Tax Form Mixup Can Extend the IRS’s Statute of Limitations

Published Categorized as Employment Tax, IRS Penalties, Tax Procedure, Trust Fund Penalties No Comments on Tax Form Mixup Can Extend the IRS’s Statute of Limitations
tax form mixup

Suppose you file a tax return and, months or years later, you get a letter from the IRS saying that it will not accept the tax return. The IRS letter says that you used the wrong tax form. And maybe even change the facts so that the IRS mailed this letter to you, but you never received it. You probably moved. Or the mail just wasn’t delivered.

The general rule is that the filing of a tax return or something similar is sufficient to start this period running. You filed a return–even if it was on the wrong form. The question is whether the statute of limitations for the IRS to assess additional tax and IRS penalties started to run.

The court recently addressed this in Lagerkvist v. United States, 1:22-cv-201-HAB-SLC (7th Cir. 2024), in the context of a Form 941 that was filed instead of a Form 944, which is an easy mistake to make and a very common mistake.

Facts and Procedural History

The taxpayer was the sole shareholder of an LLC in Indiana. By the due date for the first quarter of 2012, the taxpayer filed a Form 941, Employer’s Quarterly Federal Tax Return, to report the LLC’s payroll taxes.

The LLC also filed corresponding Forms W-2 and W-3 with the Social Security Administration to report wages and withholdings for the LLC’s employees. So the IRS had all of the information required to be on the Form 944.

On June 29, 2012, the IRS sent the taxpayer a letter saying that the Form 941 was received but not accepted. It explained that the LLC was required to file Form 944, Employer’s Annual Federal Tax Return, instead of a Form 944. The taxpayer did not file a Form 944 for 2012.

Later, the IRS conducted an audit and determined that additional payroll taxes were due. The IRS then asserted a trust fund recovery penalty against the taxpayer as owner and operator of the LLC. This is a personal penalty assessed against the taxpayer individually for the unpaid trust fund portion of the taxes (i.e., the portion of the payroll taxes that should have been withheld from the employee pay).

The taxpayer paid the penalty, filed a refund claim, and subsequently sued the government for a refund, arguing that the IRS’s assessment was untimely. The government moved for summary judgment, contending that the taxpayer never filed a return that would trigger the three-year statute of limitations for the assessment and, therefore, there was no time limit for the IRS to assess the penalty.

Employment Tax Reporting Requirements

We should first consider employment or payroll taxes. Most employers are required to report their employment tax obligations using Form 941. This form is required to be filed quarterly with the IRS.

Certain small businesses are allowed to file Form 944 instead of Forms 941. The Form 944 is intended to simplify the reporting process for these employers as it only has to be filed once a year. To be eligible for Form 944 filing, taxpayers must meet specific criteria set by the IRS. The IRS identifies eligible employers based on their past tax history and notifies them at the beginning of the tax year if they can file Form 944.

Once the IRS determines that a Form 944 is to be filed, the taxpayer must continue filing that form until notified by the IRS to switch back to Form 941. The IRS typically notifies taxpayers of their Form 944 filing requirement by letter and sends a reminder if the wrong form is filed. Taxpayers who wish to switch back to filing Form 941 must contact the IRS by phone or mail to request the change after receiving the IRS letter.

As noted by the court in this case, the IRS sent this type of letter to the taxpayer. The taxpayer did not contact the IRS to say that the LLC would file Form 941 instead of Form 944.

The Statute of Limitations

We should also pause to consider the statute of limitation rules. They are found in Section 6501 of the tax code.

Under Section 6501(a), there is a three-year statute of limitations for assessing most taxes and penalties. There are nuances, but this is the general rule applies to most types of taxes. It prohibits the IRS from assessing tax or penalties after three years.

This also applies to the trust fund recovery penalty. The statute of limitations for the IRS to assess the TFRP is generally three years from the date the Form 941 or Form 944 is filed.

Central to these rules is the concept of a tax return being filed. There are nuances as to what counts as a tax return, which is the subject of this case. But absent a tax return being filed, then there is no statute that starts to run.

This was the issue in this case. The IRS argued that the filing of Form 941 instead of Form 944 did not start the statute of limitations. To the IRS, no return was filed.

The Beard Test vs. the Quezada Test

The courts have developed a factor analysis for what qualifies as a tax return for statute of limitations purposes. This is commonly referred to as the Beard test–it is named after the court case that first announced the test. This is found in Beard v. Commissioner, 82 T.C. 766 (1984).

For a document to be a tax return under the Beard test, the document must (1) purport to be a return, (2) be executed under penalties of perjury, (3) contain sufficient data to allow calculation of tax, and (4) represent an honest and reasonable attempt to satisfy the requirements of the tax law. We have previously considered the Beard Test in the context of fraudulent returns filed by a tax protester. The courts use the test to conclude that the document filed is not actually a tax return.

The Fifth Circuit Court of Appeals developed a more liberal test in the Quezada v. IRS, 982 F.3d 931 (5th Cir. 2020) case. The Quezada Test considers a document to be a return if it contains data sufficient “(1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.”

The Combination of Returns Filed

This brings us back to the present case. The court in the present case concluded that the taxpayer did not raise an argument about the Beard Test. The court focused on the Quezada Test.

The taxpayer argued that the combination of tax returns filed satisfied the Quezada Test as it fully apprised the IRS of the information necessary to determine the trust fund penalty:

[the taxpayer] asserts that the Form 1120S gave notice as to who owed the tax because she was listed as the sole shareholder on Thrive’s Schedule K-1. (ECF No. 33 at 7). As for the second prong, she argues that the IRS could have calculated liability based on (1) “total wages paid” on lines 7 and 8 of the Form 1120S (reporting compensation of officers and salaries and wages of non-officers respectively); (2) Form 1120S’s reporting of “Payroll Liabilities” for the beginning and end of 2012; (3) the total wages paid and total withholdings reported to the Social Security Administration on Form W-3; and (4) the IRS’s knowledge of “the amount of the deposits actually made.” (Id.).

The court did not agree. It concluded that the taxpayer did not satisfy the more liberal Quezada Test.

The court found that the combination of Form 941, Form 1120S, and Form W-3 did not satisfy the requirements for a document to be considered a tax return. The court noted that the Form 1120S does not report withholding or FICA and nothing else in the Form 1120S would be sufficient to calculate the taxpayer’s trust fund liability.

While the underlying Forms W-2 attached to Form W-3 could potentially have been used to determine the total employment tax by using the information to compute the employer’s share of social security tax from the employees’ shares of social security tax withheld from wages, along with the withheld income tax, the court did not address this possibility in its analysis. The court essentially stopped short in its analysis.

The result was that the court found the trust fund penalty to have been timely assessed. The taxpayer was not entitled to a refund.

The Takeaway

The outcome of this case highlights the potential consequences for small businesses that mistakenly file Form 941 instead of Form 944. By failing to file the correct form, small businesses may unknowingly extend the statute of limitations for taxes, penalties, and even trust fund recovery penalty assessments. This is a common oversight and usually an honest mistake. This case shows that an honest mistake can lead to significant tax consequences.

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