Newsletter -- February 1997 Issue
IN THIS ISSUE
- IRS Required to Disclose Collection Efforts Against Other Responsible Persons
- Care in Drafting Tax Court Settlements Is Critical
- Supreme Court Again Avoids Resolving Split of Authority on Conditional Summons Enforcement
- Contesting Increased Interest on Large Corporate Underpayments
IRS Required to Disclose Collection Efforts Against Other Responsible Persons
When a company fails to pay over the income taxes and FICA taxes it has withheld from employee wages, the IRS pursues collection actions against the company. If these actions prove fruitless, the IRS then looks to the "responsible persons" of the company who could have caused the company to turn over the payments, but who did not. It asserts penalties against the responsible persons under IRC Search7RH6672 in amounts equal to the unpaid tax.
If there are multiple responsible persons, the IRS may assert the full penalty against each responsible person. However, the IRS has a policy of only collecting the penalty once. Thus, if one responsible person pays, say, 60% of the penalty, the IRS will only try to collect 40% from the other responsible persons. Further, if the corporation later pays over part of the tax, the IRS abates a corresponding amount of the responsible person penalties against each responsible person.
Prior to last summer, the IRS was prohibited by law from disclosing to one responsible person its collection efforts against other responsible persons. The Taxpayer Bill of Rights 2, enacted on July 30, 1996, amended the Internal Revenue Code to provide that if a responsible person submitted a written request to the IRS, the IRS must disclose to such person the name of any other person against whom the IRS has asserted an IRC Search7RH6672 penalty and "whether the [IRS] has attempted to collect such penalty from such other person, the general nature of such collection activities, and the amount collected." IRC Search7RH6103(e)(9).
In a recent case, United States v. New York State Division of the Lottery, 1996 U.S. Dist. LEXIS 16840 (SDNY 11/14/96), a responsible person, DiBella, was lucky enough to win the lottery. He had the misfortune, however, to be a responsible person with respect to a company, CBM, which had not paid over its withheld employee income and FICA taxes. The IRS brought suit against the New York State Lottery to foreclose on DiBella's interest in the winning ticket to collect a responsible person penalty it had asserted against DiBella.
DiBella knew that there was another responsible person for CBM, Savite, who had organized a separate company, Monarch, to continue the same business. In the court case, DiBella sought discovery from the IRS of its collection efforts against Savite, CBM, and Monarch. DiBella argued that he needed to know what payments had already been made by Savite, CBM, and Monarch and any arrangements they had with the IRS for future payments. Without this information, DiBella claimed he could not intelligently assess his potential liability or enter into settlement discussions with the IRS.
The IRS conceded that Search7RH6103(e)(9) required it to inform DiBella about its collection efforts against Savite. However, the IRS argued that Search7RH6103(e)(9) did not authorize telling DiBella anything about any CBM or Monarch payments or arrangements.
Judge Knapp disagreed with both parties. He agreed that the statute does not require the IRS to disclose payments made by the corporate taxpayer. However, he was concerned that the IRS might have entered into an agreement with either CBM or Monarch for one or both of those companies to pay Savite's responsible person penalty.
The statute directed the IRS to disclose the "general nature of such collection activities" against the other responsible person. Judge Knapp found that any such agreements with CBM or Monarch for the payment of Savite's penalty were part of the "general nature" of the IRS' collection efforts against Savite. Accordingly, the judge ordered the IRS to disclose to DiBella any agreements it might have with Savite, CBM, or Monarch for the payment of Savite's penalty, as well as the amount collected pursuant to those agreements. It is heartening that the judge rejected the IRS' overly narrow interpretation of the statute.
One final note. A similar amendment to IRC Search7RH6103 made by the Taxpayer Bill of Rights 2 now authorizes the IRS to disclose, upon written request, to divorced spouses who filed joint returns, whether the IRS has attempted to collect a tax deficiency from the other spouse, the general nature of such collection activities, and the amount collected. IRC Search7RH6103(e)(8). Hopefully, the courts will not allow the Service to narrowly interpret the provision.
Care in Drafting Tax Court Settlements Is Critical
A recent case illustrates what can go wrong when settling a Tax Court case. In Miller Tabak Hirsh & Co. v. Commissioner, 101 F.3d 7 (2d Cir. 11/21/96), a securities partnership was challenged by the IRS with respect to repurchase transactions ("repos") which the partnership entered into in the period 1982-1985. The repos gave rise to interest deductions in the years 1982-1984 and roughly corresponding amounts of interest income in the years 1983-1985. The IRS argued that the transactions were purely tax motivated and both the interest deductions and related interest income should be disallowed. The IRS also proposed to disallow $28 million of stock option ordinary losses from transactions which it also believed were not profit-motivated.
The partnership challenged the IRS by bringing suit in the Tax Court. Months later, at the call of the trial calendar, the parties informed the judge that they had reached a basis of settlement of the case and, thus, trial would be unnecessary. They described the settlement as reducing 1982 interest deductions by $1 million and recharacterizing $2 million of 1983 stock option losses from ordinary to capital. They also submitted to the judge a written statement setting out the settlement terms.
The judge then directed the parties to submit to him within 30 days a stipulated decision document embodying the tax liability which resulted from the settlement. However, the parties could not agree on the tax figures because the partnership believed that it was entitled to eliminate approximately $1 million of interest income from 1983 relating to the disallowed repo interest deductions in 1982.
The IRS contended that the settlement did not include any interest income elimination, although it conceded that if it had litigated the repo issues and won, both the interest expense and interest income would have been eliminated. The IRS argued that the settlement was based on no particular theory, but was simply a settlement of both the repo and stock option issues using agreed upon adjustments.
The Tax Court judge agreed with the partnership that inherent in the concept of the settlement was the elimination of 1983 repo income corresponding to the 1982 repo deductions disallowed. The Court of Appeals for the Second Circuit disagreed with the Tax Court and reversed. It agreed with the IRS' argument that a flat disallowance of $1 million was not an illogical settlement for a case involving many millions of dollars. The basis of settlement announced to the Tax Court was concededly unambiguous. The Second Circuit was unwilling to add terms to the settlement that the parties failed to include.
The lesson to be learned is that when entering into a stipulation of settled issues or announcing a basis of settlement to the Tax Court, a party should be careful to note all terms of the settlement, not merely the principal points.
Supreme Court Again Avoids Resolving Split of Authority on Conditional Summons Enforcement
When the IRS issues a summons for testimony or documents and the summoned party refuses to testify or turn over the documents, the IRS must go to federal district court to get the court to enforce the summons. Unless the summoned party presents a valid objection (e.g., attorney-client privilege), the court usually orders the party to comply with the summons. Some courts, however, have placed conditions on the IRS when enforcing a summons.
For example, in the recent case of United States v. Jose, 71 F.3d 1484 (9th Cir. 1995), the district court required that the IRS notify the taxpayer five days in advance before showing any documents obtained through the summons to any division of the IRS outside the civil examination division. The district court was concerned that the IRS might show the documents to its criminal investigation division, despite the IRS' current position that it was merely conducting a civil audit.
In Jose, the IRS appealed the judge's ruling, arguing that the judge had no authority to impose any conditions on summons enforcement. Whether a judge has the power to impose conditions is an issue which has divided the Courts of Appeal. The Fifth Circuit has held that a judge has no power to impose conditions. United States v. Barrett, 837 F.2d 1341 (5th Cir. 1988). The Ninth Circuit has held that the judge has such power. United States v. Zolin, 809 F.2d 1411 (9th Cir. 1987). In 1989, the United States brought the Zolin case to the Supreme Court to resolve this conflict. However, a 4-4 tie in the Supreme Court resulted in the Court's not being able to resolve the conflict. 491 U.S. 554, 561 (1989).
In the recent Jose case, the Ninth Circuit held that the IRS' appeal of the conditional enforcement order was premature, since the IRS contended that it as yet had no intention of showing the summoned documents to other IRS divisions. The IRS appealed this Ninth Circuit ruling to the Supreme Court. In a brief, per curiam opinion, the Supreme Court reversed the Ninth Circuit. The Supreme Court held that the district judge's ruling that imposed a condition on enforcing an IRS summons was a final disposition from which an appeal could be taken. 117 S. Ct. 463 (12/2/96).
Interestingly, in Jose, the Supreme Court noted the intercircuit conflict and the fact that it has not yet been resolved. The Court, however, expressed no opinion on whether conditions imposed on enforcing an IRS summons are ever permissible. While the Court again left this issue unresolved, by forcing the Ninth Circuit to rule in the Jose appeal on the merits, the Supreme Court may be positioning the Jose case to be a vehicle for the IRS to bring the issue back to the Supreme Court to resolve the conflict between the Circuits.
Contesting Increased Interest on Large Corporate Underpayments
Section 6621(c) imposes a two percentage point higher interest rate on any underpayment of tax by a C Corporation if at any time the underpayment exceeds $100,000 for any taxable period. The Regulations provide that for purposes of determining whether or not the underpayment of tax exceeds $100,000, any payments made after the last date prescribed for payment are ignored. For example, payments made by way of amended return or deposits in the nature of a cash bond affect the actual amount of underpayment on which interest is computed, but these payments do not affect the amount of underpayment for purposes of determining whether or not there was "at any time" an underpayment in excess of $100,000. Thus, the actual deficiency determined by the Tax Court may be only $40,000, but interest may be imposed at the Search7RH6621(c) rate because there was an underpayment in excess of $100,000 for purposes of Search7RH6621(c). If applicable, the Search7RH6621(c) rate applies for all purposes where interest applies.
The higher rate does not apply from the due date of the return; it commences only on the 30th day after a triggering Notice, if the taxpayer does not pay the amount due as set forth in the Notice within 30 days. When deficiency procedures apply, the triggering Notice is the earlier of (i) the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review by the IRS Appeals Office is sent (usually a 30-day letter), or (ii) the date the Notice of Deficiency is sent. When deficiency procedures do not apply, the triggering Notice is the first notice sent to the taxpayer advising of an assessment.
It is important to understand that there are two separate conditions for imposition of the Search7RH6621(c) rate:
- whether the Search7RH6621(c) rate applies, which depends on whether the underpayment exceeds $100,000, and
- when, if at all, the Search7RH6621(c) rate commences, which depends on (i) whether there has been a triggering Notice and (ii) whether the amounts shown thereon as due have been paid within the required 30 days.
These tests are applied separately. For example, if the Service sends a 30-day letter on June 1, 1992 asserting that $1,000 is due, which amount the corporation fails to pay by June 30, 1992, and five years later the ultimate tax deficiency is determined to be $200,000, the Search7RH6621(c) rate will apply from July 1, 1992, 30 days after the notice seeking $1,000 was sent. Thus, a C Corporation which receives a letter or notice that could trigger the Search7RH6621(c) rate should carefully consider the possible interest rate consequences of not paying the full amount within 30 days, even if the amount shown as due is small.
Unfortunately, there appears to be no way to judicially contest the imposition of Search7RH6621(c) interest in court before the interest is paid. The Tax Court recently held that it does not have jurisdiction to determine the issue as part of the pre-assessment deficiency proceeding. In Pen Coal Corp., 107 T.C. No. 14 (11/6/96), the Notice of Deficiency itself included a determination that the Search7RH6621(c) rate applied. In the petition, the taxpayer contested the imposition of the Search7RH6621(c) rate. The Tax Court granted the Commissioner's motion to dismiss this portion of the petition for lack of jurisdiction.
What alternatives are available to contest the imposition of the Search7RH6621(c) rate? The taxpayer could pay the interest, file a claim for refund and bring an action in the U.S. Court of Federal Claims or a federal district court. In addition, Search7RH7481(c) permits a taxpayer whose tax case was litigated in the Tax Court, and who pays the entire amount of the tax deficiency determined by the Tax Court, plus the interest claimed by the Service, to petition the Tax Court within one year after the decision of the Tax Court becomes final for a determination as to the proper amount of interest which should have been charged.
Tax Court Rule 261 provides that the petitioner should file a "Motion to Redetermine Interest Pursuant to Rule 261". This motion will ordinarily be disposed of without an evidentiary or other hearing unless it is clear from the motion or the Commissioner's written response that there is a bona fide factual dispute that cannot be resolved without an evidentiary hearing.