In In re Quezada, the bankruptcy court in Austin, Texas faced the issue of whether a Form 1040 could start the statute of limitations for filing Form 945. The court declined to grant summary judgment to the IRS finding that the issue was one of substantial compliance and it did not have enough information to make the determination. Because the issue of one return triggering the start of the statute of limitations for another is not an issue we have previously discussed, the case deserves some attention.
Mr. Quezada is a brick layer and one whom the IRS says owes $1,269,561.89. It will take him quite a while to lay enough bricks to pay off a liability of that magnitude. Mr. Quezada not only lays bricks but he hires others to assist him. The hiring of others leads to his problems. Many people worked for him over the years. He treated these other workers as independent contractors; however, he did not file or send the IRS the necessary forms (e.g. Form 1099) in connection with the payments to these individuals. His substantial liabilities stem from this failure over a period of several years.
Assuming that the individuals who worked with him were independent contractors, Mr. Quezada still had reporting obligations to the IRS. The IRS, in this proceeding, did not contest that the individuals working with Mr. Quezada were independent contractors. He needed to provide the Taxpayer Identification Numbers (TINs) to the IRS of all of these individuals or withhold 28% of certain taxable payments and to report on Form 945 this “backup withholding.” If an employer fails to withhold the taxes and to file the Form 945, the employer can still avoid liability by showing that the independent contractors reported and paid taxes on the payments received from the employer. To meet this exception, the employer must obtain a Form 4669 (Statement of Payments Received) from each of the persons treated as an independent contractor. This form involves the independent contractor declaring under penalty of perjury that a tax return was filed reporting all of the payments received from the employer. If you have a large number of independent contractors and if some time has passed before the IRS comes looking for compliance with the payment rules, it could prove quite difficult to locate and persuade all of the individuals receiving these payments to sign such a document.
In this case, Mr. Quezada failed to do any of the three things that could have kept him from having a huge liability for the backup withholding. He did file his own return for the years at issue reporting the income and expenses of the business. Of course, this provides no assistance to the IRS in identifying the individuals he paid and how much he paid. Because several years had passed before the IRS came to him to question his employment tax situation, he argues that the time for the IRS to do this has passed. The IRS counters that his failure to file Form 945, the correct return for reporting the backup withholding, keeps the statute of limitations on assessment open for an unlimited period.
The IRS argued that filing Form 1040, while nice and important for other reasons, has nothing to do with the liability at issue in this case. The bankruptcy court finds that no court has ruled on the issue of whether a Form 1040 can trigger the three-year limitations period for Form 945; however, it notes that several cases have addressed the issue of one return triggering the statute of limitations where taxpayer has failed to file another return. The leading case on this issue is Commissioner v. Lane-Wells Co., 321 U.S. 219 (1944). In Lane-Wells, the issue concerned whether filing a corporate tax return could cause the statute of limitations to run on the taxpayer’s obligation to file a personal holding company return. The Supreme Court rejected the taxpayer argument that a corporate return would trigger the time limitation for file a personal holding company return.
Finding that the liabilities were separate, the Court found the need to file each of the returns. The test articulated by the Court was that the statute of limitations is not triggered by the different return if the information in that return is insufficient to “show the facts on which liability could be predicated.”
In a case with facts closer to those presented by Quezada, the Ninth Circuit in Springfield v. United States, 88 F.3d 750 (9th Cir. 1996) held that filing Form 1099 did not start the time period where the taxpayer was required to file Forms 940 and 941. In that case, the taxpayer treated salesmen as independent contractors rather than employees and then argued that it put the IRS on notice of the issue when it submitted the Forms 1099 for these individuals. The Ninth Circuit opinion created a narrower test finding that the issue of whether one return could trigger the statute of limitations for another turned on “whether the return filed sets forth the facts establishing liability.” It found that Form 1099 did not provide the IRS with the necessary information.
The bankruptcy court in Quezada concluded that the rationale in these cases turned on substantial compliance. It looked at the elements of a return as articulated in Beard v. Commissioner, a case we have discussed often in the context of what triggers a discharge when a return is filed late. The bankruptcy court determined that the decision of substantial compliance turns on the specific facts of each case and since it did not have the Form 1040 filed by the Quezadas, it could not make a decision at this point.
I have sympathy for the Quezadas because many, if not most, of the individuals paid during the years at issue probably did file tax returns and pay taxes on the wages paid to them. Probably, the Quezadas will be paying the tax twice in effect. I will be surprised if the bankruptcy court finds a way to hold that the Form 1040 takes the place of Form 945. To make matters worse for the Quezadas, if the bankruptcy court finds that their Form 1040 cannot take the place of Form 945, that decision also means that the liability cannot be discharged because of the unfiled return. I suspect an offer in compromise may be in their future.