IRS Practice and Procedure as to the Collection of Payroll Taxes By: Kenneth B. Schwartz, Esq., CPA 500 North Broadway, Ste 124 Jericho, N.Y. 11754 Tel: 516-333-7020 www.schwartzattorney.com December 2, 2013 Penalties and Interest a) Failure to Make Deposits IRC 6656 imposes the following penalties when payroll taxes are not being deposited timely: 1. Two percent, if five days late or less; 2. Five percent, if six to fifteen days late; 3. Ten percent, if more than fifteen days late; and 4. Fifteen percent, if not paid within ten days after the earlier of (i) the date of the first delinquency notice, or (ii) the date on which notice and demand for payment is given. You can abate the penalties under IRC 6656 upon a showing of reasonable cause rather than willful neglect. b) Other Civil Penalties 1. Failure to File Return (IRC 6651(a)(1)) If failure due to willful neglect, 5 percent of the tax being due for each month the return not filed, to a maximum of 25 percent. To the extent that a failure to pay penalty may apply at the same time, the penalty for 1
failure to pay tax as shown on the return (see para. 2 ) will reduce the failure to file penalty dollar for dollar so the two will not apply at the same time. 2. Failure to Pay Tax Shown on Return (IRC 6651(a)(2)) If failure to pay tax is due to willful neglect, then penalty will equal.5 percent per month for each month unpaid, to a maximum of 25 percent. 3. Failure to Pay Tax Not Shown on Return (IRC 6651(a)(3)) If due to willful neglect,.5 percent per month of the unpaid tax, to a maximum of 25 percent. This penalty may apply in addition to the penalties for failure to file (para. 1, above) and failure to pay tax shown on return (para. 2, above). 4. Accuracy Related Penalty as to Underpayment of Tax (IRC 6662) 20 percent of the underpayment if attributable to (a) negligency or disregard of rules or regulations, or (b) a substantial understatement of tax. Substantial Understatement means the greater of $5,000 or 10 percent of the correct tax that s required on the return. The penalty will not apply if substantial authority exists for the position that was taken, or if adequate disclosure was made in a statement attached to the return. 5. Fraud Penalty (IRC 6663) 75 percent of any understatement of tax if any portion due to fraud. IRS would have the burden to establish fraud by showing (a) an understatement of tax, and (b) the taxpayer intended to evade his taxes (Park v. Comm. 94 TC 654 (1990)). 2
c) The Trust Fund Recovery Penalty (IRC 6672) An amount equal to the entire withholding for income, social security and medicare taxes inclusive of interest and penalties as to those who willfully fail to collect, account for or pay over the tax or who willfully acted to evade or defeat the tax. The IRS will look to all Responsible Persons for payment, severally, inclusive of anyone having the right to sign checks or to make decisions as to how the taxpayer can disburse funds, like for instance, officers and other employees having a meaningful financial involvement. Payments received under the Trust Fund Recovery Penalty will reduce the overall liability for trust fund withholdings, dollar for dollar (see eg., Ltr Rul. 200838027). The following procedures will apply to appeals and collections for the Trust Fund Recovery Penalty under IRC 6672: 1. Limitations Period IRS must serve a notice of proposed assessment prior to assessing any penalty under IRC 6672 within the limitations period in IRC 6501 (ie. generally, 3 years from the filing date of the return. The limitations period is then extended until the later of (i) 90 days after the service of the notice of proposed assessment, or (ii) 30 days after a final administrative determination if issued on a protest. IRC 6672(b)(3)). 2. 60 Day Notice IRS must serve its notice of proposed assessment, commonly known as Form 1153, at least 60 days prior to serving notice of a demand for payment. IRC 6672(b)(2). 3
3. Protest Upon receiving a notice of proposed assessment (ie. Form 1153), the taxpayer can file a protest with the Appeals Office of the IRS. This will generally stay any enforcement activity until a final determination is rendered by IRS (see Ltr Rul 200930044, citing IRM 5.7.6.1.8; also see IRM 5.7.3.6.2(2)). The withdrawal of a timely protest will constitute a final administrative determination. id. 4. No Tax Court Jurisdiction The US Tax Court would lack jurisdiction over a dispute relating to IRC 6672, except in the context of a Collection Due Process Hearing under IRC 6330. 5. Lawsuits in the Federal District Court Allowed as Exception to the Anti Injunction Act under IRC 7421 No levy allowed if a refund claim was filed as to any portion of the tax and a lawsuit for the claim was brought in the Federal District Court and the results of that case would settle the issues. IRC 6331(i). 6. Collection Due Process Applies to Levies under IRC Sec s. 6330 and 6331 After an assessment is issued, but prior to levy, IRC 6331 requires both a Notice and Demand (ie. 10 day notice) and Final Notice and Demand (ie. 30 day notice) prior to the time that a levy can occur, or in other words, prior to an actual seizure of the taxpayer s property. After the Final Notice and Demand is issued, taxpayers have the right to demand a hearing and if so demanded, the IRS Office of Appeals will hold a hearing and 4
consider all issues that were not previously considered or waived. This would exclude all issues already addressed in a protest (see para. 4, above). After the Office of Appeals issues a final determination, the taxpayer may file a petition in the US Tax Court and the Court will consider de novo, all issues having been determined by the Office of Appeals, or those not waived by the taxpayer either on consent or by operation of law. 7. Collection Due Process Applies to Notices of Lien under IRC Sec s 6320, 6321 and 6323 The IRS may file a notice of lien as to unpaid taxes after assessing the tax and serving a notice and demand for payment. If not paid after the notice and demand is given, IRS may then file a notice of lien. Within 5 business days after a notice of lien is filed, the IRS must notify the taxpayer and afford him 30 days to demand a hearing as to the unpaid tax or the propriety of the lien. The Office of Appeals will then address any issues that were not addressed in any other administrative hearing, like for instance, a pre-levy hearing. The taxpayer may then file a petition in the US Tax Court within 30 days of a final determination. d) Abatement of Penalties Upon a showing of reasonable cause you can abate the penalties for failure to file a return or pay the tax under IRC 6651, and the penalties for failure to make deposits of payroll taxes under IRC 6656. Reasonable cause will generally involve a somewhat factual determination based upon actions which the taxpayer did or did not take to show circumstances either beyond his control, like for 5
instance a serious illness as to he or members of his immediate family, the erroneous advice of an IRS Office or employee (McMahan v. Comm. (2 nd Cir., 1997) 114 F.3d 366, or reliance on a mistaken legal opinion of a competent tax adviser that it was unnecessary to file a tax return. id. Relying upon an expert s advice as to substantive questions of tax law may constitute reasonable cause. U.S. v. Boyle (1985), 469 US 241. Similarly, IRC 6664(c) provides that penalties will not apply under IRC 6662 (ie., accuracy related penalty) and IRC 6663 (ie. fraud) if the taxpayer exercised reasonable cause and good faith. IRC 6404(f) requires the IRS to abate penalties or additions to tax which are due to the erroneous advice of an officer or employee of IRS in their official capacity, which (i) was given in response to the taxpayer s written request and was reasonably relied upon, and (ii) did not result from the taxpayer s failure to provide adequate information. e) Interest Interest on an underpayment of tax will apply from the date that a payment was due and it will continue to run until payment is received except that a notice and demand for payment, once served, will stop the running of interest as long as full payment is received within 21 days after the notice date. IRC 6601(e). Interest applies not only to underpaid taxes it call also apply to certain kinds of penalties like the failure to file penalty in IRC 6651(a)(1) if payment isn t made within 21 days after notice and demand. IRC 6601(e)(2). 6
The amount of interest will fluctuate according to the federal short term rates that are designated by Treasury at the beginning of each calendar quarter under IRC 1274(d), plus 3 percent in most cases, 5 percent for corporations if the underpayment exceeds $100,000. IRC 6621. Interest charges are compounded daily. IRC 6622. As to abating interest, IRC 6404(e) provides that you can potentially abate interest where IRS has acted in a fashion to cause unreasonable error or delay and the US Tax Court might even have jurisdiction to review a determination by IRS, however the better view holds that IRC 6404(e) does not apply to employment taxes. see eg., Woodral v. Comm., 112 TC 19 (1999). 7