IRC § 6656(a) provides, in the case of any failure to timely deposit employment taxes, unless the failure is due to “reasonable cause and not due to willful neglect,” a penalty shall be imposed. The penalty is a percentage of the amount of underpayment.
- 2% for failures of five (5) days or less;
- 5% for failures of more than five (5) days, but less than 15 days;
- 10% for failures of more than 15 days; and
- 15% for failures beyond the earlier of: (i) 10 days after receipt of the first delinquency notice under IRC § 6303; or (ii) the day on which notice and demand is made under IRC §§ 6861, 6862 or 6331(a)(last sentence)(jeopardy assessment).
In addition to the “reasonable cause” exception contained in IRC § 6656(a), there are two other means by which taxpayers may avoid the imposition of the penalty.
1. Secretary has authority under IRC § 6656(c) to waive the penalty if:
- The failure is inadvertent;
- The return was timely filed;
- The failure was the taxpayer’s first deposit obligation or the first deposit obligation after it was require to change the frequency of deposits; and
- The taxpayer meets the requirements of IRC § 7430(c)(4)(A)(ii) [submits a request within 30 days and comes within certain net worth parameters].
2. The Secretary has authority under IRC § 6656(d) to waive the penalty if:
- The taxpayer is a first time depositor; and
- The amount required to be deposited was inadvertently sent to the Secretary instead of the appropriate government depository.
As the exceptions are limited in application, most taxpayers seeking abatement of the penalty are required to pursue the “reasonable cause” exception.
On April 4, 2014, the Chief Counsel’s Office issued Chief Counsel Advice 201414017 (CCA). The CCA offers guidance on this topic. Unfortunately, the guidance reflects the Service’s position that the “reasonable cause” exception under IRC § 6656(a) is narrow.
In the CCA, the taxpayer was subjected to a IRC § 6656(a) penalty when it failed to timely deposit employment taxes as the result of some of its employees exercising nonqualified stock options. The taxpayer claimed “reasonable cause” existed because its failure to timely deposit employment taxes was the error of its third-party payroll service. The taxpayer bolstered its position with two important facts.
- Its deposits had always been timely filed in the past; and
- The taxpayer immediately remedied the failure upon learning of it and
instituted procedures to avoid future repetition of the failure.
The Service commended the taxpayer for its historic compliance and its prompt remedial efforts. It concluded, however, that “[t]hese actions may amount to the exercise of ordinary business care that the reasonable cause defense requires and to the absence of willful neglect. The reasonable cause defense, however, also requires the taxpayer to demonstrate that despite its exercise of ordinary business care and prudence, it was ‘rendered unable to meet its responsibilities.’” The General Counsel’s Office ultimately concluded the taxpayer was liable for the penalty. It stated that the taxpayer’s reliance on its third-party payroll service provider is insufficient to obtain a penalty waiver as the reliance did not render it unable to otherwise meet its responsibilities.
Next, the General Counsel’s Office looked at whether the taxpayer could raise the first-time depositor defense under IRC § 6656(c) on examination rather than be required to wait until an assessment has been issued. It concluded, on the basis of administrative efficiency, the defense may be raised by the taxpayer on audit and the examiner should grant the request when appropriate.
The moral to the story is two-fold. First, the “reasonable cause” exception may be difficult to obtain. Whether it exists requires a facts and circumstances analysis. The burden of proof is on the taxpayer.
Reliance on third parties alone is generally insufficient. Likewise, failures due to mistake, ignorance of the laws or forgetfulness will not carry the day. Also, a taxpayer’s financial problems alone will generally not constitute “reasonable cause.”
The “reasonable cause” exception is narrow. Failures resulting from matters totally outside the taxpayer’s control appear to be required in order to obtain this penalty waiver. Examples of qualifying “reasonable cause” likely include situations where an otherwise compliant taxpayer, with adequate payroll procedures in place, encounters a natural disaster (e.g., fire, flood, storm), rendering it unable to process payroll and make the required deposits in a timely manner. Other examples of “reasonable cause” may include: (i) the death or serious illness of the taxpayer or the taxpayer’s immediate family; (ii) inability of the taxpayer to obtain necessary records due to no fault of the taxpayer; or (iii) embezzlement by the bookkeeper when and only when the taxpayer has reasonable protections in place.*
Second, taxpayers should raise the first time depositor defense, if applicable, on audit. The examiner should be able to accept the defense if the taxpayer qualifies. As confirmed by General Counsel’s Office, taxpayers are not required to wait for an actual assessment before raising this defense.
The courts presented with the “reasonable cause” exception to the imposition of a penalty under IRC § 6656(a) have taken varying positions—some more taxpayer friendly than others. The Service, however, is clearly taking a narrow view of the exception, leading to less taxpayer friendly results. Caution is advised.
*Reliance on a bookkeeper who embezzled funds from the taxpayer was not reasonable cause because the taxpayer did not have adequate checks and balances in place to prevent the embezzlement. Leprino Foods Co. v. U.S., 85 AFTR 2d 2000-1729 (D. Colo. 2000). Financial difficulties when adequate funds existed, but the taxpayer decided to use the funds for other things, trumped a reasonable cause defense. Van Camp & Bennion, P.S. v. U.S., 251 F.3d 862 (9th Cir. 2001). Failure of the bookkeeper delegated the responsibility of making deposits does not constitute reasonable cause when the bookkeeper was supervised by the owners of taxpayer and the outside CPA. Janet Nesse v. IRS, 93AFTR 2d 2004-1022 (DC MD 2004).
Acts of dishonesty can cost a tax practitioner his or her ability to practice before the IRS. Charles M. Edgar (“Edgar”), formerly a licensed CPA and attorney in Massachusetts, recently learned this lesson.
On May 1, 2014, the Service issued a news release (“IR-2014-58”), announcing the disbarment of Edgar. While the saga of Edgar is long and somewhat convoluted, it illustrates a significant point—failure to act honestly in matters before the IRS constitutes a violation of Circular 230. It will cost you severely.
The Secretary of Treasury has express authority to regulate practice before the IRS, including the power to suspend or disbar an individual from practice before the Service for failing to comply with Circular 230. In such instances, the practitioner must be provided notice and an opportunity for a hearing before an administrative law judge.
Circular 230 grants the Director of the Office of Professional Responsibility authority to bring proceedings to suspend or disbar practitioners from practice before the Service. Generally, an administrative law judge, not the Office of Professional Responsibility, determines the appropriate sanction, if any, taking into consideration all relevant facts and circumstances.
Circular 230 specifically provides that a practitioner may be sanctioned for giving “false or misleading” information to the Treasury or any officer or employee thereof. For this purpose, “information” means any facts or statements made in testimony, on federal tax returns, financial statements, and other documents or statements (written or oral).
Circular 230 also provides that a practitioner may be sanctioned if he or she is disbarred or suspended from practice as an attorney, CPA, PA, or actuary.
Edgar was a CPA, but his license was revoked in 2010 by the Massachusetts Board of Registration in Public Accountancy, in part, due to a 1995 felony conviction for knowingly making false statements to the government and for mail fraud. In 2011, Revenue Agent Adrienne Howley contacted Edgar in regard to an on-going audit of a corporation he previously had been designated as the authorized representative. She apparently told Edgar that the Service was going to audit the corporation’s shareholders. The agent specifically asked Edgar if he was going to represent the shareholders in the audit. Edgar told Ms. Howley that he would be representing the shareholders, and he would be submitting powers of attorney to memorialize the representation.
About six months following his disbarment as a CPA, Edgar submitted a separate IRS Form 2848, Power of Attorney and Declaration of Representative, for each of the corporation’s two shareholders. On the Forms 2848, which are signed under the penalty of perjury, Edgar represented he was a CPA duly qualified to practice in Massachusetts.
After receiving the Forms 2848, Agent Howley conducted an on-line search, a routine practice, to determine if the representative held a valid license. The search revealed Edgar’s CPA license had been revoked on December 23, 2010. Consequently, Agent Howley referred the matter to the Office of Professional Responsibility.
After an investigation, the Office of Professional Responsibility sought to discipline Edgar. The matter ended up in a hearing before Administrative Law Judge Walter J. Brudzinski. At hearing, several bad facts came out, including:
- Edgar had been convicted of a felony for making false statements and for mail fraud. As a result, he lost his CPA license;
- Edgar filed with the IRS Forms 2848 representing he was a CPA when, in fact, his license had been revoked months earlier;
- Edgar never told Agent Howley he had been disbarred;
- Edgar never told the corporate taxpayer or its shareholders he had been disbarred;
- In Edgar’s answer to the Office of Professional Responsibility’s complaint, seeking discipline, he denied his CPA license had been revoked;
- At hearing, Edgar appeared to have a memory lapse in that he could not remember his conversations with the auditor; and
- At hearing, Edgar at one point claimed he did not sign or submit the Forms 2848 to the IRS. Rather, he claimed one of the shareholders had done so. Unfortunately, it was clear from the evidence submitted at hearing that the signatures on the forms were, in fact, his signatures.
The Administrative Law Judge concluded Edgar demonstrated “a pattern of conduct and occurrences that demonstrate [he] is not fit to practice before the IRS.” His “lack of truthfulness, is troubling and bears directly on his fitness to represent taxpayers before the IRS.”
Edgar’s disbarment from practice before the IRS clearly places him on the bench. If, however, he can show he is rehabilitated in terms of fitness to practice, he could re-apply to practice before the Service after five (5) years have elapsed. Given his track record, that may be an uphill battle.
Karen L. Hawkins, Director of the Office of Professional Responsibility, stated “[t]he representations made by practitioners on powers of attorney forms are not mere procedural niceties. The forms are signed under the penalty of perjury. Claiming a nonexistent licensure status puts the IRS in the position of potentially discussing taxpayer information with an unauthorized or unqualified person.” Ms. Hawkins went on to say: “[w]e will not tolerate that type of abuse of the tax administration process by anyone.”
Caution is advised. When dealing with the Service, other government agencies, clients and others, practitioners must act with honesty and integrity.
On April 9, 2014, Oregon Governor John Kitzhaber signed into law House Bill 4138 (“HB 4138”). Effective June 8, 2014, the methodology by which an “Interstate Broadcaster” apportions its business income for purposes of the Oregon corporate excise tax changes in at least two (2) ways:
1. Method of Apportionment. Prior to June 8, 2014, an Interstate Broadcaster included in the numerator of the “sales factor” gross receipts from broadcasting in the ratio that its audience and subscribers located in Oregon bear to its total audience and subscribers located within and without Oregon. On or after June 8, 2014, Interstate Broadcasters will no longer use this method of apportionment. Rather, they will include in the numerator of the “sales factor” only those gross receipts from customers (i.e., advertisers and licensees) that have their commercial domicile in Oregon, or (in the case of individuals) who are residents of Oregon.
2. Definition of Interstate Broadcasters. HB 4138 amends the definition of “Interstate Broadcaster” to include anyone engaging in the for-profit business of broadcasting to persons located within and outside of Oregon. Prior law referred to broadcasting to subscribers or to an audience. I am not sure this change to the law is significant other than it reduces the verbiage by four (4) words.
For purposes of the statute, broadcasting is limited to transmission of any one-way signal by “radio waves, microwaves, wires, coaxial cables, wave guides or other conduits of communication.” HB 4138, as originally proposed, expanded the definition of “broadcaster” to include anyone transmitting film or radio programming by any means. Lawmakers chose, however, to retain the existing definition of broadcaster.
HB 4138 becomes law in Oregon on June 8, 2014. If, however, Oregon lawmakers do not act, the law will revert back to pre-HB 4138 law on January 1, 2017. In the interim, the Oregon legislature has directed the Legislative Revenue Officer to confer with the Oregon Department of Revenue and issue a report as to the impact of HB 4138 on revenue.
The stated intent of HB 4138 is to more accurately reflect the Oregon income of Interstate Broadcasters. Given the directive to the Legislative Revenue Officer, one could easily suspect the intent is really to increase Oregon income and the corresponding tax revenues. Time will tell. The upcoming report of the Legislative Revenue Officer (due by February 1, 2017) should be an interesting read.
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationNew York, NY, 10.24.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," Oregon Society of Certified Public Accountants (OSCPA) 2019 Northwest Federal Tax ConferencePortland, OR, 10.28.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationSan Francisco, CA, 11.14.19
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20
- "The Road Between Subchapter C and Subchapter S – It May Be A Well-Traveled Two-Way Thoroughfare, But It Isn’t Free of Potholes and Obstacles," The J. Nelson Young Tax InstituteChapel Hill, NC, 4.23.2020-4.24.2020