"Going out of business:" final tax returns and collecting taxes due.
A problem that is common to all business tax collectors(1) is what to do when a sole proprietor, a partnership or a corporation in their jurisdiction goes out of business. Many people initially do not understand why tax collectors should care about this issue, thinking it mean-spirited and unproductive to go after people who are broke.
The response is two-fold. First, going out of business does not necessarily mean that a business is broke. It may indicate that a business owner is retiring, changing occupations or relocating. In any of these instances, there is no inherent reason why the business should not pay its fair share of taxes. Second, all tax collectors have a responsibility to collect unpaid tax liability if possible and to classify their accounts receivable so that the government and the public can know what portion of the receivables are truly collectible. If the business files for bankruptcy, the jurisdiction's priority among other creditors is determined by law, and the amount it may collect generally is determined by a federal bankruptcy court. If the business does not file for bankruptcy, then the government, by not pursuing this outstanding liability, may be allowing other creditors to receive preferential treatment.
This article describes how the New York City Department of Finance (DOF) identified the problem of receiving final tax returns from corporations and what DOF is doing about it.
Types of Business Tax Bills
The following six types of business tax bills are referred to the DOF Collections Bureau for enforcement action.
* Nonfiling assessments are issued against taxpayers that have never filed for a particular tax but whom DOF believes, based on various types of information, should be filing. For example, a new corporation located in the city may have registered as such with the New York Department of State but may not have filed a city general corporation tax return. Similarly, a city business may be an active corporation tax filer but may be a nonfiler for the city's commercial rent tax.
* Delinquent assessments are issued against taxpayers that have stopped filing returns without a satisfactory explanation.
* Desk audit assessments are adjustments to filed returns, reviews conducted entirely at DOF's offices.
* Field audit assessments are adjustments made to filed returns by reviewing a taxpayer's books and records at the taxpayer's place of business.
* Federal/state change assessments are adjustments made by either the Internal Revenue Service (IRS) or the New York State Department of Taxation and Finance that also increase a taxpayer's city liability. For example, if the IRS increases a corporation's federal net income, which is the starting point for computing a corporation's city liability, then the corporation could expect a bill for the resulting increase in its city tax unless it voluntarily reported the change.
* Self-assessments are bills that are issued without changing the amount of tax self-reported (i.e., self-assessed) by a filing taxpayer. The bills may involve the assessment of a late filing penalty, late payment penalty, penalty for underpayment of estimated taxes and interest charges. Some examples of self-assessments are given in Exhibit 1. While defining self-assessments is not easy, calculating them involves straightforward comparisons, such as the due date of the return compared with the date it was actually filed and the amount of estimated tax paid compared with the amount that was required to be paid. After completing the relatively simple calculations, DOF issues the bills by computer.
Final Returns: Theory vs. Practice
It was the category of self-assessments that helped DOF identify returns from corporations going out of business (hereafter referred to as final returns) as a problem area. Self-assessment collection bills on which many taxpayers had written three words, "out of business," caught the attention of collections bureau staff due to the large number of such letters. Close inspection revealed that the taxpayers had gone out of business before their returns were ever filed. The collections bureau staff could not move fast enough to collect these bills.
What was happening was a wide divergence between the law's theoretical expectation of taxpayers' behavior and what happened in practice, as shown by the two time lines in Exhibit 2. The theory, as defined by the New York City Administrative Code, was that a corporation must file its final return "immediately" upon going out of business unless the commissioner of finance had specified an alternative time. Since the finance commissioner had never specified an alternative time, the DOF interpreted "immediately" as meaning that a taxpayer going out of business on September 1, 1992, for example, would have to file its final return on September 2, 1992. Many taxpayers were not familiar with this filing requirement.
In practice, these "out of business" taxpayers acted as though they were still in business and would file two and one-half months after the end of the year, on March 15, assuming such taxpayers had previously filed on a calendar year basis.(2) The taxpayer that had gone out of business on September 1 had been out of business for seven and one-half months when it filed on March 15. When the taxpayer finally filed, it would not include payment for the tax shown to be due.
The problem was, then, that DOF's computer would issue a self-assessment bill that remained unpaid and was referred to the collections bureau. Collections would file a tax judgment (thereby increasing the city's accounts receivable), but no assets would be available from the filing corporation for collection efforts.
At about the time that the final returns issue was being identified, DOF received some fortuitous comments from tax return preparers. The department had established a tax representatives and practitioners program (TAXRAPP) and conferences as a way to improve communication between DOF and tax lawyers, certified public accountants, enrolled agents and other preparers. Many preparers indicated that DOF was not doing a good job of processing final returns whenever they were filed. Even though the preparers' clients checked a box at the top of the corporate tax return indicating that they were filing their last return, it was clear to the preparers that the DOF's computer system often did not have that piece of information in its database. Despite the information on the corporate tax return, the following year their clients would receive a questionnaire - the first step in the department's delinquent assessment process - asking why a return had not been filed. Some of the practitioners noted, however, that if they advised their clients to write "final return" in large letters across the top of the return, DOF would correctly inactivate the account, preventing a questionnaire from being sent.
Compliance Made Easy
The DOF response was to be fairer to the customer by coming up with better defined and more realistic expectations. It seemed unfair to expect a corporation going out of business to organize its books and records and to file a detailed tax return within one day of closing its doors when corporations remaining in business receive at least two and one-half months to do so. In May 1993, DOF issued new regulations granting a dissolving corporation a six-month extension of time to file its final return provided that an application for an extension and an estimated payment were filed within 15 days of the cessation of business. A corporation that failed to file the application on time and/or submit the estimated payment would be subject to late filing and late payment penalties.
The new regulations made it easier for taxpayers to comply with the city's filing requirements for final returns, but it was apparent that taxpayers also needed an incentive to file. DOF used the issue as an opportunity to respond to the concern raised by tax practitioners. Processing problems were resolved by developing a separate application form to extend the filing deadline for final returns, thus alerting the returns processing staff to inactivate the accounts involved. This change not only made compliance easier but also would prevent complying taxpayers from receiving needless questionnaires.
One question had to be addressed: Why would taxpayers comply if compliance means paying an estimated tax upon going out of business, while noncompliance can effectively delay the payment of taxes, sometimes forever? One answer is that most taxpayers want to comply with tax laws and will do so if the law is made clear to them. If they have assets at the time they go out of business, they will use them to pay their taxes even if they know the assets will not exist in a few months. A second answer is that DOF must pursue more rigorously those taxpayers that are not complying with the law.
Transferee Assessments. DOF currently is reviewing the extent to which transferee assessments can be used in a cost-effective manner to pursue debt pertaining to out-of-business corporations. Transferee assessments apply to individuals and entities to whom corporate assets have been transferred. Such assessments act as a deterrent against those businesses that seek to dispose of leftover assets between the time that they go out of business and the time that they file their final return. Reducing the number of noncompliant corporations eligible for a transferee assessment review will increase the efficiency of the program, especially since issuing the assessments can be quite time consuming.
It is too early to evaluate the approach that DOF has taken to address this complicated problem. A prolonged outreach and education effort is needed to make taxpayers and tax practitioners aware of the new application for extension to file final return and the purpose it serves. Also, a transferee assessment program is still under development. The initial public response, though, has been favorable. Furthermore, since the new form was implemented, DOF has received $130,000 in estimated taxes that it might not have received if there had been no program to address final returns.
1 The New York City Department of Finance administers a wide variety of business taxes. While New York City does have a personal income tax, it is administered by the New York State Department of Taxation and Finance. This article does not address personal income tax issues.
2 Like many other jurisdictions, New York City requires corporate taxpayers to file their returns two and one-half months after the close of the taxpayer's fiscal year, except for taxpayers filing valid extensions. A taxpayer whose fiscal year coincides with the calendar year would be required to file on March 15th of the following year.
RELATED ARTICLE: Exhibit 1 EXAMPLES OF SELF-ASSESSMENT BILLS
1. Taxpayer files return with payment late.
Bill: Interest on principal amount Late filing penalty Late payment penalty
2. Taxpayer files timely, but prepayments are less than 90 percent of current year's tax and less than 100 percent of previous year's tax.
Bill: Estimated tax penalty
3. Taxpayer files return timely but does not submit payment
Bill: Principal amount Interest on principal amount Late payment penalty
JEFFREY SHEAR is deputy assistant commissioner for collections for the New York City Department of Finance. The author would like to thank ELLEN HOFFMAN of the department's office of legal affairs for her comments and suggestions, which greatly improved the article.
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|Publication:||Government Finance Review|
|Date:||Feb 1, 1995|
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