IRS limits employer access to employee tax payment information

Editor: Mark G. Cook, CPA, CGMA

On May 5, 2017, the IRS Chief Counsel’s Office issued Chief Counsel Advice (CCA) 201723020, stating that the Tax Court’s decision in Mescalero Apache Tribe, 148 T.C. No. 11 (2017), may not be relied upon by taxpayers or their representatives to require the Service to provide workers’ return information during employment tax audits, during either the examination process or Appeals consideration.

Background

In Mescalero Apache Tribe, the tribe was audited by the IRS under the suspicion that some of its contractors who were issued Form 1099, Miscellaneous Income, were really employees. Reclassification would make the tribe liable for employment taxes for its workers whom it improperly labeled as contractors. The tribe tried to take advantage of Sec. 3402(d), which allows an employer in such a situation to escape liability for tax it failed to deduct and withhold from employees’ wages if it can show the tax was paid. One way to do this is to ask each worker to complete Form 4669, Statement of Payments Received. The tribe tried to do that, but it was only partly successful because many of its former workers had moved, and some lived in hard-to-reach areas.

Sec. 3402(a) requires every employer to deduct and withhold a tax on the wages it pays. The employer itself is liable for this withholding tax, and the employee gets a credit on his or her income tax liability for the money withheld by the employer from the employee’s paycheck. If an employer misclassifies its employees as independent contractors, it can incur a large liability because it will not have collected and paid over the withholding tax for the misclassified employees. Employers can avoid liabilities if an employee paid the tax on his or her income even though it was not withheld. Sec. 3402(d) provides that “[i]f the employer, in violation of [Code provisions], fails to deduct and withhold the tax . . . and thereafter the tax against which such tax may be credited is paid, the tax required to be deducted and withheld shall not be collected from the employer.”

The tribe moved to compel discovery of the return information of the workers from whom it could not obtain completed Forms 4669. The IRS objected to the tribe’s request, claiming that it was barred under Sec. 6103, that the burden of proof with respect to Sec. 3402(d) remains entirely on the taxpayer, and that the production of the requested information would place a burden on the IRS. Sec. 6103(a) provides a general rule that returns and return information shall be kept confidential.

A “return” for this purpose is “any tax or information return, declaration of estimated tax, or claim for refund.” “Return information” includes the nature, source, and amount of receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments. However, there are exceptions under Sec. 6103(h)(4), including that a return or return information may be disclosed in a federal or state judicial or administrative proceeding pertaining to tax administration, but only if (1) the taxpayer is a party to the proceeding; (2) the proceeding arose out of, or in connection with, determining the taxpayer’s tax liability or its collection; (3) the treatment of an item reflected on the return is directly related to resolving an issue in the proceeding; or (4) if the return or return information directly relates to a transactional relationship between a person who is a party to the proceeding and the taxpayer, and that relationship directly affects the resolution of an issue in the proceeding.

The Tax Court focused its inquiry on the third and fourth requirements. The court determined that the requested return information was disclosable in the judicial proceeding because it was directly related to a transactional relationship between the tribe and the workers, and that the return information showing whether the workers paid the taxes directly related to the resolution of the tribe’s income tax withholding liabilities. The court determined that the workers’ return information was discoverable after the tribe showed that it had made a significant effort to locate the workers and that it had failed only with respect to a relatively small number of them.

The Office of Chief Counsel advised in the CCA that Mescalero Apache Tribe does not stand for the proposition that taxpayers and/or their representatives are entitled to workers’ return information during an employment tax audit or at the Appeals consideration level. The Mescalero Apache Tribe decision is limited, the CCA stated, to worker return information requested during the discovery process in Tax Court proceedings where the court can determine that the requested information is disclosable under Sec. 6103(h)(4) and balance the relevancy of the requested information against the burden placed on the government in producing it, in accordance with Tax Court Rules of Practice and Procedure 70(b) and 70(c).

EditorNotes

Mark G. Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.

Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.