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January 6, 2007

IRS Interest on Employment Taxes Can be Problematic

IRS Debts

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Interest imposed by the IRS on tax debts can be problematic, as is highlighted by the recent Scanlon White, Inc. v. Commissioner case.

Scanlon White Case

In Scanlon White, the IRS took four years to deny the taxpayer’s offer in compromise for its unpaid employment tax liability. The taxpayer requested that the IRS abate the interest on the underlying tax debt, presumably from the period that the IRS was considering the taxpayer’s offer in compromise. The IRS refused. The US tax court and now the Tenth Circuit Court of Appeal upheld the IRS refusal.

Can IRS interest be abated?

As the courts note, the law is clear that the IRS does not have the authority to abate interest associated with employment taxes. Congress has granted the IRS the authority and discretion to abate interest that has arisen due to “unreasonable errors and delays by Internal Revenue Service” that relates to income taxes – not employment taxes. In other words, the IRS has the discretion to abate interest related to income taxes that results from its own delays.

Given the clarity in the law, the remedy here is to convince Congress to amend the tax code so that employment taxes are included in the provision that allows the IRS to abate interest. This amendment is necessary because, as this case illustrates, the IRS does unnecessarily delay in addressing some tax issues (admittedly, current law would provide that the IRS would be deemed to have accepted the taxpayer’s offer in compromise by default, because the IRS did not reject the offer within two years).

That raises the question as to why the IRS should be able to abate interest related to income taxes, but not employment taxes. The idea seems to be that employment taxes belong to the government and are merely held by the taxpayer until remitted to the IRS. In other words, the thought is that since some of the employment taxes are withheld from employee pay, the employer is merely the middleman who passes those funds to the IRS.

I have never really understood this position because (1) not all employment taxes are withheld from employee pay (such as federal employment taxes or FUTA) and (2) income taxes belong to the IRS too even if individual taxpayers do not remit the taxes to the IRS. Why should employers not be entitled to have the IRS consider abating interest when the IRS unreasonably delays in processing employer matters, but individual taxpayers do have this right? Isn’t an IRS delay in processing an offer in compromise for employment taxes the same as an IRS delay in processing an offer in compromise for income taxes? Perhaps the tax attorney in this case should have raised Constitutional arguments….

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