IRS Can't Offset One Taxpayer's Deficiency Using a Related Taxpayer's Overpayment

(Parker Tax Publishing November 2019)

The Fifth Circuit held that, if the individual owner of a corporation who claimed to have paid the corporation's employment taxes, which resulted in an overpayment, could prove that he used his own funds to make the payment, the IRS would not be permitted to apply the overpayment to another portion of the corporation's tax debt but instead would have to refund the overpayment to the taxpayer. The court held that, under Code Sec. 6402(a), the IRS is allowed to setoff an overpayment only against the liability of the taxpayer that made the overpayment; however, the court remanded the case to the district court to determine if the facts supported the taxpayer's assertion that he paid the corporation's taxes using his own funds. Laird v. U.S., 2019 PTC 421 (5th Cir. 2019).

Background

A corporation's employment taxes generally consist of two parts. The trust fund tax liability is the employer's obligation to withhold personal income taxes, unemployment insurance, and social security taxes from its employees' paychecks. The non-trust fund portion is the employer's direct tax liability, for which no money is held in trust. If an employer fails to pay the trust fund liability, the IRS can impose a trust fund recovery penalty (TFRP) on the officers or employees of the employer who are responsible for the collection and payment of the tax liability.

Laird Electric Company, Inc., a Mississippi corporation, failed to make several quarterly employment tax payments spanning from 2006 to 2010. In 2014, the company's owner, Anthony Laird, sent three checks totaling $46,500 to the IRS as partial payment for the trust fund portions of the company's taxes. Each check was accompanied by instructions explaining that the payments were to be applied only to the trust fund portions of the company's tax liabilities, from the oldest unpaid quarter to the newest. The IRS initially applied the checks to the company's trust fund balance for the second quarter of 2006.

By January 2015, however, the company was still behind in its employment taxes in the amount of $380,115. Because of this unpaid debt, the IRS sent a Form 2751, Proposed Assessment of Trust Fund Recovery Penalty, to attorney Harris Barnes, who represented both the company and Laird. An accompanying letter explained that because the IRS had not received all of the company's outstanding payments, it proposed to assess a TFRP personally against Laird in the amount of $145,337.

Laird sent the IRS a check for $145,337. This check again included instructions explaining that it should be applied only to company's trust fund tax liability. It also included a form that Laird signed consenting to the assessment of the TFRP. Later, Barnes discovered that the IRS had erroneously assessed an additional $28,413 in taxes against the company for the second quarter of 2006. The IRS admitted its error and abated the additional tax as well as associated penalties and interest, resulting in a $50,026 overpayment for the second quarter of 2006. But despite the overpayment, the company remained in arrears for the non-trust fund portions of several other quarters. The IRS applied the overpayment to the non-trust fund portions of the company's outstanding obligations for other quarters. The IRS could not apply the overpayment to the company's trust fund liability because Laird's compliance with the TFRP had satisfied all of that debt.

Following all of these payments, the company had fully paid its employment taxes for the second quarter of 2006. And of the company's original $380,115 debt, Laird had now paid the trust fund portion in full via the $145,337 TFRP, leaving a remaining balance of $234,777, which constituted the non-trust fund portion. The IRS used the $50,026 overpayment to reduce part of the non-trust fund liability, but the company remained in arrears. Laird filed a claim for a refund of the overpayment, but the IRS did not respond. Laird then sued for the refund in a district court, but the district court granted the government's motion to dismiss the case. Laird then appealed to the Fifth Circuit.

Under Code Sec. 6511(a), a claim for a refund must be filed within three years from the time the return was filed or two years from the time the tax was paid. Code Sec. 6511(b)(2)(B) provides that, if a refund claim was filed after the three-year period, but within two years from the time the tax was paid, the refund is limited to the portion of the tax paid within the two years immediately preceding the filing of the refund claim. Under the voluntary payment rule in Rev. Proc. 2002-26, when a taxpayer voluntary makes a payment of tax, the IRS generally must follow a taxpayer's written instructions as to how to apply the payment. However, the IRS also has a right of setoff under Code Sec. 6402(a), which allows the IRS to use an overpayment to credit any liability on the part of the person who made the overpayment. In U.S. v. Ryan, 64 F.3d 1516 (11th Cir. 1995), the Eleventh Circuit held that the voluntary payment rule does not apply to overpayments of tax, and the IRS may disregard a taxpayer's written instructions with regard to overpayments.

Laird argued that the overpayment arose from the three checks totaling $46,500 that he had specifically instructed the IRS to apply only to the trust fund portion of the company's taxes. Laird contended that the IRS disregarded his instructions by applying the overpayment to the non-trust fund liability. Because the IRS disregarded his instructions, Laird said he was entitled to a refund of $52,038, which he claimed represented all credits for the second quarter of 2006 applied to the company's non-trust fund liabilities for other periods.

The government responded with three arguments. First, it asserted that Laird lacked standing because the company, not Laird individually, made the payments, leaving Laird himself with no financial injury. Second, it claimed that the refund amount was limited under Code Sec. 6511(b)(2)(B) to $46,500, the amount of Laird's three payments. Third, the government said that Code Sec. 6402(a) gave the IRS the right to reallocate Laird's overpayment to the non-trust fund portions of the company's taxes. The government argued that under Ryan, the voluntary payment rule yields to the IRS's setoff right in the case of taxpayer overpayments.

Analysis

The Fifth Circuit held that Laird had standing because it found that Laird's documentation strongly suggested that he personally paid the $46,500, and thus he incurred a stake in the litigation. The court also agreed with the IRS that, under Code Sec. 6511(b)(2)(B), Laird's refund claim was limited to the $46,500 total amount of his three payments. The court found that Laird's refund claim was filed outside of the three year period following the filing of the company's tax return, so the refund amount was limited to the taxes paid during the two years immediately preceding Laird's September 2015 refund claim.

On the issue of whether the IRS properly applied Laird's payments to the company's unpaid taxes, the Fifth Circuit remanded to the district court to determine whether the payments were funded by Laird or by the company. The court explained that if the payments were from Laird's personal resources, then the IRS would owe him a refund in that amount because Code Sec. 6402(a) allows the IRS to credit an overpayment against any liability "on the part of the person who made the overpayment." In the court's view, that language does not permit the IRS to offset one person's tax debt with another person's payments. Therefore, the court concluded that the source of the funds was an important fact that could render both Code Sec. 6402(a) and Ryan inapplicable. But the court remanded because it was unclear whether Laird or his company underwrote the checks. The court noted that attorney Barnes claimed not to know whose funds were paid to the bank for the cashier's checks. Further, Laird's complaint referred to both Laird and his company as the taxpayer.

For a discussion of the IRS's ability to credit overpayments to other taxes and obligations, see Parker Tax ¶261,120. For a discussion of the statute of limitations for refunds of tax overpayments, see Parker Tax ¶261,180.

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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