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The federal government requires that all businesses with employees withhold payroll taxes from each employee’s gross pay. These taxes, which include Social Security, Medicare, and federal income taxes, are deemed to be held by the employer “in trust” for the federal government, until the employer pays the taxes to the government each quarter. Payroll taxes are a huge burden, and can be problematic for businesses experiencing cash flow problems. When money is tight and the utility bills are due, the taxes that are supposed to be paid over to the federal government often become a lower priority. If left unpaid, trust fund taxes can be assessed against individuals who might otherwise be shielded from a company’s liabilities. The IRS is authorized to impose what is known as the Trust Fund Recovery Penalty (TFRP) on any responsible person as set out in Section 6672 of the Internal Revenue Code. This penalty is equal to the share of the employees’ payroll taxes that the business owes the IRS.
The IRS definition of responsible person is very broad— it applies to any person whose duty is to pay trust fund taxes who willfully fails to do so. A responsible person could be an officer, director, employee, or shareholder of a corporation, or a manager, employee, or member of an LLC. The term can also apply to more than one person.. Any person who has control of a business’s financial affairs, or controls payment of funds by the business, could be targeted for the TFRP.
In deciding if a person is a responsible person, the IRS considers all the facts and circumstances. Factors the IRS considers in making its determination include the individual’s ability to:
- sign checks on behalf of the business
- hire and fire employees
- determine which creditors are paid
- sign tax returns
- manage payroll
- make federal tax deposits.
The IRS will assess each of these factors to determine a person’s control over the payment of trust fund taxes.
What can you do if the IRS determines you are a responsible person, and thus subject to the penalty for nonpayment of trust fund taxes? You can challenge a TFRP assessment if your duties were ministerial, or if you lacked the ultimate authority to make financial decisions for the business. If, for example, you could sign checks and pay bills for the company, but were told by a supervisor which creditors to pay when the company had insufficient funds, it is unlikely the IRS would deem you a responsible person for purposes of the TFRP.
Even if the IRS has determined that you are a responsible person, you may be able to challenge the assessment if your failure to collect or pay taxes was not willful. For purposes of the TFRP, “willful” means intentional, deliberate, voluntary, reckless, or knowing. In other words, willful means that your failure to withhold or pay over trust fund taxes was not accidental. Your conduct will be deemed willful if the IRS can demonstrate that you were aware, or should have been aware, of the obligation to pay trust fund taxes and you showed an intentional disregard or indifference to the law.
Because the IRS aggressively enforces the TFRP, there are important facts you should know about it:
- If you are liable to pay the penalty, the obligation to pay cannot be discharged in bankruptcy.
- The IRS can collect the penalty from you, from other persons, and from the business all at the same time, until the liability is paid in full (often, the original company is no longer in business, so the IRS can only collect from responsible persons)
- If you are found liable, the IRS may demand the entire balance from you, but you may be able to seek contribution from other responsible persons
Disputing your liability for the TFRP requires an intensive analysis of the facts. If you receive a notice from the IRS proposing an assessment of the Trust Fund Recovery Penalty, act quickly to protect your rights; contact an attorney as soon as possible.
If you’ve already been assessed with a TFRP, you still have options and may be able to limit your exposure to aggressive IRS collection tactics. In either case, regardless of where you are in the process, look for someone familiar with the Internal Revenue Code, who also knows IRS assessment and collection procedures.
One often used technique for resolving unpaid personal income tax debt is now in doubt. Practitioners should take care in advising delinquent return filers that bankruptcy may be available, after a two year waiting period, to discharge the tax debt.
Whether or not a tax obligation is dischargeable in bankruptcy is, in part, determined by 11 U.S.C. § 523(a)(1). That statute provides:
A discharge under section 727, 1141, 1228(a), 1228(b), or1328(b) of this title does not discharge an individual debtor from any debt—
(1) for a tax or a customs duty—
(A) of the kind and for the periods specified in section 507(a)(3) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed;
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition;
This language has long been interpreted to meant that a tax return must of have been filed more than two years prior to commencement of the bankruptcy case for the tax debt to be dischargeable.
In 2005, for the first time Congress created a definition of “return.” Language was inserted, in a hanging paragraph, as part of the Bankruptcy Abuse Prevention and Consumer Protection Act:
. . . the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements). Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law. 11 USC § 523(a)(*).
In 2012, the 5th Circuit decided McCoy v. Mississippi State Tax Commission (In re McCoy), 666 F.3d 924 (5th Cir. 2012). That decision, relying on the new definition of return and focusing on the parenthetic language “including applicable filing requirements”, held that an untimely filed state tax return was not a “return” for bankruptcy discharge purposes. Now, two more circuits have rendered similar opinions.
The McCoy case was based on the language of Mississippi state law. However, a second case, Mallo v. Internal Revenue Service (In re Mallo), 774 F.3d 1313 (10th Cir. 2014) came up with the same result by applying 26 U.S.C. § 6072(a) language “shall be filed on or before” a particular date as an “applicable filing requirement.” Thus, the federal income tax return that was filed late, despite the intervening delay of more than two years between the tax filing and commencement of the bankruptcy case, disqualified the document filed as a “return” for bankruptcy discharge purposes.
The third opinion, Fahey v. Mass. Dep’t of Revenue (In re Fahey), 2015 U.S. App. LEXIS 2458, has followed this line of analysis and has similarly determine that a tax return, filed one day late, will never qualify the resulting debt as dischargeable in bankruptcy. Although a dissenting opinion by Judge Thompson argues for a debtor friendly interpretation of the new provision, the majority is emphatic in its plain language analysis that prohibits discharge of the tax due on a late filed return.
While the same question is currently pending in other circuits, three times is clearly the charm for the purpose of ringing alarm bells in the tax practitioner community. In the past, those of us who have worked to clean up tax delinquencies have generally considered bankruptcy a possible alternative strategy. Tax problems created by the lack of our clients’ diligence in timely complying with income return filing requirements would be well advised to seek another avenue for resolving the debt.
Before this unfavorable interpretation of the 2005 legislation, a typical non-filer may have been told to file the missing returns and then wait two years to file bankruptcy; with the promise that the unpaid tax will be discharged and the problem solved. This advice can no longer be given without strong qualification.
While the 9th Circuit has yet to address the timeliness issue in determining whether or not a late tax filing constitutes a return for bankruptcy discharge purposes, three other circuits have ruled decisively against the taxpayer on this issue and it would be imprudent to assume a different result in this circuit.
There remain two other avenues for converting an unfiled return into a future dischargeable debt. The tax court offers one alternative and a collaborative effort with the IRS to prepare a tax return pursuant to 26 U.S.C. § 6020(a) provides another. A stipulated resolution in the U.S. Tax Court should meet the requirements of “a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal.” It will now be even more important to file a timely Tax Court complaint in response to a Statutory Notice of Deficiency. The language “a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986” suggests the second route to a dischargeable tax debt for a delinquent taxpayer.
The practice of preparing a return pursuant to section 6020(a) has become so uncommon as to render it an unlikely alternative. Yet one case cited by the majority in Fahey shows a bankruptcy court willing to construe an IRS assessment made after the submission of information by the taxpayer as meeting the requirements of that statute. See In re Kemendo, 516 B.R. 434 (Bankr. S.D. Tex. 2014). If a substitute for return is pending, it may be helpful to supply information to the IRS in order to assist in the calculation of any tax due.
The ABA Taxation Section has made a formal recommendation to Congress for a change in 11 U.S.C. § 523(a) to remedy this problem. It is recommends that the phrase “other than timeliness” be added to the parenthetical language so that it would read “(including applicable filing requirements other than timeliness).” The National Taxpayer Advocate supports a change of this nature and, in its 2014 Report to Congress, recommends amendment of the bankruptcy code in order to ”provide that a late-filed tax return may be considered a return for purposes of obtaining a bankruptcy discharge.”
On May 21, 2012, the Internal Revenue Service sent a memorandum to its settlement offer specialists with guidelines that authorize much more liberal procedures for analysis of offers. While many of the changes are applicable to only limited cases, there are several big changes that will impact most individual taxpayers. The change with the broadest impact will likely be the method the IRS uses to calculate future income.
Provided there is no misconduct involved, the IRS uses a tabulation method to evaluate a settlement offer. The IRS will generally accept a settlement of tax debt when offered the net liquidation value of the taxpayer’s assets and the net present value of the taxpayer’s future disposable income. Of course, as with most everything involving the government, the devil is in the details. The IRS has just changed those devilish details and made them much more favorable to the taxpayer.
To come up with the amount of future income that must be paid as part of a tax settlement the taxpayer’s disposable income must first be determined. Disposable income has long been calculated by deducting standard living expenses from net income received by the taxpayer. The IRS uses data from a federal data compilation agency, the Bureau of Labor Statistics, to establish standard living expenses for American families.
In the past, some major potential expenses were not allowed. For example, only the repayment of student loans used to fund post-graduate education was allowed as a deduction against income. In a significant change, the IRS will now allow the deduction of payments for all government guaranteed student loans used to pay for any education after high school. Guidelines prohibited the allowance of payments required on past due state and local tax. The payment of delinquent state and local tax will now be prorated with federal liability and proportionately allowed in most circumstances. These changes will impact many taxpayers with unpaid federal tax liabilities.
However, the single largest change in the way in which the government calculates net future income involves the multiplier used to convert monthly disposable income into a settlement payment to the IRS. The IRS will accept payment of an accepted settlement in two different ways, lump sum or short term payments considered the same as cash, and deferred payment over a period of 24 months. Before the recent change, the IRS multiplied monthly disposable income by 48 to determine its net present value if the payment was to be made within six or fewer months from acceptance. If a 24 month payment period was chosen, the disposable income was multiplied by 60 to determine its net present value.
The future income net present value multiplier has been reduced by 36 months in each category. If a settlement is to be paid in cash or within six months, disposable income is multiplied by 12. If a settlement is to be paid over a period of 24 months, disposable income is multiplied by 24. For taxpayers with no home equity and few other assets, this will cut the amount of an acceptable settlement offer to as little as ¼ the amount that would have previously been required.
There are other changes that apply to the way in which the net value of the taxpayer’s assets is calculated that will be helpful to many average American families. For example, the IRS will now disregard the first $3,450 of equity in up to two vehicles in calculating asset liquidation value. Taxpayers can now keep one month’s worth of allowed living expenses in their bank account plus $1,000 without adding to the liquidation value calculation. Again, this will lower the settlement threshold for many taxpayers.
These welcome changes in the Offer in Compromise program standards should prompt a flood of new offers. In addition, many pending settlements that would not have been accepted will now be allowed. This is none too soon for many struggling Americans with unpaid tax debt. Now IRS collection officers can focus their time on cases that deserve their attention and direct besieged homeowners and wage income taxpayers to the Offer in Compromise program for relief from collection.
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Congress enacted the Tax Equity and Fiscal Responsibility Tax Act of 1982 and amended the federal tax code to prohibit deduction of ordinary and necessary expenses related to the illegal sale of controlled substances. A recent Tax Court decision highlights this law as another challenge to the feasibility of marijuana growing operations. Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. No. 4 (5/15/07), demonstrated how the Federal tax code is being used to inhibit the medical marijuana industry. In the California case IRC 280E was held to disallow the deduction of expenses attributed to the provision of medical marijuana because it was considered “trafficking” in a controlled substance.
The IRS has been unambiguous in its position on the issue of medical marijuana as a prohibited controlled substance. Citing the 2007 Tax Court opinion and a 2001 US Supreme Court case, U.S. v. Oakland Cannabis Buyers’ Co-op., 532 U.S. 483 (2001). IRS Chief Counsel Letter (2011-0005) makes it clear that absent a change in the tax code, medical marijuana will be treated as a controlled substance under 280E. This could saddle any growing operation with a substantial federal income tax burden. If growing marijuana is considered “trafficking”, federal income tax will be calculated on gross revenue without a deduction for expenses associated with its production.
Credit cards are becoming more common for use in payment of taxes. With the rapid increase in electronic filing of tax returns, online credit card payments have increased as well. Nearly 70% of 2010 personal income tax returns were filed electronically. By 2012, the federal government hopes to increase online filing to 80% for all tax returns. When the electronic filing has been done and there is tax to pay, it is convenient and even encouraged to pay by credit card.
Convenience of credit card tax payment comes at some cost. The government uses third party companies to process payment in most cases and a “convenience fee” is charged to the taxpayer for the service. The IRS has a webpage entitled “Pay Taxes by Credit or Debit Card” with information on how to do just that. The IRS website suggests that fees for the card payment range from a low of 1.9% to a high of 2.35%. The additional fee is included in the transaction at the taxpayer’s expense. Most state and local governments will accept payment through such a company.
A. An individual who is domiciled in Oregon, unless he a) does not have a permanent place of abode in Oregon; b) maintains a permanent place of abode in a place other than Oregon, and c) spends less than 31 days of a taxable year in Oregon. ORS § 316.027(A)(i)-(iii).