Tax Court Rejects APA Challenge to IRS Penalty Supervisory Approval Process

(Parker Tax Publishing November 2025)

The Tax Court held that the IRS complied with Code Sec. 6751(b)(1) in asserting a penalty against a taxpayer for an underpayment due to a substantial understatement of tax because the IRS's agent secured written supervisory approval of the initial determination to assert the penalty before the 30-day letter and notice of deficiency were issued. The court further found that the judicial review provisions of the Administrative Procedure Act do not apply to the Tax Court in the exercise of deficiency jurisdiction, including determinations regarding the IRS's compliance with Code Sec. 6751(b)(1). Computer Sciences Corporation v. Comm'r, 165 T.C. No. 8 (2025).

Background

Computer Sciences Corp. (CSC) was the U.S. parent of a group of corporations that filed a consolidated federal income tax return. CSC and its subsidiaries engaged in various aspects of the information technology business.

During 2013, CSC sold its credit services business and realized a large capital gain. With a view to offsetting this gain CSC engaged in "Project Trinity," a structured financing transaction. It involved two principal steps. First, CSC contributed stock of one wholly owned subsidiary with a large built-in loss to another wholly owned subsidiary in exchange for three classes of securities, which CSC characterized as "senior participating preferred stock," "junior preferred stock," and a senior note. Applying Code Sec. 358(b), CSC allocated to the senior preferred stock the bulk of its basis in the stock thus contributed. Several days later, CSC sold the senior preferred stock and the note for cash. When the dust settled, CSC allegedly recognized, on this sale of securities, a long-term capital loss of $651,200,000.

CSC reported the capital loss on its income tax return for 2013. It attached to its return a Form 8886, Reportable Transaction Disclosure Statement, in which it allegedly disclosed all relevant facts affecting Project Trinity and the capital loss deduction. The IRS selected CSC's 2013 return for examination and assigned the case to Revenue Agent (RA) Steven Herrera. At that time Supervisory RA Richard Guastello was Herrera's acting team manager and thus his immediate supervisor. Guastello's immediate supervisor was Renee Bowers, the acting territory manager.

In March 2017, as the examination neared completion, RA Herrera proposed to disallow CSC's capital loss deduction and to assert a 20 percent penalty for an underpayment due to a substantial understatement of income tax. His recommendation to this effect was set forth in a Form 5701, Notice of Proposed Adjustment (NOPA). On March 22, 2017, RA Herrera sent the draft NOPA to Guastello, his immediate supervisor. That same day, Guastello approved RA Herrera's recommendation to assert this penalty by affixing his digital signature on the NOPA using Adobe software.

RA Herrera promptly notified CSC that the IRS was considering the assertion of this penalty. On March 23, 2017, CSC representatives met with the examination team to express their view that CSC had adequately disclosed the pertinent tax treatment and that there was a "reasonable basis" for such treatment. That same day RA Herrera prepared and sent to CSC a draft Information Document Request (IDR) seeking the company's position as to why this penalty should not be asserted. Rather than respond to this request, CSC asked that the draft IDR be withdrawn. On March 27, 2017, Bowers - Guastello's supervisor - affixed her signature to the NOPA, signifying her approval to assert the substantial understatement penalty.

On April 1, 2017, Guastello again approved RA Herrera's recommendation to assert this penalty by affixing his signature on a "Substantial Understatement Penalty" worksheet. This worksheet, which RA Herrera had filled out, sets forth a series of instructions to guide the RA through the penalty determination process. Step 6 of the worksheet asked whether Form 8275, Disclosure Statement, or Form 8275 - R, Regulation Disclosure Statement, was attached to CSC's return. Having examined CSC's return, RA Herrera correctly answered "No" to that question. The worksheet accordingly directed him to skip Step 7 - which asked, "Does the taxpayer have a reasonable basis for the tax treatment of the item?" - and "[g]o to step 8." Step 8 asks: "Does the taxpayer meet the reasonable cause exception?" To answer that question RA Herrera was directed to "[c]omplete the [attached] reasonable cause worksheet," which he did. On that worksheet he indicated that CSC had "claimed privilege on the tax opinion" it had received regarding Project Trinity, so that the tax opinion "cannot be relied upon in claiming the reasonable cause exception." RA Herrera accordingly marked the "No" box at Step 8, leading to the conclusion that "[t]he penalty applies." Guastello signed this worksheet as "Team Manager" on April 1, 2017.

RA Herrera and Guastello met again with CSC's representatives on April 7, 2017. During this meeting they addressed (among other things) the potential applicability of the penalty and the penalty defense CSC advanced. CSC argued that no penalty should apply because it had "flagged [the] issues," an apparent reference to the Form 8886 attached to its 2013 return. On April 12, 2017, CSC made an additional submission to the examination team, arguing that no penalty should be asserted in the light of its tax return disclosures and IDR responses. On April 21, 2017, Guastello nevertheless approved - for a third time - RA Herrera's determination to assert the substantial understatement penalty by initialing his approval on a civil penalty leadsheet.

On May 15, 2017, the IRS sent CSC a 30-day letter signed by Guastello, RA Herrera's immediate supervisor. He attached to that letter Form 4549-A, Income Tax Examination Changes, which included the substantial understatement penalty. This document constituted the first formal communication to CSC that the IRS intended to assert this penalty. CSC filed a Protest to the 30-day letter, seeking review by the IRS Independent Office of Appeals (Appeals). Appeals was ultimately unpersuaded by CSC's arguments. On February 16, 2021 - almost four years after Guastello first approved the penalty - Appeals issued CSC a notice of deficiency that determined a deficiency of $276,535,161 and a substantial understatement penalty of $45,584,000.

CSC petitioned the Tax Court seeking a redetermination of the deficiency and the penalty. The IRS filed a motion for partial summary judgment seeking a ruling that the IRS complied with the requirements of Code Sec. 6571(b)(1) by securing timely supervisory approval for the penalty. CSC filed a response in which it contended that the Administrative Procedure Act (APA) applies to the prerequisite under Code Sec. 6751(b) for supervisory approval and requires "reasoned decision making" by the IRS supervisor in approving the determination of a penalty. CSC asserted that Guastello did not "meaningfully review" the penalty recommendation because he did not consider whether CSC might have a reasonable basis defense to the penalty. CSC urged that Guastello's approval should therefore be set aside under APA Section 706(2)(A) as agency action that is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.

Analysis

The Tax Court held that the IRS satisfied the requirements of Code Sec. 6751(b)(1) because RA Herrera secured written supervisory approval of the initial determination to assert the penalty before the 30-day letter and the notice of deficiency were sent to CSC. The court noted that Guastello approved, on four separate occasions, RA Herrera's initial determination to assert the penalty. He did so: (1) by affixing his electronic signature to the NOPA on March 22, 2017, using Adobe software, (2) by placing his signature on the "Substantial Understatement Penalty" worksheet on April 1, 2017, (3) by initialing his approval on the civil penalty leadsheet on April 21, 2017, and (4) by signing the 30-day letter dated May 15, 2017.

The court further held that the APA's judicial review provisions do not apply to the court's review of the IRS's compliance with Code Sec. 6751(b)(1). The court explained that Code Secs. 623 and 6214(a), rather than the judicial review procedures under the APA, govern judicial review of deficiency proceedings. Even if the APA applied to the Tax Court, the court found that the APA would not apply to its review of the IRS's compliance with Code Sec. 6751(b)(1) because a supervisor's approval of a penalty is not a final agency action. The court observed that after supervisory approval, the examination team may elect to drop or reduce the penalty or assert alternative penalties. In addition, the taxpayer may seek review by Appeals, and Appeals can drop or reduce the penalty as part of an overall settlement. Supervisor approval is also not a final agency action, the court found, because it is not an act by which a taxpayer's rights or obligations have been determined, or from which legal consequences will follow.

Even if the court regarded Guastello's approval of the penalty as a final agency action, the court found that such action would not be subject to APA judicial review because CSC had an adequate remedy in the Tax Court for any noncompliance with Code Sec. 6751(b)(1). The court found that the deficiency proceeding afforded CSC an adequate judicial remedy for the noncompliance it alleged and therefore, Section 704 of the APA would not authorize separate judicial review even if Guastello were considered to have engaged in final agency action.

The court rejected CSC's contention that Guastello failed to engage in reasoned decision making because the availability of a reasonable basis defense was never considered. The court found that Herrera had no need to consider whether there was a reasonable basis for CSC's position because CSC did not disclose the relevant facts on Form 8275 or Form 8275-R, as required under Reg. Sec. 1.6662-4(f)(1). The court concluded that the regulation on its face foreclosed CSC's ability to urge a reasonable basis defense to the penalty.

For a discussion of the penalty supervisor approval requirement, see Parker Tax ¶262,195.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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