Chief Counsel's Office Addresses Recapture of Excess Credits from Employers Using TPPs

(Parker Tax Publishing August 2024)

The Office of Chief Counsel addressed IRS assessments and collections of employment tax underpayments arising in situations involving a common law employer and a third-party payer (TPP) such as a professional employer organization, a certified professional employer organization, or a Code Sec. 3504 agent. The Chief Counsel's Office advised in these circumstances, the IRS must identify which party or parties are the "taxpayers" liable for the assessed tax; in addition, the IRS must associate and potentially apportion the resulting balance-due among the various parties according to their legal liability. PMTA 2024-5.

Background

The Office of Chief Counsel was asked how the IRS may assess and collect an employment tax underpayment in the following factual scenarios:

(1) A professional employer organization (PEO) that is not designated under Reg. Sec. 31.3504-2(b)(2) and that is not an employer under Code Sec. 3401(d)(1) filed a Form 941, Employer's Quarterly Federal Tax Return, with an attached Schedule R (Form 941) Allocation Schedule for Aggregate Form 941 Filers, on behalf of multiple clients that are common law employers (CLEs). The IRS accepted the PEO's Form 941 and assessed the reported amount of tax liability. Later, the IRS examined the Form 941 and determined that it claimed excessive amounts of the non-refundable portion of the employee retention credits (ERCs) and as a result there was an employment tax underpayment attributable to one or more of the CLEs listed on the Schedule R (Form 941).

(2) Same facts as above; however, the TPP filing the Form 941 was engaged under a different type of TPP arrangement (for example, as a certified professional employer organization) where the TPP files an aggregate employment tax return for its employer-clients under its own employer identification number (EIN).

(3) Same facts as in both issues 1 and 2 above, respectively; however, in each situation the IRS determined that the Form 941 reported excess credits other than the nonrefundable portion of the employee retention credit.

Analysis

In third-party payer relationships, the Code may impose liabilities for withholding, depositing, reporting, and paying employment taxes on the common law employer (CLE), TPP, or both depending on the particular relationship at issue. Some third-party payers are treated as an "employer" for certain employment tax purposes. For these purposes, such "employers" therefore are also "taxpayers." Generally the CLE remains liable for the underlying employment tax, but some third-party payers are made liable for the underlying employment taxes jointly with the CLE whereas others are made liable in lieu of the CLE.

The Chief Counsel's Office advised that when assessing employment taxes, the IRS must identify which party or parties are the "taxpayers" liable for the assessed tax, and this identification is a determination that depends on the TPP relationship at issue. The Chief Counsel's Office stated that the IRS will need to associate and potentially apportion the resulting balance-due among the various parties according to their legal liability. An underpayment attributable to one party whose liability is reported on the Form 941, the Chief Counsel's Office noted, may not be collected from another party who is not liable for the underpayment, even if the liability of such other party was reported on the same Form 941.

Scenario 1

In Scenario 1, the Chief Counsel's Office noted that only the CLEs are liable as taxpayers for the employment taxes at issue. The PEO in this situation is not a third-party payer that is made to have or share liability for the reported employment taxes.

The PEO in Scenario 1 filed a return reflecting employment tax liabilities of its client CLEs. The return reported a tax liability as credited by some amount of non-refundable portion of an employee retention credit. The Chief Counsel's Office observed that under current practices, the IRS would make an assessment in the amount of the reported liabilities as reduced by the non-refundable portion of ERCs that the IRS initially allowed. According to the Chief Counsel's Office, when the IRS later determines through examination that the claimed nonrefundable portions of the ERCs were excessive and the employment tax liabilities exceed those previously assessed, the IRS can assess the amount of the reported liability that was not initially assessed because of the excessively claimed credit. When the IRS assesses this marginal amount as a taxpayer-reported liability, it does so as a supplemental assessment because the earlier assessment based on the initially filed return would clearly be imperfect or incomplete.

The Chief Counsel's Office explained that for some types of taxes, the distinction between an IRS-determined liability and a taxpayer-determined liability implicates the deficiency procedures in Code Sec. 6201(e), 6211, and Code Sec. 6213(a). The Chief Counsel's Office noted that the concept of a deficiency and its related pre-assessment procedures, however, do not apply to employment taxes. Without the requirement of a deficiency notice, Code Sec. 6201 authorizes and requires the immediate assessment of any IRS-determined employment tax liability in the same manner as it does with respect to a taxpayer-determined liability that is reported on a return.

Code Sec. 6203 provides that an assessment "shall be made by recording the liability of the taxpayer in the office of the Secretary in accordance with rules or regulations prescribed by the Secretary." The IRS complies with Code Sec. 6203 by having an assessment officer timely sign a summary record of assessment (Assessment Certificate). The Chief Counsel's Office advised that the Assessment Certificate only must contain a total amount assessed and it may be associated with "supporting records," through which the different elements of a valid assessment are provided. In the context of employment taxes, the supporting records will identify the tax (e.g., an employment tax liability), the tax period (e.g., the quarter(s) listed on the respective Form 941), and, importantly, the identity of the taxpayer(s) (on the Form 941 and its attached Schedules R). This mechanism of assessment - the signing of an Assessment Certificate to record a tax liability in the Service's books and records - may be contrasted with the later recording of the fact that there was an assessment in the IRS's computer systems. According to the Chief Counsel's Office, a particular Transaction Code (TC) is the recordation of the fact that there was an assessment. However, the Chief Counsel's Office advised that the T.C. is not an assessment, nor is the taxpayer's electronic module on any business system an assessment. A T.C. reflected in an electronic module is simply a mechanism by which the IRS tracks assessments, liabilities, and other matters relevant to ensure the satisfaction of the liabilities.

The fact that the PEO filed the return that reported the liabilities and claimed the credits on behalf of a client-CLE does not, the Chief Counsel's Office advised, alter the IRS's authority or responsibility to assess the employment tax liabilities reported or later determined. Moreover, the Chief Counsel's Office found that there should be no issue with respect to the "identification of the taxpayer" as long as the examination workpapers and assessment request forms correctly identify the relevant CLE that was under examination as the taxpayer.

Scenario 2

In Scenario 2, the Chief Counsel's Office advised that the TPP in fact is treated as an "employer" and therefore is liable as a "taxpayer." But the Chief Counsel's Office said that the assessment analysis provided above for Scenario 1 is no different. Any assessment of a liability that is determined by the taxpayer/employer (e.g., reported on a filed return), and any assessment of a liability that is determined by the IRS (e.g., determined by an examination) would be accomplished once the assessment officer signs the summary record of assessment. Provided that this act is accomplished timely, supported, and procedurally valid, then the assessment would be valid as against any "taxpayer" liable for the tax that can be identified through the records that support the assessment including the return and all accompanying attachments as well as any examination file. The Chief Counsel's Office noted that, where both the TPP and the CLE are jointly liable for the employment tax liabilities, both are entitled to Code Sec. 6303(a) notice and demand and said that without individual notices and demands, there may be complications with respect to a federal tax lien.

Scenario 3

The Chief Counsel's Office advised that Scenario 3 addresses a different set of complications that might arise with respect to third-party payer relationships that result from the fact that different credits impact the assessment differently.

In Scenarios 1 and 2, the Form 941 overstated the entitlement to the non-refundable portion of an employee retention credit. As discussed above, under current practice the IRS assesses the reported liabilities as reduced by the non-refundable portion of employee retention credits that were initially allowed. The newly-determined liability that arises from the denial of those claimed credits would represent a previously-unassessed liability. However, the Chief Counsel's Office noted that there are other credits that the IRS records as credits against the reported liability post-assessment, similar to the way that a payment is applied against the remaining balance of an assessed tax liability. In these situations, the underlying liability already was subject to assessment. The Chief Counsel's Office advised that, because of the way the IRS accounts for and records such credits, any subsequent determination by the IRS with respect to the propriety of such credits only affects satisfaction of the balance that remains due, not the assessment itself. As a result, there is no further requirement to assess the liability under Code Sec. 6201.

Therefore, in Scenario 3 the Chief Counsel's Office said that there is nothing new to assess where the previously-allowed credit did not initially reduce the amount that the IRS made subject to the assessment. When the IRS's practice is to account for a credit that does not reduce the initially-assessable amount but is instead treated as if it were a payment partially satisfying an assessed liability, the Chief Counsel's Office advised that the IRS should not duplicate the existing assessment. Instead, it should administratively adjust the module to reflect the correct balance that remains unpaid. The Chief Counsel's Office said that the IRS must ensure that any enforced collection is limited to those persons who are liable as "taxpayers" and is also limited to the extent of each person's individual liability.

For a discussion of determining the employer for employment tax purposes, see Parker Tax ¶210,105.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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