When a taxpayer makes an error on their tax return or fails to make timely payments to the IRS, it can result in additional tax, penalties, and even interest owed. This can be the case even if the taxpayer is just one day late or if the applicable tax laws are unclear or highly complex. Unfortunately, the IRS does not offer leniency for taxpayers in these situations.
But what about the IRS? What happens if the IRS makes an error and wipes out a taxpayer’s liability? Can the IRS simply re-assess the liability? What if the time period for assessing tax had expired by the time the IRS notices the issue? The court addresses this in Simon v. United States, No. 00-924-D-M3 (M.D. La. 2003).
Facts & Procedural History
A business owner failed to pay employee withholding taxes of approximately $13 thousand dollars in 1985. The IRS assessed a trust fund penalty against the taxpayer individually in 1986. The assessment was within the three-year statute of limitations for assessing tax liabilities.
On December 22, 1997, the IRS computer system erroneously removed the liability from the IRS’s records. The IRS computer system calculated that the statute of limitations for collecting the liability had run. In reality, this limitations period had been suspended due to attempts by the taxpayer to enter into an offer in compromise for the unpaid balance.
After discovering the error, the IRS reinstated the liability. This was done after the three-year period for assessing tax.
The taxpayer then filed a refund suit against the government to recover the taxes paid. The IRS and taxpayer filed motions for summary judgment, which the court considered. The question was whether the IRS could re-assess the liability after the three-year limitations period.
Assessment Statute of Limitations
The time period the IRS has to assess or record a tax balance as due on its books is referred to as the “assessment statute of limitations” or ASED.
The rules for the ASED are found in Section 6501. Generally, the ASED is three years from the date a tax return is filed or the due date of the return, whichever is later. This means that after the expiration of the three-year period, the IRS is barred from assessing any additional taxes for that particular tax year.
To calculate the statute of limitations period, the date the return was filed or the due date of the return, whichever is later, is added to three years. For example, if a taxpayer filed their 2000 tax return on April 15, 2001, the statute of limitations for assessing any additional taxes for that year would expire on April 15, 2004.
There are certain exceptions to the three-year statute of limitations period. For example, if a taxpayer omits more than 25% of their gross income from their tax return, the IRS has six years to assess any additional taxes. Additionally, there is no statute of limitations period for cases of fraud or for taxpayers who do not file a tax return. This fraud can even be fraud by the tax preparer and not the taxpayer.
The Trust Fund Recovery Penalty
The Trust Fund Recovery Penalty (“TFRP”) is a penalty imposed by the IRS on individuals or entities who are responsible for withholding and paying payroll taxes, but willfully fail to do so. The purpose of the TFRP is to ensure that employees’ portion of taxes withheld from their paychecks, such as Social Security and Medicare taxes, are paid to the government in a timely manner.
The TFRP is imposed on the responsible parties, which may include officers, directors, shareholders, or other individuals who have control over the finances of the business. This can even include bookkeepers. The penalty is equal to the amount of payroll taxes that were not withheld or paid, plus interest and penalties.
With regard to the assessment period for the TFRP, the three-year statute of limitations applies. This means that the IRS has three years from the date the payroll taxes were due to assess the penalty. However, if the responsible parties file a false or fraudulent return or willfully attempt to evade paying the taxes, there is no statute of limitations period for assessing the TFRP.
Offer in Compromise
An offer in compromise is an agreement between a taxpayer and the IRS to settle a tax liability for less than the full amount owed. The purpose of an offer in compromise is to help taxpayers who cannot pay their full tax liability due to financial hardship or other reasons.
When a taxpayer submits an offer in compromise, the IRS generally suspends collection activities. This suspension can affect the statute of limitations for assessing tax liabilities. Specifically, the statute of limitations is extended by the time period during which the offer in compromise is pending, plus an additional 30 days. The assessment period is extended during this time as the IRS is prohibited from collecting the tax during this time.
Reassessment of Liability
This brings us back to the reassessment of the liability in this case.
The IRS argued that Section 6404(a) only allows the IRS to abate tax assessments in specific circumstances, such as when the assessment is excessive or unlawful, or when the statute of limitations for assessment has expired. The IRS’s argument was that the computer error in this case that led to the taxpayer’s account balance being wiped out occurred because the IRS computer incorrectly calculated that the statute of limitations for collection had expired. The IRS contends that since this is not one of the enumerated reasons for abating an assessment, the reduction of Simon’s account does not constitute a valid abatement.
Additionally, the IRS noted that the reduction was not the result of a positive determination that the taxpayer was due an abatement, but rather an accidental error. The IRS asserts that under prior court rulings, an attempted abatement that is invalid in this way does not affect the validity of the original assessment and can be reinstated as long as the taxpayer does not suffer prejudice. Therefore, the IRS concluded that the original assessment against the taxpayer remained valid despite the IRS computer error.
As one can guess, the taxpayer did not agree. He made various arguments about the meaning of the language in the relevant statute. The court sided with the IRS. It concluded that this was a ministerial act that the IRS never intended to make an abatement and, in fact, it could not abate tax due to the collection statute of limitations running.
Occasionally, the IRS can make mistakes that lead to a taxpayer’s balance being eliminated. The IRS can assess a tax liability only in certain circumstances, and the original assessment’s validity can be reinstated if the taxpayer is not prejudiced. There is seemingly no time limit for the IRS to reinstate a liability, but it is still bound by the original collection statute. If the IRS does not detect the error for some time, the collection statute may expire, so taxpayers in this situation should adopt a wait-and-see approach and see if the IRS takes notice and tries to collect on the tax.