Trust Fund Penalties

Fixing Trust Fund Recovery Penalties

The public may not be fully cognizant of this, but, the IRS is in the business of processing information and making decisions.

It accomplishes this by siloing work on tax returns and accounts. The siloed work is intended to allow the IRS to process and make consistent decisions based on a very large volume of information.

The silo works something like this. The IRS has functions it has to complete, such as processing returns, assessing tax, and collecting tax. These functions are divided among operating divisions. The operating divisions are divided up by job functions and positions. The job functions and positions have a hierarchy much as the military does.

The job functions and positions require employees to perform specific tasks, with management being tasked with reviewing decisions by lower-level workers and passing information up the hierarchy and lower-level workers performing the actual tasks on cases. The instructions as to how to complete the tasks are set out in job descriptions, performance evaluation materials, and the IRS’s policy manual.

This siloing of the work allows a tax return or account to be handled by several different functions and several different IRS employees. Why is that important? The short answer is that this process dictates how a tax return or account is handled. The shorter answer is that it is how the IRS determines that you owe more taxes, penalties, etc. and whether and how it is going to collect the taxes, penalties, etc. from you.

By understanding the workflow, one can also understand how to go about fixing IRS problems. The recent Lambert v. Commissioner, T.C. Memo. 2020-53, court case provides an example of how cases are handled and how the procedural aspects present opportunities for resolving disputes. This court case involves a trust fund recovery penalty and how the IRS determines that the penalty should be imposed.

Facts & Procedural History

The facts are simple in this case. The petitioner was the vice president and secretary of a corporation. The corporation had employees and it withheld payroll taxes from its employees’ wages. The corporation failed to remit the withholdings to the IRS timely.

The IRS eventually sent a revenue officer to investigate and to collect the unpaid employment taxes. The revenue officer determined that the trust fund recovery penalty should be imposed on the petitioner for his failure to have the corporation remit the withholdings to the IRS (trust fund penalties are imposed by revenue officers in the IRS collections function, not IRS auditors).

The IRS eventually issued a lien notice when the trust fund penalty was not paid. The petitioner appealed the lien, which resulted in the present case. It does not appear that the petitioner challenged whether he was subject to the trust fund penalty. Rather, he challenged whether the IRS had followed the law while assessing the trust fund penalty.

Manager Approval for Penalties

The petitioner questioned whether the IRS revenue officer obtained IRS manager approval prior to assessing the trust fund penalty.

This is a Graev challenge. The term “Graev” refers to the court case wherein the court found that the failure to obtain manager approval for penalties invalidated the penalty assessment. The case involved a penalty that required the IRS to obtain manager approval before assessing the penalty. There have been several court cases for similar penalties that build upon and frame the Graev challenge (here is an example of a Graev challenge that provides further explanation).

In the present case, the court summarizes the law for a Graev challenge as follows:

Section 6751(b)(1) requires that the “initial determination” of a penalty be approved in writing by the immediate supervisor of the individual making that determination; the approval must occur before the first time the “proposed adjustments are communicated to the taxpayer formally as part of a communication that advises the taxpayer that penalties will be proposed”. Clay v. Commissioner, 152 T.C. 223, 249 (2019), appeal filed (11th Cir. Nov. 6, 2019); see also Belair Woods, LLC v. Commissioner, 154 T.C. ___, ___ (slip op. at 15-16) (Jan. 6, 2020) (“[T]he `initial determination’ of a penalty assessment will be embodied in a formal written communication to the taxpayer, notifying him that the Examination Division has completed its work and has made a definite decision to assert penalties.”).

In Chadwick v. Commissioner, 154 T.C. ___, ___ (slip op. at 11-17) (Jan. 21, 2020), we held that a TFRP assessed pursuant to section 6672(a) is a “penalty” imposed by the Code to which the requirements of section 6751(b)(1) are applicable.

As described in the court case, the Form 4183 is the document the IRS uses to record its decision to assess the trust fund recovery penalty.

In this case, the Form 4183 indicated that the revenue officer’s manager had approved the penalty one day before the revenue officer mailed the Letter 1153 to the petitioner to notify the petitioner of the penalty. The court concluded that this notation on the Form 4183 one day in advance of mailing the letter to the petitioner was sufficient to uphold the assessment.

In a prior case, Chadwick v. Commissioner, 154 T.C. 5, the court had even concluded that the signature on the Form 4183 on the same date as the Letter 1153 was issued was sufficient.

Working Trust Fund Recovery Penalty Cases

As tax attorneys in Houston, we work a lot of trust fund penalty cases. The procedural history of this case provides an outline of how to fix trust fund recovery penalties.

The easiest fix is often the best fix. Trying to convince the revenue officer to not recommend the penalty is often the first step. This may include appealing the recommendation with the revenue officer’s manager.

If the revenue officer does not agree, one has to try to obtain a copy of the Form 4183 an any case activity record. The Form 4183 and case activity record provides evidence that the penalty should not be imposed.

There could be several arguments that could be made based on these records. One would be if there is a Graev challenge, as in the present case. The petitioner in the present case could have saved a significant amount of time and effort by obtaining a copy of the Form 4183 in advance of court.

Several other possible arguments for not imposing the penalty are found in the IRS’s policy manual. IRM 5.7.4.5 sets out several factors that are to be considered by the revenue officer in recommending the penalty. These categories address most of the case law that has developed that explains when the trust fund recovery penalty applies. If any of these items are not provided in or supported by what is included in the Form 4183, these items can be raised as an argument.

These arguments may be made to the revenue officer, the revenue officer’s manager, on appeal with the appeals officer or manager from the IRS Office of Appeals, or in tax litigation with the IRS attorney or district attorney, or the judge.

If the case is assessed and then an IRS lien issued and there was no prior opportunity to make the arguments (for cases where there was no prior appeal), the collection due process hearing can allow the taxpayer to make the arguments to the settlement officer and possibly their appeals team manager. If the collection case ends up being litigated, then the taxpayer can work with the IRS attorney and their district counsel and/or the judge.

Separate from this, if there is a hardship, the taxpayer can also enlist the Taxpayer Advocate Service (“TAS”). The TAS caseworker or their manager can get involved in the case.

Each of these IRS employees has a hand in, either directly or indirectly, whether the trust fund penalty is assessed, upheld, or collectible. Each employee works in their own silo. As the trust fund recovery penalty passes from one worker to another across these silos, the taxpayer can typically raise these arguments again.

It only takes one IRS employee along the way to make a decision in the taxpayer’s favor. Finding and persuading that IRS employee to take action is the key to fixing trust fund recovery penalties.

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