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Statute of Limitations Bars Backup-Withholding Assessment Despite Business Owner's Failure to File Form 945
(Parker Tax Publishing December 2020)
The Fifth Circuit reversed two lower courts and held that the time for assessing a business owner's backup-withholding liability had expired, despite his failure to file Form 945 for the tax years in question. The court concluded that because his Forms 1040 and 1099 contained data sufficient (1) to show that the owner was liable for backup-withholding taxes assessed by the IRS, and (2) to calculate the extent of the owner's backup-withholding liability, those forms constituted "the return" that triggered the three-year statute of limitations period. Quezada v. IRS, 2020 PTC 382 (5th Cir. 2020).
Background
James Quezada, a bricklayer and the owner of Quezada Masonry, builds masonry projects for general contractors. Quezada typically supplies the materials and hires contract laborers and subcontractors to perform the labor. From 2005-2008, Quezada filed tax returns, including Forms 1099-MISC, in which he reported and deducted payments made to subcontractors. Those Forms 1099 showed no withholdings on payments made to subcontractors, and Quezada did not file Forms 945, Annual Returns of Withheld Federal Income Tax, for those years. In addition, Quezada did not obtain social security numbers (SSNs) or taxpayer identification numbers (TINs) from all of his subcontractors.
The IRS sent Quezada several notices which said that, if he had missing or incorrect TINs, he had to start backup withholding. Quezada did not provide the missing or incorrect TINs for the tax years 2005 through 2008, or provide backup withholding. In February 2014, the IRS assessed Quezada's backup withholding tax liability for 2005-2008 totaling $1,269,561, including penalties and interest, pursuant to Code Sec. 3406. In 2016, Quezada and his wife filed for bankruptcy under Chapter 11 of the Bankruptcy Code. Quezada subsequently filed a complaint challenging the assessment of the backup withholding tax and his case went before a bankruptcy court. According to Quezada, his filing of Forms 1099 and 1040 began the three-year statute of limitations under Code Sec. 6501, which prohibits tax assessments made after the statute of limitations has closed. Thus, he argued, he was not liable for the backup withholding tax liability.
Code Sec. 6501(a)(3) imposes a three-year tax-assessment-limitation period beginning on the date a taxpayer files a "return required to be filed." Code Sec. 6011 requires a taxpayer to file a return in accordance with the forms and regulations prescribed by the IRS. Under Reg. Sec. 31.6011(a)-4, a person required to withhold backup withholding tax must file a Form 945. In addition, Code Sec. 3406 requires a payor to conduct backup withholding when a payee fails to provide the payor with a TIN.
In Quezada v. IRS, 2018 PTC 297 (Bankr. W.D. Tex. 2018), a bankruptcy court held that the taxes assessed on Quezada by the IRS were valid, allowed, and non-dischargeable. The court concluded that Quezada failed to prove that he had the required TINs when he filed Forms 1040 and 1099 for tax years 2005 through 2008. According to the bankruptcy court, because Quezada had a duty to withhold, he was required to file Forms 945 for tax years 2005 through 2008, rendering his tax filings for those years incomplete. The bankruptcy court further determined that Quezada's statute of limitations argument was controlled by the Supreme Court's reasoning in Comm'r of Internal Revenue v. Lane-Wells Co., 321 U.S. 219 (1944), because Quezada, like the taxpayer in Lane-Wells, was required to file two separate returns and failed to file one of them. In that decision, the Supreme Court noted that Congress granted the IRS discretion to prescribe by regulation forms of returns, the purpose of which is not just to get tax information, but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished. Quezada appealed to a Texas district court.
On appeal, the sole issue before the district court was whether the filing of Forms 1099 and 1040 by Quezada began the three-year statute of limitations under Code Sec. 6501. Quezada argued that his filings of Forms 1099 and 1040 were "returns" sufficient to trigger the three-year statute of limitations, and that his failure to file Forms 945, which Quezada asserted were not required, had no bearing on the start of the statute-of-limitations period. Quezada also argued that the bankruptcy court erred in relying on Lane-Wells because that case involved a two-level tax issue for limitations purposes whereas Quezada's case involved only one.
The IRS argued that Form 945 is the form that Reg. Sec. 31.6011(a)-4(b) prescribes for reporting backup withholding and, thus, is the "return required to be filed by" a taxpayers who, like Quezada, are required to backup withhold. Because Quezada failed to file a Form 945, the IRS said, he never filed "the return," and the limitations period never began to run under Code Sec. 6501(a)'s general rule. In In re Quezada, 2019 PTC 386 (W.D. Tex. 2019), the district court rejected the assertion that the consequences of procuring an incorrect TIN from a payee or collecting incorrect backup withholding were irrelevant to the calculation of Quezada's deductions for business income and expenses as provided in his Forms 1040. By filing his Forms 1040 and 1099, the court said, Quezada met the first level of his tax liability. However, because Quezada's Forms 1099 were missing the TlNs from some of his subcontractors, a second-level duty to collect backup withholding was triggered, requiring Quezada to file Forms 945 for tax years 2005 through 2008. Because Quezada was required, but failed, to conduct backup withholding and file Forms 945, the district court found that the statute of limitations was not triggered. Therefore, the taxes assessed by the IRS were valid, allowed, and non-dischargeable. Quezada appealed to the Fifth Circuit.
Before the Fifth Circuit the IRS invoked Lane-Wells, which the IRS said creates a per se rule requiring the taxpayer to file the return designated for the tax liability at issue and, if the taxpayer does not file that specific return, the limitations clock never begins to run.
Analysis
The Fifth Circuit reversed the lower courts' decisions and held that, because Quezada's Forms 1040 and 1099 contained data sufficient (1) to show that he was liable for backup-withholding taxes assessed by the IRS, and (2) to calculate the extent of his backup-withholding liability, those forms constituted "the return" that triggered the three-year statute of limitations period.
The court took issue with the IRS's assertion that Form 945 is the only document that can constitute "the return" for purposes of applying the statute of limitations. Indeed, the court read the Supreme Court's decision in Lane-Wells differently than the IRS. There, the taxpayer filed corporate returns but failed to file personal holding company returns in the mistaken belief that it was not a personal holding company. The IRS assessed some of the taxes more than three years after the taxpayer filed corporate returns for the relevant tax years. So, if the corporate returns started the limitations clock, the IRS would have been barred from collecting some of the taxes. The Supreme Court ruled for the IRS, holding that the corporate returns did not start the limitations clock. The Fifth Circuit noted that, in so holding, the Court emphasized that "the returns did not show the facts on which liability would be predicated." Given that emphasis, the Fifth Circuit found unpersuasive the IRS's contention that Lane-Wells eliminated the possibility that a form other than the one prescribed by treasury regulations can be "the return." The court noted that the IRS did not cite any opinion that adopted its reading of Lane-Wells. In fact, the court said, the IRS's reading clashed with the readings of several circuits which have recognized that a form other than the one prescribed by regulations can be "the return."
Accordingly, consistent with a plurality of its sister circuits, the Fifth Circuit said that the better reading of Lane-Wells is that the taxpayer is not required to file the precise return prescribed by regulations in order to start the limitations clock. Instead, "the return" is filed, and the limitations clock begins to tick, when the taxpayer files a return that 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.
In looking at whether Quezada's Forms 1040 and 1099 contained data sufficient to show that he was liable for the backup-withholding taxes assessed, the court quickly concluded that the forms did. The IRS could determine that Quezada was liable for backup-withholding taxes by looking to the face of his Forms 1099 and, if a particular form lacked a TIN, then Quezada was liable for backup-withholding taxes applied to the entire amount he paid to that subcontractor. The court then asked whether Quezada's Forms 1040 and 1099 contained data sufficient to calculate the extent of Quezada's backup-withholding liability. The court found that those forms disclosed two things: first, the amount Quezada paid each individual subcontractor, and second, whether Quezada obtained a TIN for the particular subcontractor. For every Form 1099 Quezada filed with a blank TIN line, the backup-withholding requirement applied to the entire amount paid to that subcontractor. For each subcontractor who failed to supply a TIN, the court found that the IRS could determine the amount Quezada should have backup withheld by multiplying the statutory flat rate for backup withholding by the amount Quezada paid the subcontractor.
Accordingly, the court concluded that, because Quezada's Forms 1040 and 1099 contained data sufficient (1) to show that Quezada was liable for the backup-withholding taxes assessed, and (2) to calculate the extent of Quezada's back-up withholding liability, those forms constituted "the return" that triggered the tree-year statute of limitations period. Because the IRS assessed Quezada's backup-withholding liabilities more than three years after Quezada filed Forms 1040 and 1099 for the relevant tax years, the Fifth Circuit held that the assessment was barred by the statute of limitations period.
For a discussion of the statute of limitations period, see Parker Tax ¶260,130. For a discussion of backup withholding and the requirement to file Form 945, see Parker Tax ¶251,503.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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