROUNDING § 6751 DISPROPORTIONATELY AFFECTS POOR TAXPAYERS
Congress added the procedural requirements—including the requirement for supervisory approval for certain penalty assessments—of § 6751 to the Code in 1998 because of concerns that the IRS was using penalties as a bargaining chip with taxpayers even when no basis for a penalty existed. § 6751 was not significantly litigated for nearly twenty years, until the Second Circuit decided Chai v. Commissioner in 2017.
In Chai, the taxpayer failed to pay self-employment tax related to $2 million in payments from a tax-shelter scheme, and the IRS assessed penalties. In Tax Court, the IRS failed to provide sufficient evidence that IRS agents obtained supervisory approval before assessing penalties. The Second Circuit held on appeal that supervisory approval must be obtained before the IRS issues a notice of deficiency. Since Chai, the Tax Court has applied an “ad hoc” treatment to § 6751 cases.
The Tax Court recently found against taxpayer litigants in Walquist v. Commissioner. At issue in Walquist was the IRS’s Automated Correspondence Exam (ACE) software. ACE automatically processes taxpayer returns. In many cases, ACE handles returns from receipt to closing with “minimal to no tax examiner involvement.” In Walquist, ACE processed the taxpayer’s 2014 tax return, assessed a § 6662 penalty, and issued the notice of deficiency automatically and without any human interaction. The Tax Court found that because the penalty was determined mathematically by a computer software program without the involvement of a human IRS examiner, the penalty was “automatically calculated through electronic means.”
Walquist has potential to harm many poor taxpayers. ACE software is designed to process taxpayer returns that claim the Earned Income Tax Credit (EITC)—a tax break for low- to middle-income taxpayers. In light of the Walquist decision, taxpayers who incorrectly claim the EITC, maliciously or not, can receive significant penalties on their tax returns without any human interaction, much less supervisory approval, from the IRS.
This seems ostensibly fair. If the IRS does not obtain approval, the taxpayer can simply challenge the penalty assessment. But this line of reasoning does not hold up when considering the resources available to tax litigants. Wealthy taxpayers often have the time and resources to challenge and litigate their penalties. For example, Graev v. Commissioner featured twelve years of litigation. And Chai v. Commissioner involved a taxpayer who made millions from their tax-shelter scheme. Poor taxpayers simply do not share that luxury. In practice, automatic penalty assessments against poor taxpayers are final, and these taxpayers have no avenue for challenging their penalties.
II. CONGRESS SHOULD AMEND § 6751 TO REQUIRE SUPERVISORY APPROVAL FOR ALL ACCURACY PENALTIES
At least two solutions exist for this problem: (1) the Tax Court could overturn Walquist and (2) Congress could amend the tax code. Since the former suffers from a number of defects, this Post advocates for the latter solution.
The first solution, in which the Tax Court would overturn Walquist, is problematic. First, the Walquist court’s statutory interpretation of § 6751’s “automatically calculated through electronic means” exception leaves little room for argument; after all, the IRS’s ACE software automatically calculates accuracy penalties. Only a statutory interpreter willing to disregard the Code’s text completely in favor of normative concerns could advance a good faith argument to overturn the court’s statutory interpretation. It is unlikely that this strained argument would prevail at court and even more unlikely that it would survive appeal. Second, the Tax Court dismissed the taxpayer’s case in Walquist for refusing to comply with Tax Court rules. Since it is unlikely that Walquist’s litigants will see their case relitigated, this exact issue would have to come before the Tax Court again before the court could overturn its decision. This leaves poor taxpayers with no recourse for years potentially.
The second solution is far more helpful to lower-income taxpayers. This proposed solution is simple: Congress amends § 6751 to require supervisory approval for all accuracy penalties, and excuse taxpayers from their penalties if this requirement is not met. This could mechanically be accomplished by simply eliminating the exceptions in § 6751(b)(2) and by adding statutory language specifically listing out the consequences of IRS noncompliance. This solution is normatively preferable. While taxpayers should pay penalties for noncompliance with the tax code, the IRS should ensure that every step in its audit process is accurate. If noncompliance is met with severe penalties on the taxpayer’s side, noncompliance on the IRS’s side should also be met with severe penalties. And since President Joe Biden has indicated that tax reform is on his agenda, this solution could see timely implementation. Finally, this solution offers a bright-line rule for courts and the IRS to follow, leaving little room for significant litigation. Overall, this solution is vastly superior.
The recent boom of litigation surrounding § 6751’s procedural requirements has left the Tax Court searching for answers regarding supervisory approval of penalties. This has allowed wealthier taxpayers and bad actors to escape liability through litigation, leaving poor taxpayers—who often do not have the resources to litigate their penalties—at the mercy of the IRS’s whims. With tax reform on President Biden’s agenda, there is the possibility for relief. One normatively preferable solution consists of Congress amending the tax code to require supervisory approval for all accuracy penalties, excusing taxpayers from their penalties in the event of IRS noncompliance. While taxpayers should pay penalties for willful noncompliance, the Government must safeguard their rights.
 Internal Revenue Serv., Internal Revenue Service Data Book, 2019, at 4 tbl.2 (2020).
 Compare id. at 16 tbl.7 (reporting approximately 122 million refunds issued), with id. at 35–44 tbl.17a (reporting audit data over the past ten years).
 E.g., when taxpayers substantially underreport their income, § 6662 of the Internal Revenue Code (Code) enables the IRS to assess accuracy penalties. I.R.C. § 6662.
 I.R.C. § 6751(b)(2)(A).
 I.R.C. § 6751(b)(2)(B).
 See, e.g., Walquist v. Comm’r, 152 T.C. 61, 68–74 (2019).
 See, e.g., Graev v. Comm’r, 149 T.C. 485, 485 (2017).
 See Jack Townsend, FTPB Update 05 – New IRM Summary of the § 6751 Written Supervisor Approval Requirement, Fed’l Tax Procedure (Oct. 22, 2020), https://federaltaxprocedure.blogspot.com/2020/10/ftpb-2020-update-05-new-irm-summary-of.html [https://perma.cc/BXB7-SBG5].
 Internal Revenue Service Restructuring and Reform Act of 1998, 105 Pub. L. 206, § 3306(a) (1998); see also Andrew Roberson, Kevin Spencer & Denise Mudigere, Using IRS Supervisory Approval Rules to Fight Tax Penalties, Law360 (Feb. 20, 2020, 4:49 PM), https://www.law360.com/articles/1245484/using-irs-supervisory-approval-rules-to-fight-tax-penalties- [https://perma.cc/X36N-8GDX].
 See Roberson, et al., supra note 9 (discussing Chai v. Comm’r, 851 F.3d 190 (2d Cir. 2017) and its immediate predecessor, Graev v. Comm’r, 147 T.C. 460 (2016)).
 Chai, 851 F.3d at 194.
 Id. at 223.
 Id. at 221.
 See Townsend, supra note 8. Roberson et al. list several cases illustrating this ad hoc approach, including Palmolive Bldg. Inv’rs, LLC v. Comm’r, 152 T.C. 75 (2019) (holding that penalties asserted at different times must each meet the supervisory approval requirements), Clay v. Comm’r, 152 T.C. 223 (2019) (holding that penalties must be assessed in a formal communication), Belair Woods, LLC v. Comm’r, T.C. Memo 2020-112 (July 22, 2020) (holding that the IRS bears the initial burden of production), and Frost v. Comm’r, 154 T.C. 23 (2020) (describing when supervisory approval is necessary). Roberson, et al., supra note 9.
 Walquist v. Comm’r, 152 T.C. 61, 68–74 (2019).
 IRM 126.96.36.199(1).
 Walquist, 152 T.C. at 62–63.
 Id. at 70 (citing I.R.C. § 6751(b)(2)(B)).
 See, e.g., Graev v. Comm’r 149 T.C. 485 (2017) (litigating a 2004 tax return).
 Chai v. Comm’r, 851 F.3d 190 (2d. Cir. 2017).
 Naturally, other solutions to this problem exist. For one, the IRS could implement internal procedures reflecting the changes advocated in this Post. Alternatively, the IRS could divert resources from EITC enforcement to combat tax evasion strategies employed by wealthy taxpayers. These solutions, however, seem less than likely to come to fruition.
 IRM 188.8.131.52(1).
 Walquist v. Comm’r, 152 T.C. 61, 75 (2019).
 Nancy Cook & Laura Davison, Biden Eyes First Major Tax Hike Since 1993 in Next Economic Plan, Bloomberg (March 15, 2021, 1:00 AM), https://www.bloomberg.com/news/articles/2021-03-15/biden-eyes-first-major-tax-hike-since-1993-in-next-economic-plan [https://perma.cc/TE7C-MVYP].