IRS Issues Nonacquiescence in Employment Tax Withholding Case.
(Parker Tax Publishing September 17, 2014)

The IRS will not follow the Tax Court's holding in Dixon v. Comm'r, 141 T.C. No. 3 (2013), because it contends that it is not obligated to honor an employer's designation of delinquent employment tax payments toward a specific employee's income tax liability. AOD 2014-01 (8/29/14).

Under the facts in Dixon, James Dixon and his wife, Sharon, were owners, officers, and employees of Tryco Corporation. From 1992 through 1995, Tryco failed to file employment tax returns and pay its employment taxes, including income tax withholding on employee wages. During the same period, the Dixons failed to file their individual income tax returns and pay their individual income taxes. The Dixons were criminally prosecuted for failing to file their income tax returns, and during the plea negotiations, they attempted to pay their delinquent individual income taxes in full. Instead of paying these taxes directly, they transferred funds to Tryco and Tryco used these funds to pay some of its delinquent employment taxes. Tryco additionally designated the payments to be applied to the "withheld income taxes" of the Dixons.

The plea agreements and sentencing in the criminal proceeding reflected that, as a result of the payments by Tryco, the Dixons' income taxes were mostly satisfied. However, the IRS applied the payments only to Tryco's unpaid employment tax liabilities and did not give the Dixons credit toward their income tax liabilities. The IRS sent a notice of intent to levy and right to a hearing to the Dixons with regard to their unpaid income tax liabilities. In its notice of determination, the IRS Appeals Office sustained the levy as to the payments that it determined represented tax not withheld at the source, concluding that on that basis, the Dixons were not entitled to a credit under Code Sec. 31(a) for taxes paid, and Tryco could not designate any of the payments that were not withheld at the source to the income taxes owed by the Dixons. The Dixons took their case to the Tax Court.

The Tax Court disagreed with IRS. According to the court, most of Tryco's payments represented tax actually withheld at the source within the meaning of Code Secs. 3402 and 3403, and therefore, as to these payments, the Dixons were entitled to a credit under Code Sec. 31(a) toward their income taxes. The court held that the IRS was required to honor Tryco's designations of these payments and credit the payments to the Dixons' income tax liabilities. The Tax Court reasoned that Tryco's designation of its payments to the income tax liabilities of specific employees was consistent with IRS policy and federal case law that permits a taxpayer's designation of voluntary payments of tax. The court also concluded that disregarding the designations would be inconsistent with the premises of the plea agreements and sentencing.

Generally, under Code Sec. 6330, no levy may be made on the property of the taxpayer without first giving the taxpayer an opportunity for a hearing before IRS Appeals. At the hearing, the taxpayer may raise any relevant issue relating to the unpaid tax or proposed levy. The Dixons had a CDP hearing and, at the hearing, the Dixons argued that their tax liability was paid by Tryco during the criminal proceedings.

In AOD 2014-01, the IRS said it disagrees with the Tax Court's decision that employment tax payments that were not withheld at the source may be designated by an employer to a specific employee's income tax liability. As a result, the IRS recommended nonacquiescence to the Dixon decision. According to the IRS, an employee may only get a credit for income taxes withheld at the source. If the income tax is not withheld at the source, a later payment by the employer of its liability for the tax it should have withheld does not result in a credit to the employee. In the absence of a statutory credit, the IRS said the Dixons could not rely on the rule allowing designation of partial voluntary payments. That rule, the IRS said, only allows a taxpayer to designate a payment toward its own tax liabilities, such as where an employer designates a payment of employment taxes toward the trust fund portion of its employment tax liability. According to the IRS, Tryco could not designate that its employment tax payments be applied to the income taxes of the Dixons because such income taxes were owed by the Dixons, and not Tryco. Thus, the IRS said it will not follow the holding in Dixon that an employer can designate payments of its employment taxes to income taxes of specific employees, and effectively override the statutory limitations in the availability of a credit under Code Sec. 31(a). The IRS also said it would not pursue an appeal of the Dixon decision due to the unique facts in that case.

For a discussion of the rules relating to the credit for federal income taxes withheld at source, see Parker Tax ¶103,301. (Staff Editor Parker Tax Publishing)

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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