Trust Fund Recovery Penalty – #10 – Direction Of Payments

TaxConnections Picture - Dollar Sign and Money10. DIRECTION OF PAYMENTS

§ 5:52 In General

One method of reducing the potential trust fund liability is to assure that the employer designates each payment made on account by placing a restrictive endorsement on the back of each check worded as follows:

“Direct to Trust Fund Portion of taxes only for the period ended for Corporation.” [IRM 5.7.7 & IRM 8.11.2]

§ 5:53 Designated Payments

The Internal Revenue Manual directs that the Service will follow the taxpayer’s direction of payments and states as follows:

“A designated payment is a voluntary one that the taxpayer has directed to be applied in a particular manner; i.e., a specific period, kind of tax, tax portion, interest, etc. Normally such direction will be followed by the Service.” [IRM 5.1.2.3]

§ 5:54 Contemporaneous Direction

The courts have consistently held that a designation made contemporaneously with a payment must be applied by the Internal Revenue Service in accordance with such direction. Therefore, if you make a designation on the back of the check, the entire amount must be applied toward the trust fund portion. The direction must be written, and the IRS need not honor an oral direction.

§ 5:55 Designation Of Tax Deposits

The IRS Restructuring & Reform Act of 1998 allowed the taxpayer to designate the period to which each deposit is applied. The designation must be made no later than 90 days of the related IRS penalty notice. The provision extends the authorization to waive the failure to deposit penalty to the first deposit a taxpayer is required to make after the taxpayer is required to change the frequency of the taxpayer’s deposits. The provision is effective for deposits required to be made after January 20r 1999. The Act also provides that, for deposits required to be made after December 31, 2001, any deposit is to be applied to the most recent period to which the deposit relates, unless the taxpayer explicitly designates otherwise. [Act § 3304; I.R.C. § 6656(e)]

When the Internal Revenue Service receives a payment for trust fund taxes through the Collection Division each payment is identified as to whether it is a designated payment. When reading an IRS transcript, as described in §§8:1 et seq. of this work, one notes each payment will have a designated payment code known as a DPC. The Internal Revenue Manual [IRM 5.1.2.8.1.4] describes these codes in the following manner:

1. Use of a designated payment code (DPC) is mandatory on all Collection initiated posting vouchers for Transaction Codes 640, 670, 680, 690, 694, and 700. DPCs are two digit codes, which serve a three-fold purpose. DPCs are for input to IMF and BMF only.

A. DPCs are used to facilitate identification of payments, which are designated to Trust Fund or Non-Trust Fund employment and excise tax liabilities. In such cases, DPC-01 and/or DPC-02 are input with payments to Form 941 (MFT 01), Form 720(MFT 03), Form CT-1 (MFT 09), Form 943 (MFT 11), Form 944 (MFT 14) and Form 1042 (MFT 12).

B. DPCs are used to indicate application of payment to a specific liability when a civil penalty module contains both a Trust Fund Recovery Penalty and any other type of civil penalty. In these cases, DPC-01 and DPC-02 are input to MFT 55 only.

C. DPCs-01 through 15 and DPCs-16, 17, 18, 20, 21, 22, 23, 24, 31, 50, 51 and 99 are used to identify the event which resulted in a payment. This is done at the time that payment is processed and may be used with any MFT to which the payment transaction code will post. Data from this type of input is Congressionally mandated and will be accumulated on a national basis to determine the revenue effectiveness of specific collection activities.

2. DPCs which are valid for use by Collection Field function (CFf) and the DPC definitions are as follows:

DPC Definition

01 Non-Trust Fund payment (alternate definition for MFT 55 only: Payment applied to penalty other than Trust Fund Recovery Penalty.) Trust Fund payment (alternate definition for MFT 55 only: Payment

02 Applied to Trust Fund Recovery Penalty.)

03 Undesignated bankruptcy payment

04 Levy on state income tax refund

05 Notice of Levy

06 Seizure and Sale

DPC Definition

07 Federal Tax Lien

08 Suit

09 Offer in Compromise (OIC)

10 Manually Monitored installment Agreement (MMIA)

11 Bankruptcy payment, designated to trust fund

12 Cash Bond Credit (allowed with TC 640 only)

13 Payment made in response to Reminder Notice

14 CSED expired, taxpayer authorized payment

15 Payment caused by a Notice of Levy but not a payment from the 3rd party complying with the Notice of Levy

24 Payment with Amended Return…  Used to exclude payment from systemic cross-reference

31 processing to allow different treatment of each spouse on a jointly filed return Miscellaneous payment (do not use if another DPC 99 Code is applicable)

§ 5:56 Voluntary vs. Involuntary

See Muntwyler v. United States for a discussion of voluntary versus involuntary payments. In that case, the corporation assigned its assets to an assignee for liquidation. The assignee liquidated the corporate assets and directed IRS payments to the trust fund portion. The court ruled that such payments were voluntary. See also New Terminal Stevedoring, Inc. v. M/V Belnor.

§ 5:57 Payments During Bankruptcy

The Supreme Court has held that a bankruptcy court may approve a Chapter 11 plan of reorganization which provides that payments oh behalf of the debtor are to be applied to trust fund taxes first. The bankruptcy courts have the power to make such direction pursuant to 11 U.S.C.A. § 305 which grants the power to enter any order necessary to the successful completion of a plan. The Supreme Court did not decide the issue of whether payments in a Chapter 11 bankruptcy are voluntary or involuntary.

§ 5:58 Pre-bankruptcy Payments Of Trust Fund Taxes

In Begier v. Internal Revenue Service, the Supreme Court held that the government may not be required to turn over pre-bankruptcy federal tax deposits to the bankruptcy estate. Such payments are a trust for the government and as such may not be determined to be preferential payments.

Practice Tip: If your client is about to file for bankruptcy, it would be wise to pay as much as possible to trust fund taxes. The payments would benefit corporate officers by reducing the potential Trust Fund Recovery Penalty and would not be subject to a determination that they were preferential payments pursuant to the bankruptcy code.

§ 5:59 Assertion Of Trust Fund Recovery Penalty

The government has taken the position that § 362 of the Bankruptcy Code [11 U.S.C.A. §362] does not prohibit the assertion of the Trust Fund Recovery Penalty against responsible persons during the pendency of a Chapter 11 case. Several courts have upheld the IRS position.

§ 5:60 Trust Fund Recovery Interest During Bankruptcy

In Bradley v. U.S., the court held that under § 6672 “responsible persons” were liable for interest on employment taxes for the period that the corporate employer was in bankruptcy, despite the fact that the corporation paid the underlying tax liability and the pre-petition interest pursuant to its bankruptcy plan of reorganization. The court adopted the reasoning of the Ninth Circuit in Holland v. United States.

Robert E. McKenzie is a partner of the law firm of Arnstein & Lehr LLP of Chicago, Illinois, concentrating his practice in representation before the Internal Revenue Service and state agencies. He has lectured extensively on the subject of taxation. He has presented courses before thousands of CPA’s, attorneys and enrolled agents nationwide. He has made numerous media appearances including Dateline NBC and The ABC Nightly News. Prior to entering private practice, Mr. McKenzie was employed by the Internal Revenue Service, Collection Division, in Chicago, Illinois. Since entering private practice, he has dedicated a major portion of his time to representation before the IRS. From 2009 to 2011, Mr. McKenzie was a member of the IRS Advisory Council, which advises IRS management. Mr. McKenzie serves on Arnstein & Lehr’s Executive Committee.

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