[Federal Register Volume 66, Number 11 (Wednesday, January 17, 2001)]
[Proposed Rules]
[Pages 3956-3959]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-273]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[REG-110374-00]
RIN 1545-AY21


Interest-free adjustments with respect to underpayments of 
employment taxes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains a proposed amendment to the regulations 
relating to interest-free adjustments with respect to underpayments of 
employment taxes. The proposed amendment reflects changes to the law 
made by the Taxpayer Relief Act of 1997. The proposed amendment affects 
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 (section 
530).

DATES: Written and electronic comments and requests for a public 
hearing must be received by April 17, 2001.

[[Page 3957]]


ADDRESSES: Send submissions to: CC:M&SP:RU (REG-110374-00), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 5 p.m. to: Unit CC:M&SP:RU (REG-110374-
00), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically via the Internet by selecting the ``Tax Regs'' 
option on the IRS Home Page, or by submitting comments directly to the 
IRS Internet site at http://www.irs.gov/taxregs/reglist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Lynne Camillo of the Office of Associate Chief Counsel (Tax Exempt and 
Government Entities), (202) 622-6040.

SUPPLEMENTARY INFORMATION:

Background

    This document contains a proposed amendment to the Employment Tax 
Regulations (26 CFR part 31) under section 6205. 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. Sec. 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 a proposed amendment to the regulations 
under section 6205. The proposed 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 amount of 
certain employment taxes \1\ with respect to any payment of wages or 
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. Sec. 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.
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    \1\ Section 6205 applies to underpayments of taxes under the 
Federal Insurance 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).
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    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

[[Page 3958]]

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, 105th Cong., 1st Sess., at 
639-640 (1997). Taxpayers who choose to petition the Tax 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 Service. Eastern Investment Corp. v. United 
States, 49 F. 3d 651 (10th Cir. 1995); Rev. Rul. 75-464 (1975-2 C.B. 
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 proposed 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 would be 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 Sec. 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 
proposed regulations would 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.

Proposed Effective Date

    These regulations are proposed to be 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 12, 2001. No inference is 
intended that the rule set forth in these proposed regulations is not 
current law. Taxpayers may rely on these proposed regulations for 
guidance pending the issuance of final regulations. If, and to the 
extent, future guidance is more restrictive than the guidance in the 
proposed regulations, the future guidance will be applied without 
retroactive effect.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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, this notice 
of proposed rulemaking will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic and written comments that 
are submitted timely to the IRS. The IRS and Treasury Department 
specifically request comments on the clarity of the proposed 
regulations and how they may be made easier to understand. All comments 
will be available for public inspection and copying. A public hearing 
may be scheduled if requested in writing by any person that timely 
submits written comments. If a public hearing is scheduled, notice of 
the date, time, and place for the hearing will be published in the 
Federal Register.

Drafting Information

    The principal author of these proposed regulations is Lynne 
Camillo, Office of the Associate Chief Counsel (Tax Exempt and 
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.

[[Page 3959]]

Proposed 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 Sec. 31.6205-1, paragraph (a)(6) is revised to read as 
follows:


Sec. 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 Commissioner of notice and demand for payment 
thereof based upon an assessment; or
    (ii) Receipt from the Commissioner 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.
[FR Doc. 01-273 Filed 1-16-01; 8:45 am]
BILLING CODE 4830-01-U