SERVICE ISSUES GUIDANCE ON EMPLOYMENT TAX DEPOSITS AND PENALTY CHANGES.

Notice 90-37

I. SCOPE

This notice provides guidance on changes made by Congress in the Revenue Reconciliation Act of 1989 (the "Act"), Pub. L. No. 101-239, 103 Stat. 2106, to the rules governing deposits of income tax withheld (including backup withholding) and taxes under the Federal Insurance Contributions Act (FICA) on an eighth-monthly basis.

II. BACKGROUND

A. CHANGE IN DEPOSIT RULES

In subtitle F (section 7632) of the Act, Congress revised the provisions under section 6302 of the Code for the deposit of withheld income taxes and FICA taxes, effective with respect to amounts required to be deposited after July 31, 1990.

New section 6302(g) of the Code, as added by the Act, provides as follows:

(1) IN GENERAL. -- If, under regulations prescribed by the Secretary, a person is required to make deposits of taxes imposed by chapters 21 and 24 on the basis of eighth-month periods, such person shall, for the years specified in paragraph (2), make deposits of such taxes on the applicable banking day after any day on which such person has $100,000 or more of such taxes for deposit.

(2) SPECIFIED YEARS. -- For purposes of paragraph (1)-

In the case of: The applicable banking day is:

                1990                               1st

The Act provides that for calendar year 1995 and thereafter, the Secretary shall prescribe regulations with respect to the date on which deposits of such taxes will be made in order to minimize the unevenness in the revenue effects of the new acceleration provision.

B. CHANGE IN DEPOSIT PENALTY

In subtitle G (section 7742) of the Act, Congress revised the penalty provisions under section 6656 of the Code for the failure to make deposits, effective with respect to failures made after December 31, 1989.

Under revised section 6656 of the Code, the penalty rate is 2 percent of the underdeposit if the failure is for not more than 5 days, 5 percent if the failure is for more than 5 days but not more than 15 days, and 10 percent if the failure is for more than 15 days. The penalty rate increases to 15 percent if the tax is not deposited on or before the earlier of (i) the day 10 days after the date of the first delinquency notice to the taxpayer under section 6303, or (ii) the day on which notice and demand for immediate payment is given under section 6861 or 6862 or the last sentence of section 6331(a).

III. PURPOSE

The Service will be developing regulations reflecting the changes made by Congress in the Act with respect to the federal tax deposit rules and failure-to-deposit penalty. Until further guidance is issued, this notice may be relied upon by those persons making deposits of withheld income tax (including backup withholding) and FICA taxes.

IV. APPLICATION OF DEPOSIT RULES

A. EFFECTIVE DATE -- NEW SECTION 6302(g)

The Internal Revenue Service will apply the new provision to amounts required to be deposited WITH RESPECT TO EIGHTH-MONTHLY DEPOSIT PERIODS BEGINNING AFTER JULY 31, 1990. Thus, the new provision will not apply to amounts due in August 1990 with respect to deposit periods ending before August 1, 1990.

B. APPLICATION OF SECTION 6302(g) "ACCELERATION" PROVISION

Under section 31.6302(c)-1(a)(1)(i) of the regulations, an employer who has undeposited taxes of $3,000 or more on hand at the close of an eighth-monthly period is required to deposit those taxes in a Federal Reserve Bank or authorized financial institution within 3 banking days after the close of such eighth-monthly period. "Eighth-monthly period" is defined as the first 3 days of a calendar month, days 4 through 7, 8 through 11, 12 through 15, 16 through 19, 20 through 22, 23 through 25, and the remainder of the calendar month following the 25th day.

The regulations under section 6302 of the Code provide that an employer depositing on an eighth-monthly basis generally is considered to be in compliance if a deposit for an eighth-monthly period is at least 95 percent of the amount required to be deposited and, if the eighth-monthly period is in the first or second month of the quarter, the underdeposit is remitted with the first deposit otherwise required after the 15th day of the next month. If the eighth-monthly period is in the last month of the quarter, the underdeposit must be remitted by the last day of the first month following the close of the quarter. This provision is the so-called "safe-haven" rule.

New section 6302(g) of the Code provides a special rule for persons depositing taxes on the basis of eighth-monthly periods. If, on any day, such a person has on hand, with respect to any eighth- monthly period, $100,000 or more of the taxes imposed by chapters 21 (FICA tax) and 24 (income tax withheld including backup withholding) for deposit, then that person must deposit those taxes by the close of the "applicable banking day" after such day, as provided by section 7632 of the Act. From August 1, 1990, through December 31, 1990, the applicable banking day is the first banking day.

Until further guidance is issued, the Service will apply new section 6302(g) of the Code as follows. If, during an eighth-monthly period, a person required to make deposits on an eighth-monthly basis has on hand for deposit at least $100,000 with respect to that eighth-monthly period, then that amount must be deposited by the close of the next banking day. If, by the end of the same eighth- monthly period, that same person has accumulated at least $3,000 but less than $100,000 in additional taxes for deposit with respect to that eighth-monthly period, then that amount must be deposited within three banking days after the end of the eighth-monthly period, under the general rule of section 31.6302(c)-1(a)(1)(i) of the regulations.

If, at the end of an eighth-monthly period, a depositor has on hand a sufficient undeposited amount to give rise to a deposit obligation with respect to that amount, then that deposit obligation is fixed, and that amount is not taken into account in determining whether on any succeeding day the $100,000 threshold amount in section 6302(g) of the Code has been reached. However, as in the past, if amounts on hand at the end of an eighth-monthly period are less than $3,000 and thus not subject to a deposit obligation, those amounts will be taken into account in determining amounts on hand in the succeeding eighth-monthly period. Finally, the 95 percent "safe- haven" rule will be applicable to deposits required to be made on an accelerated basis under section 6302(g).

The following examples illustrate how the new section 6302(g) "acceleration" provision applies:

Example 1: At the close of business on Thursday, August 2, 1990, Employer A's payroll date, A has on hand $105,000 in FICA tax and income tax withheld. Notwithstanding section 31.6302(c)- 1(a)(1)(i) of the regulations, A, pursuant to section 6302(g) of the Code, must deposit that amount by Friday, August 3, 1990, the next banking day after August 2, in order to prevent assertion of the failure-to-deposit penalty under section 6656.

Example 2: The facts are the same as in Example 1, except that on Friday, August 3, 1990, the close of an eighth-monthly period, A made a payroll payment that gave rise to an additional $10,000 in undeposited taxes. A must deposit the $10,000 by Wednesday, August 8, 1990, three banking days after the close of the eighth-monthly period, under the general rule of section 31.6302(c)-1(a)(1)(i) of the regulations. Because the $105,000 obligation described in Example 1 was fixed as of the close of business on Thursday, August 2, the $10,000 withheld on August 3 is the beginning of a separate and distinct deposit obligation.

Example 3: On Monday, August 13, 1990, Employer B accumulates $105,000 in income tax withheld and FICA taxes. Pursuant to section 6302(g) of the Code, B deposits that amount on Tuesday, August 14, 1990. At the close of business on Wednesday, August 15, 1990, the close of an eighth-monthly period, B has on hand an additional $2,500 in income tax withheld and FICA taxes. Under section 31.6302(c)-1(a)(1)(i) of the regulations, B is not required to make an additional deposit with respect to that eighth-monthly period since the amount on hand is less than $3,000. The undeposited $2,500 is carried forward to the next eighth-monthly period. On Thursday, August 16, 1990, B accumulates an additional $98,000 in withheld income tax and FICA taxes. Accordingly, on that date, B has on hand $100,500 in undeposited taxes. B is required to deposit that amount by the next banking day, Friday, August 17, 1990, under section 6302(g).

Example 4: At the close of business on Wednesday, August 15, 1990, the close of an eighth-monthly period, Employer C has on hand $50,000 of income tax withheld and FICA taxes. Pursuant to section 31.6302(c)-1(a)(1)(i) of the regulations, the $50,000 must be deposited within three banking days after August 15 in order to prevent assertion of the failure-to-deposit penalty. On Thursday, August 16, C has on hand an additional $60,000 of income tax withheld and FICA taxes. The acceleration provision of section 6302(g) does not require payment by the next banking day even though C has on hand $110,000 ($50,000 + $60,000) of FICA tax and income tax withheld, because the obligation to deposit the $50,000 was fixed as of the close of business on Wednesday, August 15, and that amount is not to be taken into account for purposes of the acceleration provisions of section 6302(g). The $50,000 must be deposited by Monday, August 20, 1990, three banking days after Wednesday, August 15th. The determination of the date by which the $60,000 must be deposited depends on what additional amounts, if any, are accumulated during the August 16-19 eighth-monthly period.

Example 5: The facts are the same as in Example 4 except the additional amount on hand on Thursday, August 16, is $105,000, not $60,000. The $105,000 must be deposited by Friday, August 17, 1990, pursuant to the provisions of section 6302(g) of the Code.

Example 6: On Thursday, August 23, 1990, Employer D's payroll date, D estimated that it had on hand $2 million in FICA tax and income tax withheld. Pursuant to section 6302(g) of the Code, D deposited that amount by the close of the next banking day, Friday, August 24, 1990. On Monday, August 27, D determined that the actual FICA tax and income tax withheld for the August 23 payroll date was $2.1 million. Provided that the undeposited $100,000 is deposited with the first deposit otherwise required after September 15, 1990, D is deemed, under section 31.6302(c)- 1(a)(1)(i) of the regulations, to be in compliance with section 6302 because at least 95% (95.24% in this case) was deposited. Under these circumstances, the $100,000 in undeposited taxes is not subject to the acceleration rule of section 6302(g) of the Code but the general rule of section 31.6302(c)-1(a)(1)(i) of the regulations.

C. REQUEST FOR COMMENTS

The taxes imposed by chapter 24 of the Code include amounts subject to the backup withholding provisions of section 3406 of the Code. The Service invites comments on whether amounts subject to backup withholding should continue to be taken into account in determining amounts subject to the deposit rules of section 6302(g) of the Code and section 31.6302(c)-1(a)(1)(i) of the regulations.

The Service is considering possible changes to the existing rules for the deposit of the taxes imposed by chapters 21 and 24, including but not limited to (a) the need for the 95 percent "safe- haven" exception in section 31.6302(c)-1(a)(1)(i) of the regulations, and (b) the possibility of replacing the eighth-monthly system with a less complex deposit system, such as one based on employers' payroll dates. The Service invites comments on these matters, including suggested alternatives to the current rules. Note, however, that alternatives should not significantly lengthen the time before payroll taxes are deposited.

V. PAYMENT OF UNDEPOSITED AMOUNTS AFTER NOTICE AND DEMAND

If the total employment tax liability for the quarterly return period has not been fully deposited by the due date of the quarterly Form 941, the Service will issue a notice and demand for the unpaid tax and the resulting penalties. As noted in Section II.B above, if the outstanding taxes are not paid by the tenth day following the date on which the notice was issued, the applicable failure-to- deposit penalty imposed by section 6656 of the Code rises to fifteen percent. To ensure that payment is properly credited to your account and to prevent the additional penalty charge, employers should follow these steps:

1. Submit a check or money order for the full amount billed;

2. Make the check or money order payable to Internal Revenue Service;

3. Attach the payment stub portion of the delinquency notice to the check or money order;

4. Use the envelope provided; and

5. Mail the payment within 10 days of the date on the notice.

VI. SUBMISSION OF COMMENTS

The Service invites comments with respect to matters discussed in this notice. Comments should be addressed to the Assistant Chief Counsel (Income Tax & Accounting) Internal Revenue Service, 1111 Constitution Ave., N.W., Room 5134, Washington, D.C. 20224. Comments should be received by July 20, 1990, in order to ensure that they will receive full consideration.

VII. DRAFTING INFORMATION

The principal author of this notice is Vincent Surabian of the Office of Assistant Chief Counsel (Income Tax & Accounting). For further information regarding this notice, call (202) 566-5985 (not a toll-free number).