IRS employees are tasked with making decisions. These decisions dictate who owes taxes and penalties and who does not.
These decisions are usually made in the context of well trodden areas and by employees who make the same type of decisions over and over. This is due to the volume of disputes that are created by certain types of laws and common fact patterns and the nature of the hierarchical structure of the IRS.
The IRS has established procedures and an administrative appeals process to ensure that this process works. But sometimes the process does not work. There are times when the IRS gets it wrong. There are times when the IRS gets it wrong multiple times in the same case.
This appears to be what happened in Kazmi v. Commissioner, T.C. Memo. 2022-13. The IRS appears to have gotten it wrong and the court did not have the ability to fix the problem given the procedural misstep by the petitioner.
Facts & Procedural History
The petitioner in this case was a bookkeeper. He was employed part-time as the bookkeeper for an urgent care business. The court describes his role as follows:
Mr. Kazmi was employed by Urgent Care as a part-time hourly bookkeeper during the periods at issue. He had no ownership interest in Urgent Care. He was not an officer of Urgent Care. His name was not on any of Urgent Care’s bank accounts. He did not have check signing authority for Urgent Care nor any authority to make payments on behalf of Urgent Care. At all times, he worked under the authority and direction of Dr. Senno.
The IRS conducted a trust fund penalty interview. It completed the Form 4183 as part of this. Then it issued a Letter 1153 to the petitioner proposing trust fund penalties. The letter was premised on the fact that the bookkeeper had a Form 2848, Power of Attorney and Declaration of Representative, on file with the IRS for the business. This form allowed the taxpayer to act on behalf of the business for payroll taxes.
The petitioner did not file a protest to appeal the IRS’s determination. When the IRS later filed a lien against him for the taxes, he filed a collection due process hearing request. This request ended up in court as the IRS did not allow the petitioner to challenge the liability during the hearing. The IRS did not allow him to challenge the liability as he had a prior opportunity to do so, namely, by filing a protest with the IRS to appeal the decision.
The question for the court was whether the petitioner, who was clearly not liable for the trust fund penalty, should be able to challenge the liability in the collection due process hearing.
About the Trust Fund Recovery Penalty
The trust fund recovery penalty is a payroll tax issue. Generally, payroll taxes include an employee portion and an employer portion. The employee portion is withheld from employee paychecks and is to be remitted to the IRS. These funds are said to be held in trust for the IRS.
Many taxpayers use these funds held in trust for their own purposes. This usually happens when the business has a financial crunch that the owners think the business will overcome. The funds are spent and then the business does not recover or recover fast enough to catch up on the back taxes.
Our tax laws allow the IRS to impose a trust fund penalty in these cases. This penalty makes the trust fund portion of the taxes a personal liability for those who are “responsible” for paying over the taxes to the IRS. The responsible person is the person who has control over the business payments, such as those who own the business and those who sign checks for the business.
The reason why this penalty is needed it allows the IRS to go after the personal assets of those who are assessed the penalty. Absent this penalty, the IRS is usually limited to collecting from the assets of the business. If the business has no assets, this could limit the IRS’s ability to collect anything.
The Responsible Person
The IRS commonly takes the position that anyone who could have made sure the taxes were paid over is subject to this penalty. T
The IRS will often assess the penalty against as many people as it can. It will then collect from the personal assets of the individual, and credit the business and any other trust fund penalty recipient for the payment it collects. So this creates a situation where one party has to wait out the other party with the hope that the IRS collects from the other party first.
The courts have developed several factors that it considers in deciding whether a person is “responsible.” These factors include the person (1) holding corporate office, (2) owning stock in the company, (3) serving on the board of directors, (4) having authority to sign checks, and (5) having control over corporate financial affairs.
There is also a willfulness requirement. This does not look to the person’s motive. It just requires that there be a “voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees” by the person.
The Collection Due Process Hearing
The collection due process hearing was created by Congress to allow the taxpayer to have a second IRS function review the IRS’s collection actions before the actions are completed. It applies when the IRS files a lien or imposes a levy.
The IRS Appeals Office handles these hearings. In doing so, they are required to verify that the IRS procedures were followed and, if the taxpayer disputes the underlying liability, that the liability is correct.
The rules say that a taxpayer is not able to challenge the underlying liability if they have had a prior opportunity to dispute the tax. The ability to dispute the tax has been frequently litigated. That was the issue in this case. The court declined the petitioners request to depart from existing law. Specifically, the petitioner asked the court to recognize the clear error the IRS made in its determination–as it did if the facts stated by the court are correct–and find that he was not liable for the penalty.
The court followed existing law. This highlights the limits of the collection due process hearing. The IRS verified the procedures that it had to follow, which the IRS did in this case. The court in turn verified that the IRS verified that procedures were met. It stopped there. It did not allow the petitioner to challenge the obviously incorrect determination on the penalty.
The Role of the IRS Appeals, Auditor, and Attorney
While the U.S. Tax Court is limited in what it can do, the IRS Office of Appeals is not.
The IRS Appeals Office has broad powers. This includes the power to remedy any errors or injustice that it comes across. There are appeals officers at the IRS who go to great lengths to do just that. This is needed given that our intricate tax laws often have unintended consequences, circumstances justify departing from hard rules, the IRS sometimes makes mistakes, and different IRS employees have motivations and beliefs that are inconsistent with the spirit of our tax laws. This particular case is not a case that should have made its way to tax court. It is one that should have been settled by the IRS Office of Appeals.
The IRS auditors and, as in this case, revenue officers, also have broad powers. They have the ability to imitate problems like this. If the facts are true, this is not a case that the revenue officer should have proposed a penalty for. That the bookkeeper had Form 2848 on file with the IRS for the business is not a sufficient reason for imposing the penalty. If the bookkeeper had no ability to control the finances or direct payment, the inquiry should have stopped there.
The IRS attorney also has the power to remedy problems. Technically, the IRS attorneys employed by the Office of Chief Counsel represent the IRS. They are supposed to carry out the wishes of the IRS as their client. They also owe a duty to the public and taxpayers. They have to balance these competing interests. In doing so, the IRS attorney has some leeway to ensure that justice is done. This balancing act did not result in this case being settled before court, unfortunately.
The IRS appears to have failed the petitioner in this case. This includes the IRS revenue officer, the IRS appeals officer, and then the IRS attorney.
The petitioner in this case may still not have lost, however. He may be able to wait for the business or other responsible person to pay the tax. Presumably he may also be able to sue the business and recover that way.
Setting that aside, there are several lessons from this case. The first lesson is to make sure that a protest is timely filed for the trust fund penalty. The less obvious lesson is that bookkeepers who do payroll should not have a Form 2848 for the business if possible. If the bookkeeper has to have a Form 2848, they should check the boxes on the form to limit their powers.