Interest-free Adjustments with Respect to
Underpayments of Employment Taxes

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 31 [T.D. 8959] RIN 1545-AY21

TITLE: Interest-free adjustments with respect to underpayments of
employment taxes

AGENCY:Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to
interest-free adjustments with respect to underpayments of
employment taxes. These final regulations reflect changes to the law
made by the Taxpayer Relief Act of 1997. The final regulations
affect employers that are the subject of IRS examinations involving
determinations by the IRS that workers are employees for purposes of
subtitle C or that the employers are not entitled to relief from
employment taxes under section 530 of the Revenue Act of 1978.

DATES: Effective Date: These regulations are effective August 1,
2000. Applicability Date: These regulations are applicable with
respect to notices of determination issued on or after March 19,
2001. Interest will be computed under the rule in this regulation on
any claims for refund of interest pending on January 17, 2001. No
inference is intended that the rule set forth in these final
regulations is not current law.

FOR FURTHER INFORMATION CONTACT: Lynne Camillo (202) 622-6040 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains an amendment to the Employment Tax
Regulations (26 CFR part 31) under section 6205. On January 17,
2001, the IRS published in the Federal Register (66 FR 3956) a
notice of proposed rulemaking (REG-110374-00) under section 6205 of
the Internal Revenue Code relating to interest-free adjustments of
employment tax underpayments. The notice proposed to amend
§31.6205-1 of the employment tax regulations.

No written comments responding to the notice of proposed rulemaking
were received. No public hearing was requested or held. Accordingly,
the proposed regulations are adopted as final regulations.

Section 6205 allows employers that have paid less than the correct
amount of employment taxes to make adjustments without interest,
provided the error is reported and the taxes are paid by the last
day for filing the return for the quarter in which the error was
ascertained. However, no interest-free adjustments are permitted
pursuant to section 6205 after receipt of notice and demand for
payment thereof based upon an assessment. §31.6205-1(a)(6).

The Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788),
effective August 5, 1997, created new section 7436 of the Internal
Revenue Code (Code), which provides the Tax Court with jurisdiction
to review determinations by the IRS that workers are employees for
purposes of subtitle C, or that the employer is not entitled to
relief from employment taxes under section 530. Section 7436
resulted in a change in the way employment tax examinations
involving worker classification and section 530 issues are conducted
insofar as notice and demand for payment of an employment tax
underpayment based upon an assessment cannot be made until after the
taxpayer under examination receives notice of the IRS's
determination and has been given an opportunity to file a petition
in the Tax Court contesting such determination.

Explanation of Provisions

This document contains an amendment to the regulations under section
6205. The amendment clarifies the period for adjustments of
employment tax underpayments without interest under section 6205
following the expansion of Tax Court review to certain employment
tax determinations.

As a general rule, under section 6601, all taxpayers who fail to pay
the full amount of a tax due under the Code must pay interest at the
applicable rate on the unpaid amount from the last date prescribed
for payment of the tax until the date the tax is paid. However,
section 6205 allows employers that have paid less than the
correct.Section 6205 applies to underpayments of taxes under the
Federal Insurance 1 Contributions Act (FICA), the Railroad
Retirement Tax Act (RRTA), and income tax withholding. Section 6205
does not apply to underpayments of taxes under Federal Unemployment
Tax Act (FUTA), as such underpayments are not subject to interest
under section 6601(i) amount of certain employment taxes with
respect to any payment of wages or 1 compensation to make
adjustments to returns without interest pursuant to the regulations.
The employment tax regulations under section 6205 generally allow
employers to make adjustments to returns without interest until the
last day for filing the return for the quarter in which the error
was ascertained. An error is ascertained when the employer has
sufficient knowledge of the error to be able to correct it.
§31.6205- 1(a)(4). Section 31.6205-1(a)(6) provides that no
interest-free adjustments can be made after receipt of a statement
of notice and demand for payment based upon an assessment.

In Revenue Ruling 75-464 (1975-2 C.B. 474), the IRS further
clarified the time for adjustments under section 6205. The ruling
clarifies that employers can still make interest-free adjustments
where the underpayment is discovered during an audit or examination
(i.e., where the employer has not independently ascertained the
underpayment). The ruling sets forth situations illustrating when an
error is ascertained with respect to returns under audit by the IRS.
Under the facts in the revenue ruling, an error is ascertained when
the employer signs an "Agreement to Adjustment and Collection of
Additional Tax", Form 2504, either at the examination level or the
appeals level, when the taxpayer pays the full amount due so as to
file a refund claim (if paid prior to notice and demand), or at the
conclusion of internal IRS appeal rights if no agreement is reached.
Under the factual situations in Revenue Ruling 75-464, the
employment taxes can be paid free of interest at the time the
employer signs Agreement Form 2504 or at the time it pays the tax
preparatory to filing a claim to contest the liability in court,
after having exhausted all appeal rights within the IRS, provided
the payment is made before the taxpayer receives notice and demand
for payment.

The Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788),
created new section 7436 of the Code which provides the Tax Court
with jurisdiction to review determinations by the IRS that workers
are employees for purposes of subtitle C of the Code, or that the
organization for which services are performed is not entitled to
relief from employment taxes under section 530. Section 7436(a)
requires that the determination involve an actual controversy and
that it be made as part of an examination. Subsequent to enactment
of section 7436 of the Code, the IRS created a standard notice, the
"Notice of Determination Concerning Worker Classification Under
Section 7436" (notice of determination) to serve as the
"determination" that is a prerequisite to invoking the Tax Court's
jurisdiction under section 7436. Notice 98-43 (1998-33 I.R.B. 13).

Section 7436(d)(1) provides that the suspension of the limitations
period for assessment in section 6503(a) applies in the same manner
as if a notice of deficiency had been issued. Thus, pursuant to
section 6503(a), the mailing of the notice of determination by
certified or registered mail will suspend the statute of limitations
for assessment of taxes attributable to the worker classification
and section 530 issues. Generally, the statute of limitations for
assessment of taxes attributable to the worker classification and
section 530 issues is suspended for the 90-day period during which
the taxpayer can begin a suit in Tax Court, plus an additional 60
days thereafter. Moreover, if the taxpayer does file a timely
petition in the Tax Court, the statute of limitations for assessment
of taxes attributable to the worker classification and section 530
issues is suspended under section 6503(a) during the Tax Court
proceedings, and for sixty days after the Tax Court decision becomes
final.

Current IRS guidance provides for interest-free adjustments under
section 6205 prior to assessment and notice and demand. Because of
the prohibition on assessment for cases pending in the Tax Court,
this creates a potential for inconsistent application of interest
depending upon whether an employer files a claim in the Tax Court or
in another court of Federal jurisdiction. The legislative history of
section 7436 shows no intent to create an advantage for taxpayers
who choose to litigate their cases in Tax Court as opposed to
another court of Federal jurisdiction. H.R. No. 105-148, 105 Cong.,
1 Sess., at 639-640 (1997). Taxpayers who choose to petition the Tax
th st Court under section 7436 still have the benefit of all of the
inherent advantages of litigating in the Tax Court, including the
ability to obtain judicial review without prior payment of the
additional tax the IRS has determined to be due.

Judicial and administrative precedents provide that an error is
ascertained for purposes of section 6205 (ending the period for
interest-free adjustments) when the taxpayer has exhausted all
internal appeal rights with the IRS. Eastern Investment Corp. v.
United States, 49 F. 3d 651 (10 Cir. 1995); Rev. Rul. 75-464 (1975-2
C.B. th 474). In the context of refund litigation, where a taxpayer
whose erroneous underpayment of employment taxes is discovered
during an examination pays only the required divisible portion of
employment tax prior to filing a claim for refund in order to
satisfy the jurisdictional requirements for filing suit in district
court, interest continues to accrue on the unpaid portion of
employment tax from the date upon which the tax is assessed after
the taxpayer has exhausted all appeal rights within the IRS until
the date such tax is paid. See Eastern Investment Corp., supra
(rejecting taxpayer's argument that the error could not have been
"ascertained" until a decision was made by the court and the
liability was no longer being contested). Moreover, in Tax Court
deficiency proceedings that do not involve employment taxes, unless
the taxpayer makes a deposit to stop the running of interest,
interest continues to accrue on the deficiency during the course of
the Tax Court proceeding. Rev. Rul. 56-501 (1956-2 C.B. 954).

In employment tax examinations that do not involve worker
classification or section 530 issues, the taxpayer has exhausted all
internal appeal rights by the time a notice and demand for payment
thereof based upon an assessment is received. Similarly, in
employment tax examinations involving worker classification or
section 530 issues, the taxpayer has already had the benefit of all
of the same internal appeal rights by the time a notice of
determination is received.

These final regulations provide that, in employment tax examinations
involving worker classification or section 530 issues, as in other
types of employment tax examinations, the error is ascertained for
purposes of section 6205 when the employer has exhausted all
internal appeals within the IRS. The fact that notice and demand for
payment based upon an assessment cannot be made in cases involving
worker classification and section 530 issues until the suspension of
the statute of limitations is lifted, following issuance of a notice
of determination, does not result in an extension of the period
during which interest-free adjustments can be made under section
6205. Accordingly, in order to clarify that the error is ascertained
for purposes of section 6205 once a taxpayer has exhausted all
internal appeal rights with the IRS, the existing regulations are
hereby modified by prohibiting interest-free adjustments after
receipt of the notice of determination.

However, if, prior to receipt of a notice of determination, a
taxpayer makes a remittance which is equal to the amount of the
proposed liability, the IRS considers the remittance a payment and
assesses it. Rev. Proc. 84-58 (1984-2 C.B. 501). In such a
situation, no notice of determination would be sent to the taxpayer.
If a taxpayer wants to stop the running of interest and contest the
adjustment in the Tax Court, the taxpayer may make a remittance,
designating it in writing as a deposit in the nature of a cash bond.
If the taxpayer makes such a deposit, the IRS does not consider the
remittance a payment. Id. at §4.02. The deposit stops the
running of interest and, if the taxpayer does not waive the
restrictions on assessment, the IRS will send the taxpayer a notice
of determination, thus permitting the taxpayer the option of Tax
Court review.

In order to provide a mechanism for taxpayers to make a remittance
to stop the accrual of interest, yet still receive a notice of
determination and retain the right to petition the Tax Court, these
final regulations further modify the existing regulations to provide
that, prior to receipt of a notice of determination, the taxpayer
may, in lieu of making a payment, make a cash bond deposit which
would have the effect of stopping the accrual of any interest, but
would not deprive the taxpayer of its right to receive a notice of
determination and to petition the Tax Court under section 7436.

Special Analyses

It has been determined that this final regulation is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations and,
because these regulations do not impose on small entities a
collection of information requirement, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Code, the notice of proposed rulemaking preceding this
regulation was submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.

Drafting Information

The principal author of this final regulation is Lynne Camillo,
Office of the Assistant Chief Counsel (Exempt Organizations/
Employment Tax/ Government Entities). However, other personnel from
the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 31

Employment taxes, Income taxes, Penalties, Pensions, Railroad
retirement, Reporting and recordkeeping requirements, Social
Security, Unemployment compensation.

Amendments to the Regulations

Accordingly, 26 CFR part 31 is proposed to be amended as follows:

PART 31 -- EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT THE
SOURCE

Paragraph 1. The authority for part 31 continues to read in part as
follows: Authority: 26 U.S.C. 7805 * * *

Par. 2. In §31.6205-1, paragraph (a)(6) is revised to read as
follows: §31.6205-1 Adjustments of underpayments.

(a) * * *

(6) No underpayment shall be reported pursuant to this section after
the earlier of the following--

(i) Receipt from the Director of notice and demand for payment
thereof based upon an assessment; or

(ii) Receipt from the Director of a Notice of Determination
Concerning Worker Classification Under Section 7436 (Notice of
Determination). (Prior to receipt of a Notice of Determination, the
taxpayer may, in lieu of making a payment, make a cash bond deposit
which would have the effect of stopping the accrual of any interest,
but would not deprive the taxpayer of its right to receive a Notice
of Determination and to petition the Tax Court under section 7436).

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue

Approved:

Mark A. Weinberger
Assistant Secretary of the Treasury

SEARCH:

You can search the entire Tax Professionals section, or all of Uncle Fed's Tax*Board. For a more focused search, put your search word(s) in quotes.

2001 Regulations Main | IRS Regulations Main | Home