The IRS has finalized the regulations (TD 10017) on supervisory approval of certain penalties assessed by the IRS under IRC Section 6751(b). The final regulations adopt the proposed regulations with minor clarifications on the initial proposal of the penalty and who can approve it.

Treasury disagreed with many comments on the proposed regulations, saying they essentially mischaracterized the statute's text, scope and legislative history, and the caselaw interpreting it. Treasury maintained that the regulations are consistent with IRC Section 6751(b) and "promote nationwide uniformity, administrability for the IRS, and ease of understanding by taxpayers."

The regulations are effective December 23, 2024.

Background

IRC Section 6751(b) requires penalty assessments under IRC Section 6751(a) to be personally approved (in writing) by the immediate supervisor of the individual making the determination or a higher-level official designated by the Treasury Secretary.

Various federal district and appellate courts have found inconsistently on issues, such as when the approvals must be made and who is authorized to make those approvals.

The IRS issued proposed regulations in April 2023 (see Tax Alert 2023-0696). In response to several comments, the IRS said in the Summary of Comments and Explanation of Revisions (Summary) that "the adopted rules faithfully interpret the statutory text, ensure penalties are imposed where appropriate, and guard against inappropriate use of penalties."

Timing rules

The final regulations adopt the timing rules in the proposed regulations without change.

Penalties included in a pre-assessment notice: For penalties included in a pre-assessment notice that is subject to the Tax Court's review, such as a statutory notice of deficiency, supervisory approval may be obtained at any time before the IRS issues the notice. This "bright line rule" allows the IRS to review the penalty assessment while it still has discretion to consider all the factors.

Penalties raised in Tax Court: For penalties the IRS raises in an answer, amended answer or amendment to the answer to a Tax Court petition, supervisory approval may be obtained at any time before the commissioner requests that the Tax Court determine the penalty.

Penalties not subject to pre-assessment review in the Tax Court: For these penalties, supervisory approval may be obtained at any time before assessment of the penalties.

Definitions

The final regulations adopt the proposed regulations' definitions of the terms used in IRC Section 6751(b) with some minor modifications.

Individual who first proposed the penalty: For purposes of determining which individual first proposed a penalty, the final regulations clarify that the individual must have proposed the penalty either to a taxpayer (or the taxpayer's representative) or to the individual's supervisor or designated higher-level official. A penalty proposal to a taxpayer "does not include mere requests for information relating to a possible penalty or inquiries of whether a taxpayer wants to participate in a general settlement initiative for which the taxpayer may be eligible, but does include offering the taxpayer an opportunity to agree to a particular penalty in a particular amount other than a penalty under a settlement initiative offered to a class of taxpayers," according to the final regulations.

Immediate supervisor: The final regulations define an immediate supervisor as any individual with responsibility to review another individual's proposal of penalties without subjecting the proposal to an intermediary's approval. The proposed regulations had defined an immediate supervisor as any individual with responsibility to approve another individual's proposed penalty. "This definition recognizes that a person assigned to review a penalty proposal has the responsibility to make a judgment call about the appropriateness of the penalty," according to the Summary.

Higher-level official: The final regulations adopt the proposed regulations' definition as any individual who is allowed by the Internal Revenue Manual or their assigned job duties to approve another individual's proposed penalties.

Personally approved (in writing): Under the final regulations, this means "any writing, including in electronic form, that is made by the writer to signify the writer's assent and that reflects that it was intended as approval." In response to comments, the Summary said that, while "it may be a best practice to use digital signatures with software-generated timestamps, mandating their use would go beyond the scope of the statute and these regulations."

Exceptions

The rules under IRC Section 6751(b)(1) do not apply to (1) penalties under IRC Sections 6651, 6654, 6655, 6662(b)(9), 6662(b)(10) or 6673, or (2) any other penalty automatically calculated through electronic means.

The final regulations adopt the definition in the proposed regulations that penalties calculated through "electronic means" refers to penalties proposed by "an IRS computer program without human involvement." If a taxpayer responds to a computer-generated notice and challenges the penalty, the electronic-means exception no longer applies because an IRS employee would then be working the case.

Implications

The final regulations differ little from the proposed rules on penalty approvals. The rules set out both the timing required for the different types of penalties and which IRS employees can sign off. By adopting the bright line rule allowing approval any time before a notice of deficiency is issued, the IRS may be inviting continued challenges to penalty assessments based on whether they were timely under IRC 6571(b)(1). The statute itself requires a supervisor to approve the "initial determination of such assessment"; many commentors interpreted this language as requiring approval before a notice of deficiency could be issued. The possibility of continued challenges may also be heightened given the Supreme Court's recent decision in Loper Bright, which may embolden courts to apply their own interpretation to statutory language rather than deferring to agency interpretations. Given Loper Bright, the prior litigation on this issue, and taxpayers' general sensitivity to penalty assessments, litigation may continue around IRC 6571(b)(1), despite the finalized regulations.