Incorrect Submission Leads to Dismissal of Refund Claim

 

You should be able to talk with someone at the IRS and work it out over the phone.”

I have lost track of how many times I have heard that over the years.

I do not disagree, and sometimes it works out. Many times it does not, and we recently went through a multi-year period when the IRS was barely working at all.

There are areas of tax practice that are riddled with landmines. Procedure - when certain things have to be done in a certain way or within a certain timeframe – is one of them. Ignore those letters long enough and you have an invitation to Tax Court. You do not have to go, but the IRS will – and automatically win.

I was looking at a case recently involving a claim.

Tax practitioners generally know claims under a different term – an amended return. If you amend your individual tax return for a refund, you use Form 1040X, for example.

There are certain taxes, including penalties and interest, however, for which you will use a different form. 

Frankly, one can have a lengthy career and rarely use this form. It depends – of course – on one’s clients and their tax situations.

And yes, there is a serious procedural trap here – two, in fact. If you use this form but the IRS has instructed use of a different form, the 843 claim will be invalid. You will be requested to resubmit the claim using the correct form. By itself it is little more than an annoyance, unless one is close to the expiration of the statute of limitations. If that statute expires before you file the correct form, you are out of luck.

There is another trap.

Let’s look at the Vensure case.

Vensure is a professional employer organization, or PEO. This means that they perform HR, including payroll responsibilities, for their clients. They will, for example, issue your paycheck and send you a W-2 at the end of the tax year.

Vensure had a client that stiffed them for approximately $4 million. As you can imagine, this put Vensure in a precarious financial situation, and they had trouble making timely payroll tax deposits in later quarters.

I bet.

Vensure did two things:

(1)  They filed amended payroll tax returns (Forms 941X) for refund of payroll taxes remitted to the IRS on behalf of their deadbeat client.

(2)  They submitted Forms 843 for refund of penalties paid over the span of six quarters (payroll taxes are filed quarterly).

Notice two things:

(1)  The claim for refund of the payroll taxes themselves was filed on Form 941X, as the IRS has said that is the proper form to use.

(2)  The claim for refund of the penalties on those taxes was filed on Form 843, as the IRS has said that is the proper form for the refund or abatement of penalties, interest, and other additions to tax.

Vensure’s attorney prepared the 843s. Having a power of attorney on file with the IRS, the attorney signed the forms on behalf of the taxpayer, as well as signing as the paid preparer. He did not attach a copy of the power to the 843, however, figuring that the IRS already had it on file.

Makes sense.

But procedure sometimes makes no sense.

Take a look at the following instructions to Form 843:

You can file Form 843 or your authorized representative can file it for you. If your authorized representative files Form 843, the original or copy of Form 2848, Power of Attorney and Declaration of Representative, must be attached. You must sign Form 2848 and authorize the representative to act on your behalf for the purposes of the request.” 

The IRS bounced the claims.

The taxpayer took the IRS to court.

The IRS had a two-step argument:

(1) For a refund claim to be duly filed, the claim’s statement of the facts and grounds for refund must be verified by a written declaration that it is made under penalties of perjury. A claim which does not comply with this requirement will not be considered for any purpose as a claim for refund or credit. 

(2)  Next take a look at Reg 301.6402-2(c):  

Form for filing claim. If a particular form is prescribed on which the claim must be made, then the claim must be made on the form so prescribed. For special rules applicable to refunds of income taxes, see §301.6402-3. For provisions relating to credits and refunds of taxes other than income tax, see the regulations relating to the particular tax. All claims by taxpayers for the refund of taxes, interest, penalties, and additions to tax that are not otherwise provided for must be made on Form 843, "Claim for Refund and Request for Abatement."

Cutting through the legalese, claims made on Form 843 must follow the instructions for Form 843, one of which is the requirement for an original or copy of Form 2848 to be attached.

Vensure of course argued that it substantially complied, as a copy of the power was on file with the IRS.

Not good enough, said the Court:

The court agrees with the defendant that the signature and verification requirements for Form 843 claims for refund are statutory.”

Vensure lost on grounds of procedure.

Is it fair?

There are areas in tax practice where things must be done in a certain way, in a certain order and within a certain time.

Fair has nothing to do with it.

Our case this time was Vensure HR, Inc v The United States, No 20-728T, 2023 U.S. Claims.

The 2014 Tax Act and Professional Employer Organizations (PEOs)

We know that Congress passed, and the President signed, the Tax Increase Prevention Act of 2014 at the end of last year. This is the tax bill that retroactively resurrected certain tax deductions that many taxpayers have become used to, such as deducting sales taxes (rather than state income taxes)  should one live in Tennessee, Florida or Texas or deducting (a certain amount of) tuition payments if one’s child is in college.

There is something else this bill did that was not as well publicized.

It has to do with professional employer organizations, known as PEO’s. These are companies that provide human resource (HR) functions, such as the paperwork involved in hiring, as well as running payroll and depositing payroll taxes and other withholdings.

There has long been a hitch with PEOs and payroll taxes: the IRS considered the underlying employer to still be liable for withholdings if the PEO failed to remit or failed to do so timely. The IRS took the position that an employer could not delegate its responsibility for those withholdings. To phrase it differently, the employer could delegate the task but could not delegate the responsibility.

You can guess what happened next. There were cases of PEO’s diverting withholdings for their own use, then going out of business and leaving their employer-clients in the lurch. If you were one of those employer-clients, the experience proved to be very expensive. You had paid payroll taxes a first time to the PEO and then a second time when the IRS held you responsible.

The answer was to watch over the PEO like a hawk. The IRS encouraged employer-clients to routinely go into the electronic payment system (EFTPS), for example, to be certain that payroll taxes were being deposited.

That unfortunately collided with many an employer’s reason to use a PEO in the first place: to have someone else “take care of it.”

Back to the tax bill. Stuck in with the tax extenders was something called the ABLE Act, which is a Section-529-like-plan, but for disabled individuals rather than for college expenses.

Stuck (in turn) onto the ABLE Act was a brand-new Code section just for PEOs. The provision requires the IRS to establish a PEO certification program by July 1, 2015. There will be a $1,000 annual fee to participate, but – once approved – the IRS will allow the PEO to be solely responsible for the employer-client’s payroll taxes.

You have to admit, this is a marketing bonanza if you own a PEO. It will separate you from a non-PEO who is bidding on the same prospective client.

The PEO will have to post a bond in order to participate in the program. In addition the PEO will have to be audited annually by a CPA. The PEO will have to submit that audited financial statement to the IRS.

I do not know the answer as of this writing, but I have a strong suspicion the AICPA was in the room when that audit requirement was included. Why do I say that? Because only CPAs are allowed to render an opinion that financial statements are “presented fairly in accordance with generally accepted accounting principles.” 

NOTE: That would be CPAs who practice as auditors. There are CPAS who do not. For example, I specialize in taxes.

There is – by the way – risk to the PEO. This is not a one way street. The PEO will be responsible for the payroll taxes, even if the employer-client does not pay the PEO.

“Largest Ever” Texas Payroll Tax Fraud Scheme

We prepare payroll for our clients. We do not handle money, mind you, but we do the calculations, observe the deposit schedules and prepare the tax returns. ADP and Paychex do the same thing, but in much larger volume.

Have you ever wondered who is responsible for penalties if these payroll taxes are not prepared correctly: you or me (that is, the provider)? Let’s ramp this up a notch: what if you remit monies trusting the provider to make the deposits … and they don’t? Think about this for a second. Would the IRS really expect you to make the deposit again? After all, you are out the monies remitted to the provider. And, if they did, would the IRS add insult to injury by applying penalties?

Chances are the answer is yes (to the first) and no (to the second).

Let’s review the buzzwords in this area and then let’s discuss a horror story.

Technically there are three types of payroll providers:

(1)   Payroll Service Providers (PSP)

a.     A PSP prepares the payroll tax returns but the client signs and files the paperwork. This is what we do. Under this arrangement, you remain the employer in the eyes of the IRS.

(2)   Reporting Agent (RA)

a.     RA’s prepare and file the paperwork. It is a slight difference, granted, and again you remain the employer in the eyes of the IRS.

(3)   Professional Employer Organization (PEO)

a.     PEO’s are more difficult to pin down.

                                                    i.     PEO’s perform the range of human resource functions: tax filings and administration, benefit design and ERISA, compliance with federal and state workplace regulations, disciplinary actions, unemployment, disability and workers compensation.

b.     It gets tricky on who is the “employer” in this instance. You are paying the PEO as a virtual outsourcing of your personnel and payroll departments. Odds are – for example – that the PEO is issuing W-2s in its name and identification number. Again, odds are that employee benefits – health and other – are also provided under their name.

                                                    i.     That sets up the question: who is the employer – you or the PEO?

c.      The tax law is not as clear as it could be.

                                                    i.     There is a way for the PEO to be the “employer”, but certain requirements must be met and paperwork has to be filed to notify the IRS.

d.     PEO’s commonly use an indemnity provision requiring them to reimburse you in the event of liability attributable to their failure to collect or remit taxes.

                                                    i.     An indemnity provision – by itself – is not enough to have the IRS consider the PEO to be the employer.

                                                  ii.     This means that – if all that happens is an indemnity provision - you remain the employer, and the IRS can act against you for penalties and undeposited taxes. 

What can go wrong?

I am looking at an FBI release dated February 21, 2014.  There is a court in San Antonio that is sending three individuals to jail for participating in what the FBI describes as “the largest real dollar loss fraud and tax related case ever prosecuted in the Western District of Texas.” At the core of this case were PEOs.

·       John Bean, owner of Synergy Personnel and an officer with several other San Antonio and Austin PEOs, was sentenced to six years in prison and order to repay more than $120 million in restitution.

·       Pat Mire, owner and manager of several San Antonio PEOs (including one with John Bean) was sentenced to three years in prison and order to repay $10 million.

·       Mike Solis, an executive at several San Antonio PEOs, was sentenced to two years in prison.

·       John Walker II owned and managed several San Antonio PEOs. He was sentenced to five years of probation and ordered to repay $450,000.

They had an unusual – but track-proven way - of dealing with the pesky payroll taxes they collected from clients and were supposed to remit to the government: they didn’t. Needless to say, they were extraordinarily profitable. They admitted that between 2002 and 2008 they stole more than $133 million from clients.

Good grief!

That is Nimitz-class payroll taxes, and someone is going to pony up. If you were a client of these PEOs, you would not want the IRS to come knocking, expecting you remit payroll taxes after you already paid these guys to do the same. You would be paying twice.   

The technical lexicon is that you want the PEO to be the “Section 3401” employer. The concept doesn’t apply to a PSP or RA, as their functions are limited. A PEO, on the other hand, performs so many of the employer functions that they practically “are” the employer. You want to be certain that the IRS agrees with that, though, by acknowledging the PEO as the “Section 3401” employer.

BTW, will the IRS go after the San Antonio employers? Truthfully, I cannot tell. I hope that the PEOs involved were the Section 3401 employers. Even if they weren’t, this case is so egregious that I would like to believe the IRS would make exceptional accommodation for the employers affected.

Update as of 3/10/14: Last Friday I had an IRS employment tax specialist in the office. Yes, she is auditing one of our clients (sigh). We spoke about the San Antonio PEO fraud and whether the IRS would accept 3401 status for the underlying employers.

She believes the IRS will act against the underlying employers and not even pause for any 3401 argument. Her observation: "it is a risk you take when you hire a PEO."

Be informed.