If you owe a third party for several different items and you voluntarily pay a debt, you should get to designate which item the payment is to be applied to. This is the general rule for voluntary payments made to the IRS. But according to IRS Action on Decision 2014-01, the IRS will not follow this general rule in some cases.
The Dixon Case
The IRS’s action of decision is in response to the court’s holding in Dixon v. Commissioner, 141 T.C. 3 (2013). The taxpayers in Dixon did not file or pay their employment or income taxes. The Dixon’s were criminally prosecuted for not filing their income tax returns.
They attempted to pay their income tax liabilities as part of the plea negotiations. They did so by paying funds to their business and having the business remit the funds to the IRS. The business did this, specifically designating the payments as income tax payments withheld from the taxpayers.
The taxpayers likely had the business file in this manner to shift the tax liability to the business entity, rather than to them personally. This may be the case as the owners would get credit for withholding taxes, but not for the business’ income or employment taxes.
The IRS applied the payments to the taxpayers employment tax liabilities–not their income tax liabilities.
Litigation ensued. The court concluded that the IRS erred in applying the payments to the taxpayers employment tax liabilities, as the taxpayers had specifically designated the payments as withholdings for the taxpayers income taxes.
The IRS’s Reasoning
The IRS disagrees with the court’s holding. It does not believe it is bound by the business’ ability to designate how tax payments are applied.
It’s reason for this is that the payment made by one taxpayer cannot be designated by that taxpayer on behalf of another taxpayer, namely, the business cannot designate payments for its owners. The IRS cites Rev. Proc. 2002-26 for the proposition that a taxpayer can only designate its own voluntary tax payments.
The IRS issued its action of decision to put taxpayers on notice that it would not follow the Dixon holding.
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