IRS disagrees with Tax Court on ability to designate employment tax payments as income tax withholding.

• Author: Dell, Michael

The IRS announced in Action on Decision (AOD) 2014-001 that it will not follow the Tax Court's holding in Dixon,141 IC. 173 (2013), that an employer may designate payments of its employment taxes to the income taxes of specific employees. The IRS stated in the AOD that it did not appeal the Tax Court's ruling because the case has limited precedential effect.

Facts

James Dixon and Sharon Dixon owned Tryco Corp., which failed to file employment tax returns and pay its employment taxes from 1992 through 1995. The Dixons also failed to file their individual income tax returns and pay their taxes during that same period.

The government criminally prosecuted the Dixons for failing to file their income tax returns. During plea negotiations, the Dixons attempted to pay their taxes in full; however, instead of paying the taxes, they transferred the funds to Tryco and directed Tryco to use the funds to pay some of its delinquent employment taxes. Tryco also designated that the payments be applied to the Dixons' withheld income taxes. Because of Tryco's payments, the plea agreements and sentencing in the criminal proceeding indicated that the Dixons' income taxes "were mostly satisfied" (AOD 2014-001).

The IRS, however, applied Tryco's payments to the unpaid employment tax liabilities, not to the Dixons' income tax liabilities, and sent a notice of intent to levy and right to a hearing to the Dixons. The Dixons requested a collection due process hearing, and the Office of Appeals sustained the levy, concluding that the Dixons were not entitled to a credit under Sec. 31(a) because the payments represented tax "not withheld at the source." Appeals also determined that Tryco could not designate payments that were not withheld at the source to the income taxes the Dixons owed.

The Dixons filed a petition with the Tax Court, which disagreed with Appeals and held that the Dixons were entitled to a credit under Sec. 31(a) because most of Tryco's payments "represent[ed] tax actually withheld at the source within the meaning of sections 3402 and 3403." However, the Tax Court determined that the Dixons were not entitled to a credit for the payments that represented tax not withheld at the source.

Additionally, the court held that the IRS had to honor Tryco's designations of the payments and credit the Dixons' income tax liabilities. The court observed that designation of its payments to the income tax liabilities of specific employees is consistent with IRS...