IRS Required to Honor Designation of Employment Taxes
(Parker Tax Publishing: October 4, 2013)

A company's designation of delinquent employment tax payments towards its owners' past income tax liabilities discharged those liabilities in full and the IRS's proposal to levy on the owners' assets to collect the tax a second time was an abuse of discretion. Dixon v. Comm'r, 141 T.C. No. 3 (9/3/13).

James and Sharon Dixon were criminally prosecuted for failure to file individual income tax returns for 1992-1995. At the time, the Dixons were owners, officers, and employees of Tryco Corporation, which failed to file employment tax returns and corporate income tax returns during this period. As part of a plea agreement with the Department of Justice, the Dixons agreed that their wrongdoing had inflicted a tax loss on the IRS of $61,021 and acknowledged that they could be required to make restitution of this amount.

On advice of their attorney, the Dixons transferred funds to Tryco with instructions that Tryco remit the funds to the IRS. In December 1999, Tryco sent $61,021 to the IRS with a cover letter from the Dixons' attorney designating the payment as payment of [Form] 941 taxes of the corporation that was to be applied to the withheld income taxes of the Dixons for specified calendar quarters of 1992-95.

In early 2000, the Dixons' accountants determined that the Dixons actually owed $30,202 more in individual income tax for 1992-1995 than Tryco had remitted to the IRS in December 1999. Accordingly, the Dixons transferred additional funds to Tryco, and in June 2000, Tryco remitted to the IRS an additional check for $30,202. The cover letter from the Dixons' attorney stated that the payment was submitted as a preassessment designated payment of [Form] 941 taxes of the corporation which represents the withheld income taxes of the Dixons for the fourth quarter of 1995. The Dixons argued for a downward adjustment to their sentence and for a probated sentence on the ground that they had remitted taxes to the IRS in excess of the tax loss determined in the plea agreements. They were sentenced to probation and a small fine.

The IRS subsequently filed a notice of intent to levy on the Dixons' assets in satisfaction of their assertedly unpaid 1992-95 income tax liabilities. The Dixons were granted a collection due process (CDP) hearing in which they challenged the levy on the ground that Tryco's 1999-2000 remittances had discharged their 1992-95 income tax liabilities in full. The Appeals officer upheld the levy, concluding that Tryco's 1999-2000 payments were not withheld at the source and could not be designated to the withholding of a specific employee. The Dixons filed a petition under Code Sec. 6330(d)(1) asking for a review of this determination.

Code Sec. 31(a)(1) sets forth the consequences for the employee of the employer's withholding at the source. It provides that the amount withheld by the employer as tax from an employee's wages is allowed to the recipient of the income as a credit against his or her income tax liability for that year. Under Reg. Sec. 1.31-1(a), this credit is available only if the tax has actually been withheld at the source.

The Tax Court held that the Dixons were not entitled to a credit under Code Sec. 31(a) for the $91,223 Tryco remitted to the IRS in 1999-2000 because that amount was not actually withheld at the source by Tryco from the Dixons' wages during 1992-95. However, the court also held that the IRS was required to honor Tryco's designation of its 1999-2000 delinquent employment tax payments towards the Dixons' income tax liabilities for 1992-95. Because those payments discharged the Dixons' 1992-95 income tax liabilities in full, the Tax Court held that the IRS's proposal to levy on the Dixons' assets to collect this tax a second time was an abuse of discretion.

OBSERVATION: Code Sec. 31(a)(1) and Reg. Sec. 1.31-1(a) provide a credit to employees against their income tax obligation with respect to their wages if that tax is deducted and withheld at the source, even if their employer failed to remit it to the government. Under Code Sec. 31(a)(2), that amount so withheld during any calendar year is allowed as a credit for the tax year beginning in such calendar year. Thus, the effect of the Dixons' position would let the corporation's late payment of the withholding tax not only satisfy their income-tax debt, but also cancel the portion of that debt that consisted of compounded interest.

For a discussion of the credit for federal tax withheld on wages, see Parker Tax ¶103,301.

Parker Tax Publishing Staff Writers

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