Rev. Rul. 75-464

Rev. Rul. 75-464

Advice has been requested concerning the interpretation of section 31.6205-1(a)(4) of the Employment Tax Regulations which states that for purposes of that section, "an error [in underreporting certain employment taxes] is ascertained when the employer has sufficient knowledge of the error to be able to correct it."

Section 6205(a)(1) of the Internal Revenue Code of 1954 provides that an employer who has made an error and underpaid certain employment taxes shall correct such error in the manner prescribed by the regulations and no interest will be charged on such underpayment. Section 6205 applies to Federal Insurance Contributions Act taxes, Railroad Retirement Act taxes, and income tax withholding. Federal Unemployment Tax Act taxes are not covered under section 6205.

Section 31.6205-1 of the regulations provides that an employer who, after filing the appropriate employment tax return for the return period, ascertains that an error was made and the tax was underpaid, shall correct the error.

If FICA or RRTA tax is underpaid, the employer shall report the additional amount due as an adjustment on Forms 941, Employer's Quarterly Federal Tax Return, 941C, Statement to Correct Information, CT-1, Employer's Quarterly Railroad Retirement Tax Return, or CT-2, Employee Representative's Quarterly Railroad Retirement Tax Return, for the return period in which the error was ascertained or report the amount on a supplemental return for the period in which the payment of compensation or wages was made.

If the income tax withholding was underpaid, the employer shall correct such error by reporting the amount due on any return for a period within the same calendar year in which the wages were paid to which the withholding relates, or by reporting the amount due on a supplemental return for the period in which the wages were paid. Such supplemental return is not required to be filed within the same calendar year in which the wages were paid to which the withholding relates. It may be filed during any succeeding year which is open under the statutory period of limitations on assessments.

To constitute an interest free adjustment, supplemental returns reporting additional FICA tax, RRTA tax, or income tax withholding, or Forms 941C reporting additional FICA tax, must be filed on or before the last date prescribed for filing the return for the period in which the error was ascertained. Furthermore, the amount of the underpayment must also be paid at the time for reporting the adjustment, except in the case of income tax withholding which the employer is relieved from paying under section 3402(d).

The time limit prescribed for making an interest free adjustment of FICA tax, RRTA tax, or income tax withholding is the last day for filing the return for the quarter in which the error was ascertained. Section 31.6205-1(a)(4) of the regulations states that "For purposes of this section, an error is ascertained when the employer has sufficient knowledge of the error to be able to correct it." Ascertain means to find out with certainty; to make certain or definite. (Webster's New World Dictionary, Second College Edition, 1972.)

Section 31.6205-1(a)(6) of the regulations provides further that no underpayment of tax may be reported under the interest free adjustment procedure outlined above after receipt of a statement of notice and demand for payment thereof, but the amount shall be paid in accordance with such notice and demand.

If interpreted literally, the above cited law and regulations places the responsibility upon the employers for discovering and adjusting the underpayment of taxes when, in fact, the error may not be discovered until an audit is made of the employer's tax returns by the Internal Revenue Service. Therefore, it has been the practice of the Service that if the return is audited, additional tax is found to be due, and the taxpayer accepts the adjustments proposed by the examining officer and signs the Agreement to Assessment and Collection of Additional Tax * * *, Form 2504, at the conclusion of the examination, the additional tax shall be due without interest. The agreement form executed by the taxpayer is considered to stand in lieu of a supplemental return as required by sections 31.6205-1(b) and/or (c) of the regulations.

When the examining officer presents the results of his audit to the taxpayer, the addition to the tax liability determined by the examiner is only a proposal to which the taxpayer may agree or disagree. If he disagrees, he may be permitted certain appeal rights afforded him under section 601.103 of the Statement of Procedural Rules. If the taxpayer is afforded these appeal rights, it is neither certain nor definite that an error was made by the employer and the tax underpaid until all levels of appeal have been exhausted, since the results of the examining officer's audit are subject to reversal or agreement at any level of appeal. Furthermore, to conclude that an error by the employer is ascertained at the time the examiner completes his audit, in effect, denies the taxpayer any appeal of the examiner's decision as it would be impossible to complete such appeal procedure before the due date of the return for the return period in which the examiner submitted his proposed findings to the taxpayer.

The application of the law and rationale discussed above is illustrated by the following situations:

Situation (1). Employer X filed timely Forms 941 on which he reported the proper employment taxes for all those persons whom he considered to be his employees. At a later date, within the statutory period of limitations on assessments, an audit of Forms 941 was conducted and the examining officer determined that employer X failed to include the taxes for certain other persons working for him who should have been considered as employees. Employer X immediately agreed to the findings of the examining officer, signed the agreement form, Form 2504, and promptly paid the tax due. Since the Form 2504 is considered to stand in lieu of a supplemental return, filed within the period in which the error was ascertained and the requirements of the regulations have otherwise been met, no interest is due from employer X on such underpayment.

Situation (2). The same facts exist as in situation (1) except that the employer did not agree to the examining officer's determination, elected to exercise the appeal procedures, and was granted an appellate conference. An agreement was reached at that level, an agreement form was executed, and the tax due was paid. Based on the rationale discussed above, it is considered that the "error was ascertained" at the conclusion of the appellate conference, and corrected in accordance with the regulations before the time required for making such correction. Accordingly, no interest is due on this adjustment.

Situation (3). The same facts exist as in situation (2) except that no agreement was reached at the appellate level. Therefore, the employer, instead of waiting for the statement of notice and demand to be issued, voluntarily paid the amount that the Service claimed was due with the intention of subsequently filing a claim for refund so that his tax liability can be decided in the courts. In this case, it is considered that the error was ascertained at the time of the voluntary payment of tax, prior to the issuance of a statement of notice and demand, even though the tax liability will be subsequently contested in court. Accordingly, no interest should be charged on the payment of tax, provided the employer has compiled with the instructions contained in section 31.6205-1 of the regulations for correcting the ascertained error.

Situation (4). Employer Y did not agree with the examining officer's determination of tax due, did not sign Form 2503, and declined to exercise his appeal procedure afforded him under the applicable provisions of the Statement of Procedural Rules. The tax was subsequently assessed and a statement of notice and demand was issued. Under the facts present in this situation, interest would accrue under section 6601 of the Code on the underpayment of tax in accordance with section 31.6205-1(a)(6) of the regulations which states that no adjustment shall be reported pursuant to that section after receipt by the taxpayer of a statement of notice and demand, but the amount shall be paid in accordance with such statement of notice and demand.

Situation (5). The same facts exist as in situations (1), (2), and (3) except that the Service and the taxpayer failed to reach an agreement at the regional appellate level, the tax was assessed and a statement of notice and demand was issued. Therefore, interest is due on the underpayment as no interest free adjustment may be reported by the taxpayer after receipt of a statement of notice and demand for payment of tax due, but the amount shall be paid in accordance with such statement of notice and demand. Section 31.6205-1(a)(6) of the regulations.

Notwithstanding the interpretation in this Revenue Ruling of the allowance of interest free adjustments provided by section 6205 of the Code, the Service will not allow interest free adjustments in cases in which the taxpayer's returns for prior years were audited and additional tax found to be due with respect to the same issue involved in the current audit, nor in cases in which the taxpayer, after having been informed of his tax status as an employer, knowingly underreports his employment tax liability in subsequent years. Interest will be assessed on such adjustments in accordance with section 6601.