Typically, a taxpayer convicted of Internal Revenue Code (IRC) §7201 tax evasion can fully expect to also incur the IRC §6663 civil fraud penalty. However, on July 1, 2020, the Tax Court in Minemyer v. Commissioner strictly applied the statutory language of IRC §6751(b), holding that the Internal Revenue Service (IRS) was precluded from assessing the civil fraud penalty because the IRS failed to show timely supervisory approval of such civil fraud penalty.¹ Although this case presents rather atypical circumstances as compared to the numerous cases recently looking at supervisory approval timeliness, it is noteworthy in that the Tax Court is apparently determined to enforce this rule even following a criminal conviction of tax evasion.
In July of 1998, Taxpayer and a business associate organized LLC. LLC was taxed as a partnership with Taxpayer as a 50% member.
On April 8, 2008, Taxpayer was charged with two counts of income tax evasion under IRC §7201. The indictment accused Taxpayer of “filing false and fraudulent income tax returns for 2000 and 2001, alleging that he had substantially understated his income by knowingly omitting passthrough income from [LLC].”² Pursuant to a plea deal in 2009, Taxpayer pled guilty to income tax evasion for 2000, and the government dismissed the claim for 2001. Thereafter, Taxpayer paid $200,918 in restitution and was sentenced to prison.
While in prison, Taxpayer was visited on March 4, 2010, by an IRS revenue agent who provided Taxpayer with a Form 4549, Income Tax Examination Changes, for 2000 and 2001. The report was not accompanied by a letter from the Commissioner. Taxpayer signed the Form 4549 and by doing so agreed to deficiencies and penalties; however, Taxpayer later requested that the agreement be withdrawn.
Pursuant to Taxpayer’s request, the Form 4549 was withdrawn. Subsequently, in May of 2010, a Letter 950 (30-day letter) was sent to Taxpayer. The Letter 950 was signed by the immediate supervisor of the revenue agent. Included with the Letter 950 was Form 4549-A, Income Tax Examination Changes (Unagreed and Excepted Agreed), wherein the IRS asserted that Taxpayer was liable for an IRC §6663 fraud penalty of $42,708 for 2001. This Form 4549-A “included the words ‘corrected report’ at the top of both pages of the form.”³ The revenue agent signed and dated the form. Above the agent’s signature was this statement: “This Report supersedes the report issued 3/4/2010.”⁴
On August 19, 2010, the IRS issued Taxpayer a notice of deficiency for income tax and IRC §6663 fraud penalties for the tax years 2000 and 2001. On August 11, 2010, a Civil Penalty Approval Form was executed by the revenue agent’s immediate supervisor, approving the IRC §6663 fraud penalty.
The Tax Court engaged in a careful analysis of case law and statutory provisions to arrive at its holding, beginning by noting that: “[t]he [IRS’s] burden of production under section 7491(c) with respect to the section 6663 fraud penalty includes introducing sufficient evidence to establish compliance with the supervisory approval requirement of section 6751(b).”⁵
First, the Tax Court emphasized that according to IRC §6751(b)(1):
No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher-level official as the Secretary may designate.⁶“
The court explained that it has understood this section of the IRC to “require approval before the penalty determination is communicated to the taxpayer.”⁷
The Tax Court then noted that it had previously determined that the “initial determination” described in IRC §6751(b)(1):
Occurs no later than “when those proposed adjustments are communicated to the taxpayer formally as part of a communication that advises the taxpayer that penalties will be proposed and giving the taxpayer the right to appeal them with Appeals.”⁸“
Moreover, the Tax Court clarified that such “initial determination” of the assessment presents in a “document by which the Examination Division formally notifies the taxpayer, in writing, that it has completed its work and made an unequivocal decision to assert penalties.”⁹ The Tax Court also considered that IRC §6741(b)(1) does not require that a “specific person” provide approval in a “particular manner;” rather, according to the statutory language, the initial determination “must be approved in writing ‘by the immediate supervisor of the individual making such determination.’”¹⁰
Ultimately, the Tax Court was unable to determine whether the IRS’s attempt to get a Taxpayer-signed Form 4549 (which the Tax Court noted was not offered into evidence) before the IRS sent out the 30-day letter was the “initial determination”—rather than the 30-day letter itself. And, according to the Tax Court, “[i]f the Form 4549 was the initial determination of the fraud penalty for 2001, there is no evidence of its timely written approval.”¹¹ For those reasons, the Tax Court held that the IRS did not meet the burden of production, and therefore, Taxpayer was not liable for the tax year 2001 fraud penalty.
Again, this is not your typical setting for an IRC §6751(b) case. One would normally expect that a taxpayer convicted of Internal Revenue Code (IRC) §7201 tax evasion would also incur the IRC §6663 civil fraud penalty. Many would argue that Taxpayer’s civil fraud penalty was “approved” the moment the Department of Justice was tasked with prosecuting the matter. In this case, though, the Tax Court strictly applied the statutory language of IRC §6751(b) and determined that the IRS was precluded from assessing the civil fraud penalty because the IRS did not show timely supervisory approval.