Employment / Payroll tax penalty abatement, Payroll tax problem, Abate tax penalty

Employment tax penalty abatement, Payroll tax problem, Abate tax penalty

Court says bank error (not employee error) may be reasonable cause to abate employment tax assessment

Mike Habib, EA

Don Johnson Motors, Inc. v. U.S., DC TX, 101 AFTR 2d 2008-370, Civil Action No. B-06-047, 12/21/07


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A Texas U.S. district court has ruled that employment tax penalties and interest for the 1999-2002 tax years could not be abated due to reasonable cause, even though the taxpayer was unaware that its in-house accountant and its office manager had failed to perform their payroll tax duties. However, there may be reasonable cause to abate an employment tax assessment for the 2003-2004 tax years because of a bank error.

Employee Errors
Facts. From 1999 to 2002, Don Johnson Motors, Inc. (Don Johnson) delegated its payroll tax functions to an in-house accountant, Michael Ezequiel, who performed his role under the supervision of the company’s office manager. Ezequiel prepared the company’s employment tax returns and was also in charge of monitoring the payroll accounts and the information included on Forms 940 and 941. At some point in 1999, for reasons not explained, Ezequiel stopped paying portions of the company’s payroll taxes to the IRS. As a result, Don Johnson Motors made incomplete deposits to the IRS from 1999-2002. The executives of Don Johnson Motors were unaware of this problem until December 2002. Shortly thereafter, the IRS assessed penalties against the company for failure to file employment tax returns and to timely pay taxes.

Law. IRC §6651(a) allows an employer to avoid penalties for noncompliance if it can show that its failure to file, pay, or deposit taxes was due to “reasonable cause” and not willful neglect. Don Johnson Motors requested an abatement of the aforementioned penalties based on IRC §6651(a) .

Ruling. The district court denied the taxpayer’s abatement request. In issuing its ruling, it noted that other federal courts have consistently held that the failure of a taxpayer’s employee to file or pay taxes does not establish reasonable cause (e.g., see McMahan v. Commissioner, 114 F. 3d 366 (1997), and Conklin Bros. of Santa Rosa, Inc. v. U.S., 986 F. 2d 315 (1993)).

The district court also distinguished the current ruling from In the Matter of American Biomaterials Corporation, 69 AFTR 2d 92-611 (1992). In American Biomaterials, the Third Circuit Federal Court of Appeals ruled that there may be reasonable cause to abate employment tax penalties when corporate officers commit criminal acts (e.g., embezzlement) against the corporation. The district court distinguished the current ruling from that one by pointing out that Don Johnson Motors had never presented any evidence that its in-house accountant and its office manager had engaged in any criminal action. The district court said that the employment tax deficiencies incurred by Don Johnson Motors simply resulted from having “lax internal controls or failing to secure competent external auditors that even the court in American Biomaterials stated was insufficient to establish reasonable cause.”

The district court also rejected the taxpayer’s argument that there was reasonable cause to abate the penalties because of the lack of notification from the IRS that the company was falling behind in its tax obligations. The court cited IRC §6151 and said that the IRS was under no obligation to provide taxpayers with notice that they failed to file their returns or pay their taxes.

Bank Error
The IRS also assessed penalties against Don Johnson Motors for untimely employment tax deposits for the 2003 and 2004 tax years. The company was required to pay its taxes electronically using the Electronic Federal Tax Payment System (EFTPS). The company was provided with new software by its bank for EFTPS transactions. The bank sent one individual over to Don Johnson to train the company on the software. The trainer had been employed with the bank for two days. The software required the tax period to be entered in two separate fields or the deposit would not be made by the bank. This fact was not mentioned to company employees. Consequently, the bank did not make any of the taxpayer’s employment tax deposits for the period in question.

The IRS assessed penalties against Don Johnson Motors for failing to make its deposits on a timely basis. An IRS revenue officer reviewed this situation and determined that the assessment was proper. Don Johnson Motors appealed the ruling to the district court.

The district court said that there may be reasonable cause to abate the penalties because none of the previous rulings on this matter had considered the bank’s concession that it had failed to properly train Don Johnson employees. The court also noted that: (1) Don Johnson had provided the bank with the information necessary to make the company’s employment tax deposits in a timely manner, and (2) there were sufficient funds in the company’s bank accounts to make the deposits. According to the EFTPS handbook, these two facts provide sufficient evidence to establish reasonable cause. As a result, the court remanded the case back to the IRS for further consideration as to whether the penalties should be abated.

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