Abatement of interest and penalties on payroll taxes.

Look carefully at the date payroll taxes were required to be deposited when requesting abatement of penalties for failure to timely deposit such taxes and the related interest. The first Taxpayer Bill of Rights, which was part of the Technical and Miscellaneous Revenue Act of 1988, granted taxpayers various rights in dealing with the IRS, provided procedures for taxpayers regarding the Service and extended the Tax Court's jurisdiction. A follow-up Taxpayer Bill of Rights 2 (TBOR2) was enacted on July 30, 1996. Among the new laws are provisions dealing with abatement of interest and penalties. The new laws cover expansion of IRS authority to abate interest, Tax Court review of the Service's refusal to abate interest, extension of the interest-free period for payment of tax and abatement of the penalty for failure to deposit payroll taxes.

Prior to TBOR2, the IRS'S power to abate overpaid interest on delinquent taxes was very limited, and the Code did not extend that authority to include employment taxes. This earlier provision is supported in Speers, Fed. Cl. Ct., 6/23/97. The taxpayers were partners in a machine shop in California. The business did not pay FICA, FUTA and state employment taxes for its operations during 1981-1983. The state conducted a payroll audit and concluded that the business had hired employees rather than independent contractors. After obtaining a copy of the audit report and interviewing the taxpayer, the Service also concluded that the business had erroneously treated its employees as independent contractors. The IRS and the taxpayers reached a settlement of about $7,000 in delinquent employment taxes and penalties and about $29,000 in interest. In 1995, the taxpayers filed claims for refunds with the Service, requesting that the IRS abate the interest attributable to the Service's errors and delays. The IRS disallowed these claims in February 1996, stating that it lacked the power to abate interest on employment taxes. The taxpayers filed suit and the court granted the Service's motion to dismiss, ruling that the IRS did not have such abatement authority. As in effect at that time, Sec. 6404(e) allowed the Service to abate interest due to errors and delays by the agency in performing a ministerial act, one carried out in a prescribed manner that does not involve the exercise of judgment or discretion. This provision was limited to the overpayment of interest on tax deficiencies relating to income taxes, estate and gift taxes, occupational taxes, public charities, private foundations, black lung benefit trusts, qualified pension plans and qualified investment entities; excluded was any authorization to abate interest on employment taxes.

TBOR2 amended Sec. 6404(e). Under the new provisions, the IRS's authority to abate interest is expanded to allow abatements for its unreasonable errors and delays in performing ministerial or managerial acts. Managerial acts include delays resulting from the loss of records by the Service, transfers of IRS personnel, extended illness, extended personnel training and extended leave. The expansion of authority to abate applies to interest accruing after TBOR2's enactment date.

The court in Speers also explained that even if the abatement of interest on employment taxes was allowed at that time, a court still could not review the Service's failure to refund interest because its action under Sec. 6404(e) was discretionary and was not subject to judicial review. TBOR2 gives the Tax Court jurisdiction to determine whether the IRS's refusal to abate interest is an abuse of discretion. A taxpayer can bring an action for review of failure to abate interest after the Service has mailed its final determination not to abate interest. The petition must be received by the Tax Court within 180 days after the notice was mailed, or the IRS's decision is binding. This enhanced jurisdiction applies to abatement requests made after July 30,1996.

As to employment taxes, TBOR2 expands the Service's authority to abate penalties for failure to deposit payroll taxes, effective july 30, 1996. The IRS is permitted to abate penalties for taxpayers who inadvertently fail to deposit any employment tax if (1) the taxpayer meets net worth requirements (generally, net worth may not exceed $2 million for individuals and $7 million for corporations), (2) the failure to deposit occurs during the first quarter required to deposit payroll taxes and (3) the employment tax return was timely filed. The Service may also waive the penalty for first-time depositors who mistakenly submit the taxes to the IRS rather than to the required government depository.

Furthermore, the new provisions extend the period for tax payment, which permits the taxpayer to avoid incurring interest on the liability. If the amount assessed is less than $100,000, the interest-free period is 21 calendar days after the date of notice and demand. If the tax is $100,000 or more, the interest-free period is 10 business days after the date of notice and demand. This extension applies to any notice and demand given after Dec. 31, 1996.

TBOR2 contains more than 40 provisions of widespread application. It provides useful assistance to tax practitioners representing clients before the IRS and expands the taxpayers' rights in litigation. (For a more detailed discussion, see Herskovitz, Dougherty and Gribens, "A Practitioners' Roundtable on the Taxpayer Bill of Rights 2," TTA, July 1997,p. 426.)