Federal Taxation - David A. Brennen

• Jurisdiction: United States,Federal
• Publication year: 2003
• Citation: Vol. 54 No. 4

Federal Taxation¹ by David A. Brennen^*

I. Introduction

During 2002 federal courts in the United States decided nineteen cases that directly impact federal tax law in the Eleventh Circuit.¹ These cases involve a variety of tax law matters including Federal Insurance Contributions Act ("FICA") payroll tax,² estate and gift tax,³ IRS authority to levy and assess tax,⁴ and discharges in bankruptcy.⁵ Other tax-related matters addressed by courts in 2002 that impact tax law in the Eleventh Circuit include inventory recapture in an S-corporation conversion,⁶ attorney fees for the prevailing party in a tax dispute,⁷ and injunctions against tax preparers.⁸ By far the most important tax case decided in the Eleventh Circuit was an Alabama district court case concerning the constitutionality of the new public disclosure requirements for tax-exempt political organizations.⁹ Of the nineteen tax cases from 2002, the government prevailed in fourteen,¹⁰ the taxpayer prevailed in three,¹¹ one case was a split decision,¹² and one case did not involve suit against the government.¹³ This Article will examine each of these cases by category, pausing along the way to make observations about trends and themes to the extent they appear.

II. FICA PAYROLL TAX

The FICA payroll tax cases from 2002 include one Supreme Court case, United States v. Fior D'ltalia,¹⁴ two appellate court cases, McDonald v. Southern Farm Bureau Life Insurance Co.¹⁵ and Thosteson v. United States,¹⁶ and two district court cases, Crutcher v. United States¹⁷ and Perlman v. United States.¹⁸ FICA payroll tax was by far the most frequently litigated tax issue in 2002. This frequent litigation is likely due to the circumstances under which FICA tax liability arises for employers and other "responsible" persons. As many of the 2002 tax cases indicate, the employee pays one-half of the tax to the employer, the employer holds these funds in trust for the government, and the employer eventually pays the government both the employee-paid funds and an additional amount equal to the employee-paid amount. Because of the trust aspects of the FICA tax payment scheme, the typical risks associated with a mostly voluntary compliance tax system, and various aspects of responsible person status, it is not at all surprising that FICA taxes appear to be the most frequently litigated category of tax.

A. IRS May Use Aggregate Estimates to Determine Employer's FICA Tax Obligation

In Fior D'Italia the Supreme Court addressed the long-unresolved matter of the scope of IRS authority to estimate an employer's FICA tax liability.¹⁹ In Fior D'Italia the IRS conducted a compliance audit of a restaurant after discovering a difference between the amount of tips reported by the restaurant as FICA wages and tips actually shown on credit card slips. As a result of its audit, the IRS issued an assessment, based on an aggregate estimate of unreported tips, against the restaurant for additional FICA taxes. Pursuant to the aggregate estimate, the IRS examined the taxpayer's credit card slips to determine the average percentage paid as credit card tips, multiplied this average percentage by total restaurant receipts to come up with an estimate of total tips, and subtracted tips reported by the restaurant to come up with an estimate of unreported tips. The IRS applied the FICA tax rate to this unreported tip amount. The restaurant paid a portion of the assessment and filed a refund suit in district court. The IRS counterclaimed for the unpaid portion of the assessment.²⁰

The issue in Fior D'Italia was whether the IRS is authorized to base FICA tax assessments on aggregate estimates of tips received by all employees, or whether the IRS must first determine tip income for each employee and use that information to calculate the employer's FICA tax liability.²¹ The district court and the Ninth Circuit ruled in favor of the taxpayer restaurant, concluding that the IRS is not legally authorized to use aggregate estimates, at least not without first adopting appropriate regulations.²² Because the Ninth Circuit's decision created a split among the circuits,²³ the Supreme Court granted the government's petition for certiorari.²⁴ The Supreme Court concluded that the IRS is authorized to use aggregate estimates.²⁵ The Court explained that IRS estimation authority stems from Sec. 6201(a),²⁶ which authorizes the IRS "to make . . . assessments" of unpaid taxes.²⁷ This "assessment" authority, the Court explained, includes the "power to decide how to make . . . assessment[s]."²⁸ Courts have routinely held that reasonable estimates of tax liability are an appropriate means of assessment.²⁹ Thus, concluded the Court, the aggregate estimate is permissible so long as a reasonable method of calculation is employed.³⁰

The restaurant argued that because FICA tax is calculated based on "wages" paid, which are defined as including tips received "by an employee," the employer's FICA tax liability should be based on each individual employee's wage, as opposed to an aggregate of all employee wages.³¹ The Court rejected this argument, stating that the reference to the singular "employee" is contained in the definition section of the statute, not the operational section.³² The statute that actually imposes the tax is the operational section, and it speaks in the plural referring to wages of employees.³³

The Supreme Court also rejected the Ninth Circuit's contention that other tax statutes negatively imply that the IRS lacks authority to estimate income for purposes of determining FICA tax liability in the absence of specific statutory or regulatory authority.³⁴ For example, when a taxpayer does not use an appropriate method of accounting to calculate taxable income, one tax statute authorizes the IRS to use a method of accounting that, "in the opinion of the Secretary, . . . clearly reflect[s] income."³⁵ Additionally, another tax statute permits the IRS to make "proper adjustments . . . without interest" to the reported amount of FICA taxes when an employer underpays those taxes.³⁶ The Supreme Court concluded in Fior D'Italia that these statutes only apply to small aspects of tax law and say absolutely nothing about particular methods of calculation.³⁷

The Supreme Court also rejected the taxpayer's contention that several features of aggregate estimates make it "unreasonable" for the IRS to use this method.³⁸ The taxpayer claimed that aggregate estimates sometimes include tips that should not count for purposes of calculating the employer's FICA tax liability³⁹ and that using credit card slips can overstate tips.⁴⁰ The Supreme Court rejected these over-inclusive arguments because the taxpayer had already stipulated that it did not challenge the accuracy of the IRS estimate of tips in this case.⁴¹ Thus, while the Supreme Court recognized the possibility that this argument could indicate that an aggregate estimate is unreasonable in a particular case, the taxpayer restaurant in this case could not make such a claim.⁴²

Justice Souter's dissent in Fior D'Italia is very persuasive. Indeed, Justice Souter argued that the government's FICA tax assessment authority should not exceed what the taxpayer restaurant was required to report initially as wages for FICA tax purposes.⁴³

B. Employees Do Not Have a Private Right ofAction Against Employers for Failing to Collect FICA Taxes

In McDonald the Eleventh Circuit rejected an insurance agent's attempt to sue his employer for failure to pay one-half of the FICA tax imposed on the insurance agent's wages.⁴⁴ The employer sought to dismiss the suit, arguing that no private right of action exists under FICA.⁴⁵ The Eleventh Circuit agreed, concluding that Congress did not intend to allow a private right of action by an employee against his employer for failure to comply with FICA.⁴⁶ The Court explained that FICA was not enacted for the benefit of employees.⁴⁷ Instead, FICA is simply "a tax-assessing statute designed to raise revenue for the federal government."⁴⁸ Additionally, although FICA and the Social Security Act⁴⁹ ("SSA") are linked in that the money raised through the FICA tax must be used exclusively to fund Social Security, the purposes ofthe two statutes are different.⁵⁰ The court reasoned that "FICA assesses a tax on employers and employees in order to fund a government program."⁵¹ Conversely, "the SSA . . . provides funds for disabled and retired employees."⁵² Thus, a qualifying employee receives SSA benefits even if his employer has not complied with FICA.⁵³ Therefore, an employee does not need to sue his employer to collect SSA benefits because their availability does not depend on the employer's FICA compliance.

C. "Responsible Persons" Can Be Held Liable for Payment of FICA Taxes Even if Another Person is Also Liable

The next group of FICA cases involved "responsible" persons, such as officers and shareholders of an employer, who were held liable for FICA taxes that were not paid by the employer as the primary obligor. When a company fails to pay FICA taxes withheld from employee wages, Sec. 6672(a) imposes a penalty equal to the total amount of the unpaid tax on a "responsible person," who is "[a]ny person required to collect, truthfully account for, and pay over" the tax.⁵⁴ A responsible person can include any person who, based on her status in the business, has the actual authority or ability to pay the tax.⁵⁵ Thus, factors to consider when deciding if a person is a responsible person include whether the person holds corporate office, controls financial matters, has authority to disburse corporate funds, owns stock in the company, or has authority to hire and fire employees.⁵⁶ Once an individual is established as a responsible person, she then has the burden of proving that her failure to pay FICA taxes was not willful.⁵⁷ The willfulness requirement is satisfied if the responsible person knows of payments to other creditors after becoming aware of the failure to pay the...