IRS New Fast Track Settlement Program (Or The Audit From Hell)

We very recently concluded the appeals of a tax audit that had dragged out for years. A CPA friend had begun the audit, and he eventually brought me in as a hired gun to represent on selected issues. He was facing a young examiner who – while bright enough – did not have the accounting background or tax experience to understand the waters he had waded into.

I will give you an example. My friend’s firm did the routine bookkeeping for this client. The routine pretty much consisted of tracking bank accounts and notes payable, with no monthly adjustments to Accounts Receivable or Accounts Payable. Those two accounts put the books on an “accrual basis,” so my friend was essentially maintaining the books on a “cash basis.”

At the end of a period (say year-end), he adjusted the books with the following entries:

            Accounts Receivable                              XXXX

                    Revenues                                                 XXXX

            Some Expense Account                         XXXX

                    Accounts Payable                                    XXXX

When I was a young accountant, I saw this bookkeeping more times than I can count.

The examiner came across one of those interim ledgers without revised Accounts Receivable and Accounts Payable, and he charged the client with maintaining two sets of books.

It was one of the few times I seriously considered running an examiner to ground. And yes, I did discuss the matter with the group manager. A charge like that borders on alleging fraud. The client hated (and hates) the IRS, but at no time was there fraud.

The examiner’s inability to comprehend routine bookkeeping alerted me that the audit was going to be rough. It was. Eventually I took over the audit, and my friend was glad to hand it off. To be fair, he is a general practitioner while I have specialized in tax for years. I guess I am more accustomed to beating my head against a wall.

It was a pain. We had complex tax issues, like methods of accounting and tax credits, and the examiner had already stumbled over prosaic stuff.

We tried to force issues away from the examiner and to the group manager. We appeared to have agreement from the manager, only to see issues reappear like some accounting knock-off of The Living Dead.

So now I am looking at the expanded IRS Fast Track Settlement Program. Fast Track has been around for years, but it has been limited to larger companies. The IRS has now expanded the program to smaller businesses and self-employed taxpayers. The program is an alternative to standard dispute resolution arising from an IRS audit.

There are requirements, of course. The issues must be fully developed, which is a fancy way of saying that both sides have presented their reasoning, with supporting authority and footnotes and all that. The taxpayer, the examiner or the group manager can initiate the request, which will go to IRS Appeals.

NOTE: What makes it “fast track” is the change in administrative procedure. Normally I have to wait for the examiner (that is, Examination) to write-up his/her adjustments and submit it in the form of a 30-day letter. I then appeal the 30-day letter. This program instead hauls one or more issues out of Examination and immediately puts it with Appeals. In effect, Examinations and Appeals are working simultaneously and before any of those 30-day or 90-day letters go out. 

If Appeals accepts the request, its goal is to resolve the matter within 60 days.

            COMMENT: Big improvement over the audit from hell.

To be able to respond so quickly, Appeals will not accept certain cases, such as correspondence audits or where Appeals believes the taxpayer has not worked fairly with the IRS.

If you change your mind, you can withdraw from Fast Track.

And, if Appeals decides against you, you still have the traditional Appeals rights you would have had anyway.

How did the audit from hell turn out? Examination wanted over $310 thousand. We went to Appeals. We just settled the case for around $5 thousand. Not bad, except for the tax fees the client had to pay for an audit that ran off the rails. 

Can Payroll Taxes Put You In Jail?

Can you go to jail for not remitting payroll taxes?

Let’s set this up:

• You have a temporary nursing staffing agency in Minnesota.
• You treat your nurses as independent contractors.
• You had a predecessor company which the IRS charged with willfully misclassifying workers and failing to remit payroll taxes.  You survived that occasion by settling with the IRS, but the settlement included language similar to the following:

 “... with respect to any other business similar to the ... entities that he might own, operate or control in the future, he would treat as employees for tax purposes all workers who performed functions or duties that were the same or similar as the function or duties performed by the nurses and nursing assistants who worked for the ... entities. In other words, defendant ... was obligated to withhold and pay over employment taxes for the nursing professionals who worked for any of his entities.”

• Minnesota has a law requiring nursing staffing agencies to certify that they are treating their nurses as employees and not as independent contractors. You have made this certification to Minnesota.

So, can you go to jail for not remitting the nurses’ payroll taxes?

A too-common problem is a cash-strapped business falling behind on depositing their payroll taxes. You can fall behind on many types of taxes and still be able to work something out. You fall behind with payroll taxes, however, and the IRS can be very harsh. The reason is that the IRS (and the states also) considers it stealing. You pay an employee $700 and withhold $200 for taxes. That $200 is not your money: it is the employee’s money that you now hold as agent for remittance to the IRS. The IRS reserves one of its most frightening penalties for this: it is called the trust fund recovery penalty. This penalty is 100% (you read that right), and it attaches to you as an individual. You cannot shed that penalty by leaving or bankrupting the business, because the penalty applies to you. It follows you like a bad haircut.

That penalty however is not what we have here. What we have here is Francis Leroy McLain (U.S. v McLain). The case was appealed to the Eight Circuit from the District Court of Minnesota.

The IRS looked at two entities owned by McLain, Kind Hearts and Kirpal Nurses, and came to the conclusion that the nurses were employees.

OBSERVATION: The IRS will almost always say that someone is an employee, whether they are or not. They want the payroll taxes, of course.

McLain owed about $340,000 in payroll taxes. He had been down this path before, and the IRS had not forgotten. They dusted off Section 7202, a very special tax gem for someone who pushes the sled too far:

Any person required ... to collect, account for, and pay over any tax imposes by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to the other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the cost of prosecution.”

McLain left the shores of the responsible person penalty far behind. He sailed into the deep waters of going to jail. He is now dealing with CID, the criminal side of the IRS.

NOTE: A word to the wise: you never want to deal with CID. These guys have badges. They have guns. And they will put you in jail. I know. I had a client who had gone to jail courtesy of CID, and I know a tax practitioner in northern Kentucky who will be going.

As a tax guy, I am hoping that McLain has some serious technical arguments to make in his defense. I am expecting a ferocious goal-line stand. Here comes his first play:

(1)   McLain referred to the two agencies, King Hearts and Kirpal Nurses, as “Kirpal.” He argued that Kirpal was the employer, and, as the employer, only Kirpal had a duty to account and pay over taxes on its employees.

COMMENT: McLain starts off by irritating me. There was a case on this issue before I even came out of school. The case is Slodov v United States. It was a Supreme Court case and included the following language:

“Sections 6672 and 7202 were designed to assure compliance by the employer with its obligation to withhold and pay the sums withheld, by subjecting the employer’s officials responsible for the employer’s decisions regarding withholding and payment to civil and criminal penalties ...”

            McLain was an officer. What part of this did he not get?

            SCORE: IRS (1) McLain (0)

(2)   McLain argues that he had a good faith belief that the nurses were not employees. The lawyers refer to this as “mens rea,” and he argued that his state of mind did not rise to “willful.” Without willfulness, McLain cannot come under Section 7202.

COMMENT: I like this argument. Unfortunately, he had a prior run-in with the IRS on this very same point, which greatly diluted the argument’s persuasiveness.

            SCORE: IRS (2) McLain (0)

(3)   McLain argues that the IRS has to pursue a civil penalty before it can pursue a criminal penalty, and the civil penalty requires a written notice. He received no written notice, so the IRS cannot proceed with criminal prosecution.

COMMENT: I noticed that the Court reminded McLain’s attorney that he “has an independent obligation, regardless of what his client may demand, to refrain from filing frivolous motions.”

            SCORE: IRS (3) McLain (0)

(4)   McLain moved to dismiss the charges because (1) he is a “natural human being” and the United States does not have authority over him.

COMMENT: McLain’s attorney blanched here, and McLain fired him. McLain represented himself from this point on.

A tax protest argument? Seriously?

SCORE: IRS (4) McLain (0)

McLain lost soundly.

This type of action by the IRS is rare. I can assure that – in almost all cases – the IRS does not want to put anyone in jail. They want your money, and being in jail impedes you getting the IRS any money. And all parties in the system – the IRS, the courts and judges, responsible practitioners – are tired of the tax protest siren song.

I am sympathetic to arguments that our tax system left the world of rational thought years ago, but that does not mean the income tax is illegal. It can be irrational, immoral, confiscatory, divisive and destimulative without being illegal.

McLain has taken what could have been a civil penalty – albeit a stiff one – and morphed it into a multi-year stay at Club Fed. There likely is a fairly impressive fine also. He did however enter the tax literature, primarily for being a blockhead.