Payroll InsightsJune 2008
About This NewsletterPayroll Insights is a publication from KPMG LLP’s Employment Tax Practice. It is designed to provide you with current developments in the payroll and employment tax arena and will be published periodically throughout the year as developments warrant. IRS Proposes Amendments to Interest Free Adjustment RegulationsThe IRS has proposed modifications to make the process less burdensome for interest free adjustments for underpayments and overpayments of the following employment taxes: Federal Insurance Contributions Act, Railroad Retirement Tax Act, and Federal income tax withholding. The amendments are related to new forms the IRS is developing for reporting adjustments of employment taxes that will replace the current process. 72 Fed. Reg. 74233. The proposal streamlines the employment tax adjustment process by establishing a process for employers to file an adjustment as soon as the need is identified. The proposed amendments would eliminate the current process which requires the employer to make a line item adjustment on the current return. The new adjusted return would not be filed as an amendment to the current return and would not affect the liability reported on the current return. The amendments would eliminate references to supplemental returns, although Forms 2504 and 2504-WC would be treated as adjusted returns. Form 941c would no longer be used. Under the proposed regulations, for an adjustment to be interest free, the return for reporting an underpayment must be filed by the due date of the adjusted return for the return period in which the error is ascertained, and the amount of the underpayment must be paid by the time the adjusted return is filed. If not, interest accrues from the date the adjusted return is filed. For underpayment or overpayment where the incorrect amount of income tax was withheld, an adjusted return may only be filed for errors ascertained during the calendar year in which the wages were paid. The rules for employee repayment or reimbursement for overpayment remain the same. Adjusted returns will be subject to applicable period of limitations on credits or refunds. Currently, an employer can receive an interest free adjustment for failing to file only if they filed a FICA return instead of a RRTA return, or vice versa. The proposal also would allow for an interest free adjustment if the employer did not file because it failed to treat an individual as an employee. This latter provision was proposed originally in 1992, and is now being re-proposed. The proposed amendments would be effective on the date final regulations are published in the federal register, and would be applicable to any error ascertained on or after January 1, 2008. IRS Corrects Error in Personal Use of Employer’s Vehicle CalculationThe IRS has issued Announcement 2008-15 (Mar. 3, 2008) to correct previously issued guidance regarding the cents-per-mile valuation method for personal use of an employer provided vehicle. If an employer provides an employee with a vehicle available to the employee for personal use, the value of the personal use generally must be included in the employee’s wages for income tax purposes. One of the methods an employer may use to value the employee’s personal use is the cents-per-mile valuation method, under which the number of miles the employee drives for personal purposes is multiplied by a standard mileage rate (50.5 cents for 2008) to determine the value of the benefit to the employee. Treas. Reg. § 1.61-21(e). The cents-per-mile valuation method is available as long as the fair market value of the vehicle does not exceed a maximum value, which is adjusted for inflation. Announcement 2008-15 clarifies that the cents-per-mile method is available only if the vehicle’s fair market value does not exceed $15,000 (for passenger automobiles) or $15,900 (for trucks and vans). Revenue Procedure 2008-13 (Feb. 11, 2008) incorrectly listed the maximum fair market values as $15,400 and $16,700 respectively. Federal District Court: CEO, CFO Liable for Unpaid Employment TaxesIn Horovitz v. United States, the U.S. District Court for the Western District of Pennsylvania determined that a corporate taxpayer’s chief executive officer (CEO) and chief financial officer (CFO) were both “responsible persons” for purposes of Internal Revenue Code (IRC) section 6672. The court also found that the CEO and CFO willfully failed to pay over federal employment taxes, and accordingly both were subject to penalties and interest on those penalties. Horovitz v. United States, 2008 WL 382761 (W.D. Pa. Feb. 11, 2008). The FactsIn Horovitz, a corporate taxpayer failed to pay its federal employment tax obligations for several quarters. As a result of the failure to pay, the IRS assessed penalties under IRC section 6672 against the corporation’s CEO and CFO. Each individual argued that he was not a “responsible person” for purposes of IRC section 6672, and thus should not be liable for penalties. The LawIRC sections 3102 and 3401 require employers to withhold social security and income taxes, respectively, from employees’ wages. Under IRC section 6672, a penalty is imposed upon [a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof. The penalty is equivalent to the amount of unpaid tax. Thus, an individual is liable for the penalty if: (1) the individual was a “responsible person,” and (2) the individual’s failure to pay the tax was “willful.” The Court’s AnalysisThe court considered several factors in determining whether an individual is considered a “responsible person,” including: (1) the contents of the corporate bylaws, (2) the ability to sign checks on the company’s bank account, (3) the signature on the employer’s federal quarterly and other tax returns, (4) the payment of other creditors in lieu of the United States, (5) the identity of officers, directors, and principal stockholders in the firm, (6) the identity of individuals in charge of hiring and discharging employees, and (7) the identity of individuals in charge of the firm’s financial affairs. Furthermore, the court observed that a responsible person acts willfully when: (1) he pays other creditors in preference to the IRS, knowing that taxes are due; or (2) he acts with reckless disregard for whether taxes have been paid. Reckless disregard includes failing to investigate or correct mismanagement after being notified that withholding taxes were not paid, according to the court. Both the CEO and CFO were “responsible persons” under IRC section 6672, the court determined, because of the authority they both wielded. The court noted that the CEO exercised significant control over the corporation, invested several million dollars in the company, had unlimited hiring/firing and check-writing authority, had active day-to-day involvement in the business, and owned 80 percent of the corporation. Similarly, the CFO exercised significant control over the disbursement of the corporation’s funds, had hiring/firing and check-writing authority, signed certain tax returns, and owned 20 percent of the business. The court further concluded that the CEO and CFO had willfully failed to pay employment taxes. The CEO displayed reckless indifference by failing to investigate or correct the situation after being notified that employment taxes had not been paid. Additionally, the CFO made numerous payments to other creditors, knowing that employment taxes remained unpaid. The court addressed and rebutted the several defenses asserted by the CEO and CFO. In response to the CFO’s argument that the CEO had ordered him not to pay the employment taxes, the court ruled that even the threat of termination does not excuse a “responsible person” from paying the IRS. To the CEO’s argument that he was not liable for the unpaid liabilities because the CFO was responsible for all financial matters of the business, the court responded that a “responsible person” could not avoid liability by delegating responsibility for payment of taxes to a subordinate. Thus, both the CEO and CFO were subject to the penalties imposed under IRC section 6672 with interest. Federal District Court Addresses Abatement of Penalties for Reasonable CauseA federal district court has held that a taxpayer’s failure to report and remit employment taxes due to employee negligence did not constitute reasonable cause so that penalties should be abated. However, for a different tax period, the court ruled that the Internal Revenue Service (IRS) should have considered a bank’s failure to adequately explain its software to the taxpayer’s employees in determining whether penalties should be abated for reasonable cause. Don Johnson Motors, Inc. v. United States, 532 F. Supp. 2d 844 (S.D. Tex. Dec. 21, 2007). The FactsUntil 1999, the owner of the taxpayer, a car dealership, had prepared and signed all of the dealership’s tax returns, and made the deposits himself. In 1999, the owner delegated its payroll tax functions, including the filing of employment taxes electronically, to an in-house accountant who was supervised by the dealership’s office manager for the tax years 1999 through 2002. At some point in 1999, the accountant stopped paying a portion of the dealership’s payroll taxes. The fact that the deposits were made—at least in part—“masked” the dealership’s noncompliance until the owner began an internal review at the end of 2002. Beginning in 2003, the taxpayer designated a bank to make its employment tax payments through the Electronic Funds Transfer Payment System (EFTPS). The bank gave the taxpayer software to use for making EFTPS transactions, but failed to properly train the taxpayer’s employees on how to use it. As a result, the employees did not to fill out the EFTPS forms correctly. As a result, the bank failed to timely report and pay the taxpayer’s employment taxes from 2003 through 2004. The IRS assessed penalties against the taxpayer for its failure to file returns and timely pay taxes from 1999 through 2002 and from 2003 through 2004. The taxpayer argued that these penalties should be abated due to “reasonable cause.” The RulesIn order to obtain relief from penalties assessed under Internal Revenue Code (IRC) sections 6656 or 6651, a taxpayer must show that the failure to deposit and pay are “due to reasonable cause and not due to willful neglect.” IRC §§ 6651(a), 6656(a). Neither willful neglect nor reasonable cause is defined in the IRC. However, a treasury regulation addresses reasonable cause: A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship . . . . Treas. Reg. § 301.6651-1(c). Court’s AnalysisIn the Don Johnson Motors opinion, the court first addressed the penalties related to tax periods from 1999 through 2002. The court noted that “relying on another person to perform a required act is generally not sufficient for establishing reasonable cause.” Furthermore, the court observed that “[c]ourts have consistently held that the failure of a taxpayer’s employee to file or pay taxes does not establish reasonable cause.” The taxpayer argued that a previous case, In re American Biomaterials Corp., supported its proposition that reasonable cause existed to abate the assessed penalties. In American Biomaterials, two corporate officers committed criminal acts against the corporation which caused the corporation to fail to fulfill its tax obligations. Penalties assessed against the corporation were abated for reasonable cause. However, the court in American Biomaterials noted that a corporation would not be able to prove reasonable cause if its lax internal controls or failure to secure competent auditors had resulted in the corporation’s neglecting its tax obligations. The Don Johnson Motors court observed that the taxpayer did not present any evidence of criminal action on behalf of the employee or offer any explanation for why the corporation’s employees failed to file and pay employment taxes, thus distinguishing the taxpayer’s situation from American Biomaterials. Accordingly, the court ruled that the penalties should not be abated for reasonable cause for the tax periods from 1999 through 2002. The court next addressed the taxpayer’s argument that penalties arising from the 2003 through 2004 assessment should be abated for reasonable cause. The court determined that the IRS received a letter from the taxpayer’s bank accepting responsibility for failing to adequately train the taxpayer’s employees on the bank’s software. Additionally, the court observed that the taxpayer provided the bank all the necessary information to transmit its employment tax payments to the IRS, but had not properly entered the information as required by the software. These factors, the court held, were “quite probative of reasonable cause” and as such, should have been considered by the IRS. Accordingly, the court remanded the issue for further proceedings on whether penalties assessed for 2003 through 2004 should be abated for reasonable cause. Louisiana: Ruling Addresses Income Tax Withholding IssuesThe Louisiana Department of Revenue (DOR) has issued a ruling discussing when a Louisiana business is obligated to withhold Louisiana personal income taxes from its resident and nonresident employees. Revenue Ruling 08-004. The ruling sets forth a fact pattern covering resident and nonresident employees who work both within and without the state. The DOR has ruled that a company should withhold income taxes on the wages of Louisiana residents who perform services both in Louisiana and in states that do not have an income tax (e.g., Texas and Florida). If an employee is a Louisiana resident and works in another state, the employer will not be penalized for failure to withhold Louisiana income taxes on wages earned in that state so long as the employer has withheld income taxes for the state in which the services are performed. The ruling also addresses withholding for nonresident employees trained in Louisiana. A company should withhold Louisiana taxes on wages for all nonresidents, regardless of their state of residence, for work performed while they are trained in Louisiana. Once the training is complete, companies are not required to withhold income taxes for nonresident employees who do not perform any additional services within the state. Massachusetts Freezes Unemployment Insurance RatesThe governor of Massachusetts signed a bill on February 13, 2008 to freeze Massachusetts unemployment insurance rates for 2008. Massachusetts House Bill 4528 (H.B. 4528). Under Massachusetts law, employers must make unemployment insurance contributions based on the employer’s payroll. A schedule sets forth the applicable rate that the employer uses to calculate its unemployment insurance contribution obligations. For 2008, H.B. 4528 requires employers to contribute according to the same schedule used in 2007, effectively freezing the unemployment insurance rates.
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