CCA 1132023: IRS advised that relevant fuel-use factors may determine a dyed-fuel penalty

Plain-English summary

Chief Counsel Advice addressed how the IRS may determine the amount of dyed fuel held for a taxable use when assessing a penalty under IRC § 6715(a)(2). The advice stated that the Service may consider any relevant factors, including the amount of fuel in bulk storage and credible evidence of the taxpayer's past usage. A presumption that all fuel in a bulk tank is held for taxable use is rebuttable, and the taxpayer may present evidence before assessment. The advice explained that Needsome Farms did not change this analysis because the taxpayer there had not disputed that the fuel in storage was held for taxable use.

Ruling snapshot

• Question: How may the IRS determine the amount of dyed fuel held for a taxable use for purposes of an IRC § 6715(a)(2) penalty?
• Outcome: advice given
• Key authorities: IRC §§ 6715(a)(2) and (b)(1); Internal Revenue Manual Part 4.24.13.18.2; Notice 1215

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201132023
       Release Date: 8/12/2011
       CC:PSI:B07 CLangley
       PRENO-118769-11

UILC: 6715.00-00

date: July 06, 2011

 to:   Holly McCann
       Chief, Excise Tax Program

from: Frank Boland,
Chief, Branch 7
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

subject: Penalties imposed under § 6715

       This Chief Counsel Advice responds to your request for assistance for non-taxpayer
       specific legal advice. This advice may not be used or cited as precedent.

       ISSUES

       How may the Internal Revenue Service (Service) determine the amount of dyed fuel
       held for a use other than a nontaxable use for purposes of assessing a penalty under
       § 6715(a)(2) of the Internal Revenue Code? How does the decision in Needsome
       Farms v. U.S., No. 97-1375-MLB, 1999 WL 1313697 (D.Kan. July 16, 1999) affect this
       analysis?

       CONCLUSION

       The Service may consider any relevant factors when calculating the amount of dyed fuel
       a person held for a use other than a nontaxable use (i.e., a taxable use) in assessing a
       penalty under § 6715(a)(2).

       FACTS

       The following example can be used to illustrate the issue: The Service inspects a
       farmer's registered pick-up truck on the highway and determines that the truck holds 30
       gallons of dyed fuel. The Service then proposes a penalty of $1,000. The Service also
       determines that the farmer fueled the truck from the farmer's bulk storage tank that

PRENO-118769-11 2

contains 10,000 gallons of dyed fuel. While at the farm, the Service observes numerous
pieces of off-highway farm equipment that are fueled from the same bulk storage tank.

LAW AND ANALYSIS

Section 6715(a)(2) imposes an assessable penalty if any dyed fuel is held for use or
used by any person for a use other than a nontaxable use and such person knew, or
had reason to know, that such fuel was so dyed.

Section 6715(b)(1) generally calculates the amount of the penalty as the greater of (A)
$1,000, or (B) $ 10 for each gallon of the dyed fuel involved.

In the example we gave above, it is not improper for the Service to initially presume that
the entire volume of fuel in the bulk storage tank is held for a taxable use. However,
this presumption is rebuttable. Thus, before the penalty is actually assessed, the
taxpayer is allowed to present its case to Service officials who have authority to
determine the matter. See the Internal Revenue Manual Part 4.24.13.18.2 and Notice
1215 for further information on taxpayers’ rights to disagree and appeal a penalty
assessment.

If the taxpayer does not present any evidence of nontaxable use, or if the evidence
presented is not credible or otherwise not convincing, it is not unreasonable for the
Service to base its assessment on the entire 10,000 gallons of dyed fuel in the tank.

On the other hand, if the taxpayer does present credible and convincing evidence of its
past usage, the Service can use this evidence to infer a pattern of future usage. Thus in
the example, if the taxpayer can show that, historically, only 60% of the diesel fuel it
dispenses from a bulk tank of dyed fuel is used for nontaxable purposes, it might be
reasonable to assess the penalty on 40% (4,000 gallons) of the dyed fuel in the bulk
storage tank even though those gallons have not yet been used. Note, however, that
this result might not be appropriate if the taxpayer has established a new pattern of
usage that is not consistent with its past practices.

Additionally, another way to use credible and convincing evidence of a taxpayer's past
usage is to base the penalty on the use of dyed fuel that the taxpayer has actually used
for a taxable purpose. For example, if the Service determines that the taxpayer bought
and used 100,000 gallons of dyed fuel during the previous year and that, historically,
only 60% of the diesel fuel it dispenses from its bulk tank is used for nontaxable
purposes, it might be reasonable to assess the penalty on 40% of that amount (40,000
gallons) that the taxpayer actually used for a taxable use.

Note that the three possible results described in this memorandum are not necessarily
the only results that are reasonable in all particular cases. Each case may have
different facts and should be resolved on its own merits.
PRENO-118769-11 3

In Needsome Farms, the Service inspected a farmer’s registered truck and determined
the truck was using dyed fuel for other than a nontaxable use. The Service then
determined that dyed fuel in the truck came from a bulk storage tank on the farmer’s
farm and that the tank contained 1,833 gallons of dyed fuel. The Service assessed a
penalty under § 6715(a)(2) of $1,500 for the truck violation and $18,330 for the dyed
fuel in the storage tank. The taxpayer argued that the fuel in the storage tank was not
“involved” in the truck’s violation and § 6715(b)(1)(B) calculates the penalty at $10 for
each gallon of the dyed fuel “involved.” The court ruled that according to the plain
meaning of § 6715(a)(2), dyed fuel that is held for a taxable use is “involved.” The court
noted that it was undisputed that the fuel held in the farmer’s storage tank was for a
taxable use.

Needsome Farms does not change the analysis of our advice. In Needsome Farms,
the Service determined that the entire 1,833 gallons were held for a taxable use and
assessed the penalty based on that amount. The court agreed with the Service’s
determination, calling it “undisputed”. However, if Needsome Farms presented credible
and convincing evidence to the Service that only 50% of the dyed fuel was held for a
taxable use, then it might have been reasonable for the Service to assess only 50% of
the penalty.

Please call (202) 622-3130 if you have any further questions.