Three days ago, the Tax Court published its opinion in Dixon v. Commissioner, and had an interesting holding regarding following the allocation of a corporate tax payment for two employees’ income taxes. It may result in an appeal by the Service; although, the end result in this case did not seem far off from what the Service requested, but the Court did not follow the Service’s argument. The Court was split on this decision, and the majority opinion, and the dissents are worth a read.
The facts are that the Dixons failed to file income tax returns, and were criminally prosecuted for the same. It was agreed that they would pay restitution in an amount over $60,000. The Dixons were the owners, officers, and employees of Tryco Corp. In 2000, Tryco owed in excess of $23MM in employment taxes to the IRS. To pay the restitution for their individual income tax, the Dixons paid the funds to Tryco, and then had Tryco submit payment with Form 941 and a cover letter stating the payment was “to be applied to the withheld income taxes of [the Dixons]” for the applicable years. Initially, the Service followed those directions, and then reversed course and applied the funds to the unpaid employment taxes.
The change in IRS position was based on the fact that Section 31 requires withheld income tax to be withheld at the source, and remittance from the employee to the corporation and then to the Service, which occurred years later, could not be withheld at the source. The Service then attempted to levy the Dixons’ assets to collect the income tax, and the Dixons requested a CDP hearing. That didn’t go well for the Dixons, so a timely appeal was made to the Tax Court. From the Court, the holdings in this case were (P’s are the Dixons, and R is the Service):
1. Held: Ps are not entitled to a credit under I.R.C. sec. 31(a)
for the $91,223 Tryco remitted to the IRS in 1999-2000 because
funds in that amount were not “actually * * * withheld at the source”
by Tryco from Ps’ wages during 1992-95. See sec. 1.31-1(a), Income
Tax Regs.
2. Held, further, this Court has subject matter jurisdiction to
determine whether R was obligated to honor Tryco’s designation of
its 1999-2000 delinquent employment tax payments toward Ps’
income tax liabilities for 1992-95.
3. Held, further, there is no need to decide the applicable
standard of review in these CDP appeals because, under Ps’
alternative argument, R’s proposed collection action would be
impermissible either under an abuse of discretion standard or under a
de novo standard.
4. Held, further, R was required to honor Tryco’s designation
of its 1999-2000 delinquent employment tax payments towards Ps’
income tax liabilities for 1992-95. Because those payments
discharged Ps’ 1992-95 income tax liabilities in full, R’s proposal to
levy on their assets to collect this tax a second time was an abuse of
discretion.
The holding was essentially that the Dixons did not get the credit under Section 31, but the Service was still required to follow the direction of the allocation of the tax payment by Tryco, even if there was no clear statutory reason. The majority stated that the IRS policy is to respect allocations of voluntary payments, and the Circuit Courts generally enforce voluntary allocations based on the IRS policy. With this fact patter, however, the Service believed that Tryco had no continuing authority to remit income tax payments for the Dixons, so the policy was inapplicable.
I’ll quickly highlight Judge Holmes dissent argument, as I thought it made sense on my initial read. Judge Holmes stated that the remittance of the income tax didn’t qualify for Section 31, and there are no other Code provisions allowing employers to allocate tax payments to employee liabilities. He provided an example similar to the notion that I cannot pay my taxes and say that I would also like my taxes credited against Keith’ tax liability. Here, it is slightly different, because such a payment could work like that if the corporation had properly withheld income tax at the source and remitted the same, thereby meeting its obligation to withhold and remit taxes and pay the income taxes of the employee.
Judge Holmes stated that without a statutory authority, the Court could not allow this just because it thought it was “fair”. He added the quotations. The Dixons do not appear to be the type courts go out of their way to help. Both had been convicted of tax crimes, and had a lengthy past of failing to pay various taxes individually and through their corporation.
Judge Holmes also indicated that had the Dixons paid the liability directly, Tryco would have received credit for its withholding obligation under Section 3402 for the payment, and the real reason the Dixons made the payment this way was the hope that the Service would credit the payment at the time it should have been withheld, thereby reducing the penalties and interest on both the income taxes due and the employment taxes due (more realistically income taxes, if anything). I thought the majority opinion gave the impression that handling payment directly from the Dixons to the Service would not have credited the employment taxes, but that could have been because I read the case too quickly.
Judge Holmes also authored this Tax Court Memorandum Opinion issued the same day, which was the precursor to the above review by the full court.
Saltzman, Section 6.03 discusses voluntary allocation of payments, but we do not delve into this particular issue (yet). Keith has also written an article that is not directly on point, but argues folks like the Dixons should not be able to do something similar in the trust fund recovery penalty world. The opinion discusses the overlap in the areas a bit. That article is “In Whom We Trust” 43, Creighton Law Review 357, 398 (2010). In general, this is an interesting issue, but not an overall assault on the Service respecting allocation of tax payments. The case also had a jurisdictional question and a standard of review question, which Keith and Les may look at in greater detail.