D.O. Creasman Electronics, Inc. v. U.S., (DC NC 05/10/2011) 107 AFTR 2d ¶2011-826
In a case involving whether “rental payments” made to an electronics company's employees for the use of their trucks and tools are wages subject to federal employment taxes, a district court has granted in part the company's motion to compel IRS to disclose the employees' tax returns in order to determine whether the employees paid taxes on the payments. The court decided that although disclosing the entire contents of the returns was unnecessary, disclosure of redacted returns was appropriate.
Background on withholding. Withholding applies to “wages,” as defined by Code Sec. 3401(a). Subject to certain exceptions, this includes all remuneration for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash. (Reg. §31.3402(a)-1(c)) However, certain payments, such as those for travel, transportation, or other reimbursements, if properly substantiated, can be excluded from the employee's income and not subject to withholding.
Under Code Sec. 3402(d), if an employer that fails to deduct and withhold the tax can show that the income tax was paid by the employee, the tax won't be collected from the employer. However, the employer may still be liable for penalties for the failure to deduct and withhold.
Background on disclosure of return information. In general, under F.R.Civ.P. 26(b), parties are entitled to discovery of any non-privileged matter relevant to any claim or defense. However, subject to exceptions, the government is generally prohibited from disclosing tax returns under Code Sec. 6103(a). One such exception is Code Sec. 6103(h)(4)(B), which provides that a return may be disclosed in a federal judicial proceeding pertaining to tax administration if the treatment of an item reflected on such return is directly related to the resolution of an issue in the proceeding.
Facts. D.O. Creasman Electronics, Inc. (Creasman) hires individuals known as “cable splicers” to install and splice cable lines in order to build and expand cable networks. The cable splicers are paid for the work they perform based on either hourly or unit rates. Creasman doesn't provide the cable splicers with tools or transportation, but instead provides them with rental payments in exchange for the use of their trucks and tools.
Creasman reported the rental payments that it made to cable splicers for use of their trucks and tools as miscellaneous income, not wages. IRS, however, determined that the payments were wages subject to employment taxes and assessed the taxes and penalties. Creasman disagreed, claiming that the rental payments were made in accordance with standard industry practice.
Creasman filed a refund suit, alleging that it has overpaid other taxes at various times, but that IRS has refused to refund these overpayments and instead applied them against its improper assessment. IRS counterclaimed for over $500,000 that Creasman allegedly failed to withhold from the cable splicers' wages.
Creasman served its “First Request for Production of Documents” on the government seeking copies of the individuals' tax returns for the 2004 and 2005 tax years. It argued that the entire return was necessary in order to determine whether the employees reported the rental payments as income, which in turn would potentially reduce its liability under Code Sec. 3402(d).
The government objected, asserting that it should disclose only a summary chart of the relevant return information or redacted copies of the returns. Creasman filed a motion to compel production.
Partial production ordered. The district court determined that the disclosure of redacted returns was appropriate in this case. It noted that, as the parties agreed, the information contained in the returns was subject to disclosure under Code Sec. 6103(h)(4)(B) because it directly related to Creasman's tax liability under Code Sec. 3402(d). It then evaluated the scope and manner of the disclosure, weighing the individuals' right to privacy against Creasman's right to discovery, and ultimately concluded that the government should redact the personal taxpayer information and disclose the returns.
The government was instructed to, in addition to marking the returns as “confidential,” redact all identifying information, including social security numbers, of the taxpayers and their spouses and/or dependents. Further, the production was specifically limited to returns of individuals that Creasman employed as cable splicers.
References: For unwithheld tax paid by an employee, see FTC 2d/FIN ¶J-9001.1; United States Tax Reporter ¶34,024.07. For types of remuneration subject to withholding, see FTC 2d/FIN ¶H-4332; United States Tax Reporter ¶34,014.03; TaxDesk ¶532,005; TG ¶9205.
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