If an employer makes a voluntary partial payment of overdue taxes, the IRS can generally apply the taxes as it sees fit. However, if the employer provides specific directions as to how the payment should be applied, the IRS will follow those directions that are in Rev. Proc. 2002-26, 2002 C.B. 746. So, for example, this rule allows an employer to designate a partial payment to cover the “trust fund” portion of unpaid taxes (i.e., income and payroll taxes withheld from employees) that could also be collected from a responsible person. Similarly, when an employer owes interest and penalties as well as taxes, the employer can designate a partial payment to the underlying taxes to stop the running of additional interest and penalties.
Only its own liabilities. The IRS says that an employer cannot direct a voluntary payment to the income tax liability of an employee if that liability was not withheld by the employer. According to the IRS, an employer is only permitted to designate a payment to its own tax liabilities, including the employer’s liability for trust fund taxes that were withheld from employees. When income taxes were not withheld, they are a liability of the employee–not the employer.
Tax Court disagrees. The IRS will not follow the Tax Court’s decision in Dixon [141 T.C. No. 3]. In that case, the Tax Court concluded that the IRS had to honor a corporation’s designation of its payments toward its owners’ income taxes even though the taxes had not been withheld from the owners. In reaching its decision, the Tax Court said the designation of the payments to the income tax liabilities of specific employees is consistent with IRS policy and case law permitting a taxpayer to designate voluntary payments of tax.
Although the IRS will not follow the holding in Dixon, the IRS will not appeal the decision because of the case’s unique facts and limited precedential value (IRS Action on Decision, IRB 2014-38, September 15, 2014.)
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