IRS Analyzes Whether Third-Party Employment Tax Returns Are Sufficient to Start Assessment Statute of Limitation

By John Keenan, J.D., and Andrew Brewster, J.D., LL.M., Washington

Editor: Valrie Chambers, Ph.D., CPA

Employment Taxes

Sec. 6501(a) generally prohibits the assessment of any tax beyond the three-year period after the date a return is filed. If the IRS fails to assess the tax within three years, then it is prohibited from collecting the tax, as well as interest, penalties, or other additions to tax that are collected as part of the tax. The critical act to commence the statute of limitation on assessment is the filing of a return, which is defined in Sec. 6501(a) as "the return required to be filed by the taxpayer (and does not include a return of any person from whom the taxpayer has received an item of income, gain, loss, deduction, or credit)." Consequently, when a document is filed with the IRS, the characterization of the document as a return can control the assessment statute of limitation and the validity of any subsequent assessment.

Recently, the IRS issued Chief Counsel Advice (CCA) 201438021, in which the Office of Chief Counsel (OCC) analyzed, under four examples, whether an employment tax return prepared and filed by a third party on behalf of an employer was sufficient to commence the period of limitation on assessment for the employer under Sec. 6501.

Third-Party Arrangements

Employers generally are required by Secs. 3402(a) and 3102 to deduct and withhold federal income tax and Federal Insurance Contributions Act (FICA) taxes from wages paid to employees and are separately liable for the employer's share of FICA taxes under Sec. 3111 (collectively referred to as employment taxes). An employer may choose to enter into an agreement with a third party to ensure that the employer's employment tax obligations of withholding, reporting, and payment are satisfied.

One common third-party arrangement is for an employer to request, pursuant to Rev. Proc. 2013-39, that the IRS authorize an agent to file employment tax returns on the employer's behalf under Sec. 3504 using the agent's employer identification number (EIN).

In another common third-party ­arrangement, an employer enters into an agreement with a third party to perform the employer's employment tax obligations under the third-party payer's EIN but without receiving authorization from the IRS to do so. In these cases, the IRS may designate certain third-party payers under Regs. Sec. 31.3504-2 to perform the acts required of an employer with respect to wages or compensation paid by the third-party payer to any individual performing services for any employer. The third party becomes the agent of the employer, and both parties assume responsibility for filing and payment.

Four Examples

In CCA 201438021, the OCC set out the following four examples involving arrangements between an employer and a third party to illustrate the rules regarding whether the third party's filing with the IRS was sufficient to commence the running of the statute of limitation on assessment for the employer.

Example 1. Facts: An employer has authorized an agent to act on its behalf with Form 2678, Employer/Payer Appointment of Agent. The Form 2678 is signed by both the employer and the agent. The form is approved by the IRS, making both parties responsible for fulfilling the employer's employment tax filing and payment obligations. The agent files an aggregate Form 941, Employer's Quarterly Federal Tax Return, with its own EIN and attaches Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers,on which it allocates the amount shown on Form 941 among all the employers it represents.

Example 2. Facts: An employer has authorized an agent to act on its behalf with an approved Form 2678. The agent files an aggregate Form 941 with its own EIN but does not attach Schedule R.

Example 3. Facts: An employer does not have an approved Form 2678 in place with respect to a third-party payer. However, the IRS has designated, pursuant to Regs. Sec. 31.3054-2, the third-party payer to perform the acts required by the employer. The payer files an aggregate Form 941 with its own EIN but does not attach Schedule R. The employer does not file its own Form 941.

Example 4. Facts: An employer does not have an approved Form 2678 in place with respect to a third-party payer, which files a Form 941 using its own EIN on which it includes wages or compensation that it paid for the employer. The third-party payer does not qualify under Regs. Sec. 31.3054-2 for a designation by the IRS to perform the acts required by the employer. The employer does not file its own Form 941.

Return Requirements

The statute of limitation on assessment in Sec. 6501(a) begins to run with the filing of a return. But not all filings qualify as a "return" under that section.

Congress has granted the IRS broad authority to determine what information should be submitted with a tax return and how that information should be submitted. Sec. 6011(a) states:

When required by regulations prescribed by the Secretary any person made liable for any tax imposed by this title, or with respect to the collection thereof, shall make a return or statement according to the forms and regulations prescribed by the Secretary. Every person required to make a return or statement shall include therein the information required by such forms or regulations.

The IRS's broad authority to prescribe the manner of filing has been recognized by the Supreme Court. In Lane-Wells Co., 321 U.S. 219 (1944), the Court stated:

Congress has given discretion to the Commissioner to prescribe by regulation forms of returns and has made it the duty of the taxpayer to comply. It thus implements the system of self-assessment which is so largely the basis of our American scheme of income taxation. The purpose is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished. [Lane-Wells Co., 321 U.S. at 223.]

Although the IRS has broad authority to determine what information should be submitted with a tax return and how that information should be submitted, the issue of what constitutes a valid return to commence the assessment statute of limitation has been litigated frequently. The current test used by courts for determining whether a return is valid under Sec. 6501 is outlined in Beard, 82 T.C. 766 (1984). For a document filed with the IRS to be considered a valid return sufficient to begin the limitation period of Sec. 6501, it must:

  1. Have sufficient data to calculate the tax liability;
  2. Purport to be a return;
  3. Be an honest and reasonable attempt to satisfy the requirements of the tax law; and
  4. Be executed under penalties of perjury (Beard, 82 T.C. at 777).
Analyses of the Four Examples

The OCC applied the Beard factors to the four examples to determine whether, in its opinion, the filings described in each case would be sufficient to qualify as returns.

Example 1. Conclusion: Because the employer had an approved Form 2678 on file with the IRS, the agent was authorized to file a return on behalf of the employer, thereby meeting the Beard requirement that a filing purport to be a return. In addition, because the filing included both Form 941 and Schedule R, the IRS had all the necessary information to determine the employer's liability, thereby meeting the data sufficiency requirement of Beard. As a result, the IRS concluded the filing described in Example 1 would be sufficient to start the limitation period described in Sec. 6501.

Example 2. Conclusion: Unlike in Example 1, the third-party agent did not file a Schedule R. As a result, the IRS was provided with the gross amount paid by the third party but had no way of determining to which employer(s) the payments should be allocated. Because of this omission, the IRS concluded that the data sufficiency requirement of Beard had not been satisfied and the filing did not constitute a return. As a result, the OCC concluded that the filing described in Example 2 would be insufficient to begin the running of the Sec. 6501 statute of limitation for the employer.

Example 3. Conclusion: As in Example 2, the IRS concluded that because only aggregate data were provided, the filing had insufficient information to constitute a return and, therefore, would not start the running of the period of limitation in Sec. 6501. The OCC noted that in this example, the IRS would have even less data than in Example 2, where, although the IRS did not have details on the payments, it could at least determine to which employer(s) the filings related, based upon the previously filed Forms 2678. The IRS concluded that the filing described in Example 3 would be insufficient to begin running the limitation period in Sec. 6501 for the employer.

Example 4. Conclusion: In this example, the IRS did not analyze the sufficiency of the data provided in the filing. Because the third party had no authorization to file on behalf of the employer (and as a result, had no liability for the employer's taxes), the IRS concluded that the third party was not authorized to sign the return and, as a result, the return was insufficient to start the assessment statute of limitation for the employer.

Conclusion

Because the IRS has broad authority under Sec. 6011 to dictate the form of filing for returns, taxpayers should take care to ensure that their filings are sufficient to meet IRS standards. IRS acceptance of a filing as a return is crucial because a valid return is necessary to start the statute of limitation period under Sec. 6501.

That the IRS has three years to assess taxes is a well-known rule, but the complexities of that rule are not equally well-known. As a result, taxpayers can be unpleasantly surprised to discover, years later, that the IRS still considers the assessment statute open for a year the taxpayer had thought was closed. As illustrated by this CCA, this problem is compounded when third-party filers are involved, because unseen missteps by those third parties can have far-reaching impacts on taxpayers.

This publication contains general information only, and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

Contributors

Valrie Chambers is an associate professor of accounting at Stetson University in Celebration, Fla. Andrew Brewster is a manager in the Tax Controversy Services group for Deloitte Tax in Washington. John Keenan is the managing director of the Tax Controversy Services Group in the Washington National Tax Office of Deloitte Tax LLP. Mr. Keenan is a member of the AICPA IRS Advocacy & Relations Committee. For more information about this column, contact Prof. Chambers at valrie.chambers@stetson.edu.

 

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