Our Federal tax laws often look to state law. Differences in state law can expand or limit the IRS’s ability to assess and collect Federal taxes.
In Patrick’s Payroll Services, Inc. v. Commissioner, T.C. Memo. 2020-47, the court considers whether a defunct Michigan corporation can bring suit against the IRS.
This case provides an opportunity to consider what Texas law differs from Michigan law and the implications for businesses in Texas.
Facts & Procedural History
The taxpayer was a Michigan corporation. The corporation functioned as a payroll company for a security guard business. It treated the security guard business’ employees as its own employees and filed the Forms W-2, payroll tax returns, etc. for the employees.
For 2010 and 2011, the taxpayer failed to file its payroll tax returns and failed to remit payroll taxes to the IRS.
The taxpayer corporation was dissolved with the state in 2013.
The IRS audited the corporation in 2015. In 2017, the IRS assessed nearly $1 million in employment taxes and penalties thereon.
The taxpayer filed a collection due process hearing request for the unpaid taxes. In 2018, the IRS Office of Appeals held the hearing. The taxpayer allegedly failed to provide records to the Appeals Office, which resulted in the case being closed. Litigation ensued in the U.S. Tax Court.
Standing to Bring Suit
The U.S. Tax Court’s opinion starts with the jurisdictional question. The question is whether the taxpayer, a defunct corporation, has standing to sue the IRS in U.S. Tax Court.
This is an important question as a taxpayer who does not have standing cannot bring a lawsuit against the IRS. The court will typically dismiss the case before even getting to the merits of the case.
As noted by the court, the U.S. Tax Court looks to state law to determine whether a defunct entity has standing to bring suit.
In Michigan, the law provides a defunct corporation with a “reasonable period” for winding up its affairs. This allows the corporation to bring a lawsuit in winding up its affairs.
In this case, the U.S. Tax Court concludes that bringing suit in 2018 for taxes due from 2010 and 2011 was within a “reasonable period” of time. The court did not look to the tax years in making this determination. Rather, it looked to the time that the IRS assessed the tax. The IRS assessed the tax in 2017 and the corporation filed suit a year later.
Standing for Defunct Corporations in Texas
While Michigan law provides for a “reasonable period” and does not define what time period that is, what about Texas law? How does Texas law handle this issue?
The answer is in Texas Business Organizations Code § 11.356. It provides that:
the terminated filing entity continues in existence until the third anniversary of the effective date of the entity’s termination only for purposes of:
(1)?prosecuting or defending in the terminated filing entity’s name an action or proceeding brought by or against the terminated entity;
Thus, a taxpayer has three years from the date of the date the business is terminated to bring suit. This includes three years to bring suit against the IRS in the U.S. Tax Court.
If the corporation in this case had been formed in Texas rather than Michigan and it had terminated its business in 2013, it would not have standing to sue the IRS in 2018. It would be out of luck.
The IRS’s Ability to Collect from Businesses in Texas
On first glance, the Texas rule may seem unfair. A taxpayer formed in Michigan is allowed to bring suit to challenge the IRS’s determination after three years, but a taxpayer formed in Texas cannot.
The collection rules reverse this inequity. While the Texas corporation may not be able to bring suit to challenge the IRS’s determination after three years, the owner of the Texas corporation is no longer liable for the corporation’s liabilities after three years. This can cut off some of the IRS’s collection options as many of these options look to state law. While it may be easier for the IRS to assess the tax against a Texas corporation, it may be harder for the IRS to collect the tax.
It should be noted that the IRS has other means for collecting after this period of time, such as imposing trust fund recovery penalties against the corporate owners and officers. The trust fund penalty only applies to the employee withholding portion of the taxes, which is typically less than half of the amount of the employment taxes owed.
Terminating Texas Corporations
Texas corporations that are likely to go out of business and owe the IRS back taxes, particularly unpaid payroll taxes, are usually better off filing their tax returns timely. This starts a three year period for the IRS to assess the taxes (and trust fund penalty) under Federal law.
They should also terminate the corporation with the State of Texas sooner rather than later. This will start the three year period under state law noted above.
If it turns out that the taxpayer needs to bring suit against the IRS, the taxpayer can take steps to reinstate the entity at that point. As this case shows, in many cases, the taxpayer has plenty of time to do so. The IRS generally does not issue the final collection due process hearing notice until several months after the hearing is unsuccessful.