The U.S. Tax Court has overturned an IRS assessment imposing penalties and interest on an employer for failure to deposit and pay employment taxes, finding that there was “reasonable cause” for the failure [Custom Stairs & Trim Ltd. Inc. v. Commissioner, TC Memo 2011-155, 7/5/11].
The facts. Custom Stairs & Trim Ltd. (Custom Stairs) is a Florida business that fabricates staircases for residential properties. It was strongly affected by Hurricane Ivan in 2004, the collapse of the housing market, and the recession. The company laid off employees, eliminated vacations and paid holidays, and cut employee benefits. Custom Stairs went so far as to list its office property with a real estate broker in hopes of paying off its debts.
The company had a history of timely filing its Forms 941 and making deposits of the tax assessed. However, following the hurricane, it also had a history of failing to pay the full amount and having to pay penalties and interest. The company fell behind with its employment taxes in early 2005 and was thereafter consistently in arrears. For most of the calendar quarters at issue, Custom Stairs actually paid over to the IRS amounts that would have fully satisfied its liability for the current quarter, but the IRS applied its payments to prior arrearages, leaving all or portions of each successive quarter's required deposits underpaid. This situation caused the IRS to assess cascading penalties.
On Nov. 20, 2008, Custom Stairs received from the IRS a “Final Notice, Notice of Intent to Levy and Notice of Your Right to a Hearing” (CDP levy notice), that showed a $9,919.27 liability for the quarter ended June 30, 2008. On Dec. 2, 2008, Custom Stairs was mailed a “Notice of Federal Tax Lien Filing and Your Right to a Hearing.” On Dec. 11, 2008, Custom Stairs timely filed a Form 12153, Request for a Collection Due Process or Equivalent Hearing. Under the heading “Offer in Compromise,” Custom Stairs requested a “reduced penalty, under the present economic conditions.” Under the heading “Lien Withdrawal,” Custom Stairs stated that the IRS lien was filed prematurely because Custom Stairs had been keeping current while slowly paying its past due liabilities. Custom Stairs also claimed that, as of Dec. 4, 2008, all of the past due amounts (except penalties) had been paid.
In early 2009, Settlement Officer Salinger from the IRS Appeals Office contacted Rebecca Cordes, Vice President of Custom Stairs, about the federal tax lien. Cordes claimed that the lien was unnecessary because the underlying taxes had been paid and the only balance for that period was a penalty. Cordes did not believe that she had to submit the documentation that Salinger had requested because she had been making payments on the delinquent tax liability. Still Salinger argued that Custom Stairs did not have “reasonable cause” for abatement of the penalty, as Custom Stairs had not submitted any of the documentation requested, and the company had not suggested any collection alternatives. When Salinger asked Cordes how she wished to resolve the liability, she informed him that she did not know because she did not have the money to pay it.
Reasonable cause. Code Sec. 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. Reg. § 301.6651-1(c) states that in determining whether the taxpayer exercised ordinary business care and prudence, “consideration will be given to all the facts and circumstances of the taxpayer's financial situation, including the amount and nature of the taxpayer's expenditures in light of the income.” The primary factors cited by the federal courts of appeals in determining whether there was “reasonable cause” are: (1) the taxpayer's favoring other creditors over the government; (2) a history of failing to make deposits; (3) the taxpayer's financial decisions; and (4) the taxpayer's willingness to decrease expenses and personnel.
The ruling. The Tax Court ruled that Custom Stairs' failure to timely deposit and pay was due to reasonable cause. The court analyzed the four factors above. It concluded that Custom Stairs' failure to make the deposits, in the context of cascading penalties being assessed from one quarter to another, was due in significant part to Hurricane Ivan, the 2008 economic collapse, and the practical fact of the cascading penalties themselves. The court also noted that Custom Stairs had exercised ordinary business care and prudence in cutting benefits and payroll, selectively paying business expenses, and attempting to sell its real property to pay its tax liability. While the IRS argued that if the company cannot afford to make timely tax payments it should not be in business, the court found that the economy is negatively impacted by such an approach.