IRS Practice and Procedures News Briefs for February 2017

TRUST FUND RECOVERY PENALTY DEFENSE – United States v. Liddle, 119 AFTR 2d ¶2017-381 (USDC, ND CA 2017)

Why This Case is Important: One of the IRS’s most effective tools in collecting unpaid employment taxes is the trust fund recovery penalty (TFRP), which enables the IRS to hold certain individuals, who were responsible for ensuring that employment taxes were paid, personally responsible for the unpaid “trust fund” portion of the taxes (the portion that should have been withheld from the employees’ wages). This case is a good example of an ineffective defense against a potential TFRP assessment.

Facts: In Liddle, the taxpayer was the CEO of a company that failed to pay its employment taxes on a timely basis. In that capacity, he was responsible for overseeing and determining the company’s financial policy and the hiring and firing of employees. When the taxpayer became aware of the unpaid taxes, he discussed the issue with the company’s board of directors. The board resolved to pay all future taxes, but the company did not pay the past-due taxes. IRS assessed the TFRP against the taxpayer in an amount equal to the company’s unpaid trust fund taxes and then filed suit seeking a judgment against the taxpayer in that amount.

Law and Analysis: Trust fund taxes are those federal income and FICA taxes that are (or are supposed to be) withheld from an employee’s wages by an employer and paid to the IRS. When a business fails to remit trust fund taxes to the IRS, the IRS can hold certain individuals in the business personally liable for unpaid amounts by assessing the TFRP. To be held personally liable, an individual must have been “responsible” for ensuring that the business paid its employment taxes and must have willfully failed to collect, account for, or pay over such taxes to the IRS. The taxpayer conceded that he was responsible for the practice’s payment of its employment taxes. He contested the assessment of the TFRP based on the argument that he did not willfully fail to collect, account for, or pay the practice’s taxes to the IRS. He argued that he did not act willfully because he acted with “reasonable cause.” Reasonable cause is normally a defense to the IRS’s assessment of other penalties, such as the late-payment or late-filing penalty. While the 2nd, 5th, and 10th federal Circuits all accept reasonable cause as a defense to the TFRP, the 9th Circuit (where this case took place) does not. That being the case, the Court rejected the taxpayer’s defense and entered judgment in favor of the IRS. The 7th Circuit has not weighed in on whether reasonable cause constitutes a defense to a TFRP assessment.

SIGNING A TAX RETURN FOR A SPOUSE – Moss v. Commissioner, T.C. Memo. 2017-30 (2017)

Why this Case is Important: For a variety of reasons, including convenience, married taxpayers may wonder whether they are permitted to sign a joint tax return for their spouses. This case discusses the requirements for doing so.

Facts: In Moss, the taxpayer was married. In 2009, his wife, due to mental illness, insisted on filing her own separate 2008 federal income tax return to claim $350,000 in theft losses she incurred related to investments with Bernie Madoff (in fact, she never had any investments with Madoff). She filed the return claiming the loss and reporting other inaccurate figures. Thereafter, the taxpayer prepared a joint income tax return accurately reporting the couple’s income and deductions, claim exemptions for both of them, and claiming an $823 refund. Because his wife refused to sign the return, he signed for her and submitted it with a letter explaining the circumstances, including that her separate return should be disregarded due to her mental illness. However, he did not include a signed power of attorney authorizing him to sign the return on her behalf (because she gave this authorization). The IRS accepted the taxpayer’s wife’s return, with adjustments, and collected the balance due from her Social Security. In 2011, the IRS issued a notice of the deficiency to the taxpayer, in which it recalculated his tax liability using a married-filing-separate status rather than a joint states and removed the claimed exemption for his wife, but did not remove her income in the calculation of his tax liability. The taxpayer filed a Tax Court petition arguing that his wife’s separate return should be invalidated and that the joint return should be accepted as filed. The IRS conceded that, at a minimum, her income should be removed from the calculation of his separate tax liability/refund.

Law and Conclusion: Generally, a joint tax return must be signed by both spouses. There are two exceptions to this rule – where one taxpayer acts as agent for the other and where there is sufficient evidence that, despite the lack of a signature on the return, the spouse consented to the joint filing. For one spouse to sign a return as the other’s agent, IRS regulations require that signing spouse to submit: (1) an IRS Form 2848, Power of Attorney, signed by the other spouse authorizing the signature; (2) a signed statement confirming that his or her spouse is incapacitated and consented to the signing; or (3) a request for permission form to the IRS district director, which request must be approved prior to signing the return. The taxpayer did not take any of these steps. Furthermore, there was no evidence that she consented to the joint filing. In fact, she directly opposed it. For that reason, the taxpayer’s filing of a joint return with him having signed on his wife’s behalf was invalid. The Court found in favor of the IRS.

PENALTY ABATEMENT BASED ON RELIANCE – Estate of Hake v. U.S., 2017 U.S. Dist. LEXIS 19020 (M.D. Pa. 2017)

Why This Case is Important: Taxpayers’ defenses to IRS penalty assessments under a reasonable cause theory are most often unsuccessful. This case is an example of a taxpayer successfully defeating an IRS penalty assessment.

Facts: In Hake, Esther Hake died in 2011. Her two sons were executors of her estate. Disputes among her children about the distribution of her assets prevented the executors from resolving estate issues on a timely basis, including the filing of the federal estate tax return. Because the executors had little experience with estate issues, they hired tax attorneys for assistance. The estate tax return and related payment was due July 2, 2012. Because the executors were unable to file the return and pay the taxes by that date, the estate’s attorney advised them to seek an extension of these deadlines. The attorney filed the request for an extension. When it was granted, he advised the executors that the filing and payment deadline had been extended by one year. In fact, the IRS only granted the one-year extension with respect to the payment deadline; the filing deadline was only extended six months. Less than one year, but more than six months after the original due date, the estate filed its return and paid the related taxes. The IRS assessed a late-filing penalty of almost $200,000. The estate requested an abatement of this penalty but the IRS rejected that request. The estate then filed suit in federal court requesting the abatement.

Law and Analysis: Section 6651(a) of the Internal Revenue Code imposes a late-filing penalty in the event that a return on which tax is due is not filed on time and a late-payment penalty in the event that taxes are not paid on or before the filing deadline (without extensions). However, these penalties do not apply to the extent that such late filing and/or late payment was due to reasonable cause and not willful neglect. Reasonable cause exists if the taxpayer exercised “ordinary business care and prudence” but nevertheless could not file or pay the tax when due. On the other hand, willful neglect means a “conscious, intentional failure or reckless indifference.” In this case, the Court found that the estate’s reliance on its attorney, who was experienced in tax matters, on the interpretation of statutes and regulations regarding filing extensions, was reasonable and by following the attorney’s instructions, the estate exercised ordinary business care and prudence. That being the case, the Court ordered the IRS to abate the penalties.

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