Last week in Steve’s second post on the Liftin case he described how a taxpayer can get smacked with a failure to file penalty when the taxpayer had made a full timely payment of all tax due. Similarly, in this post I will describe how a bank is potentially on the hook for over $250,000 in failure to deposit penalties under Section 6656(a) even though it timely deposited the correct amounts of income taxes it was obligated to withhold and remit in its capacity as fiduciary of pension plans, individual retirement accounts, and employee benefit plans.
The case, Commonwealth Bank v US, was decided last week and comes from the Western District of Kentucky. I will describe the context, and offer some brief analysis.
The case involves Section 6656 and the regulations Treasury has issued under the statute. Section 6656(a) provides that “[i]n the case of any failure by any person to deposit (as required by this title or by regulations of the Secretary under this title) on the date prescribed therefor any amount of tax imposed by this title in such government depository as is authorized under section 6302(c) to receive such deposit, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be imposed upon such person a penalty equal to the applicable percentage of the amount of the underpayment.” (emphasis added).
Treasury regs add that for taxpayers depositing more than $200,000 of taxes they “must use electronic funds transfer [EFT]… to make all deposits of those taxes.” 26 C.F.R. § 31.6302-1(h)(2)(ii).
The opinion succinctly lays out the relevant facts:
There is no dispute that Commonwealth’s tax obligation, on the occasion in question, was in excess of $200,000, and that 26 C.F.R. § 31.6302-1(h)(2)(ii) required Commonwealth’s payment to be by EFT. There is also no dispute that the IRS furnished deposit forms to Commonwealth, and that Commonwealth erroneously used those forms to deposit its tax obligation rather than using an EFT. Commonwealth’s deposit was timely, and in the full amount due.
So IRS sent the bank forms to make deposits; the bank used the forms that IRS sent rather than EFT to make its deposits. IRS turned around and assessed a hefty penalty attributable to the bank’s failing to use the required means of depositing. The bank paid the penalty, filed a refund claim and ultimately sued on the basis that there was no underpayment:
26 U.S.C. § 6656(b)(2) defines the term “underpayment” as “the excess of the amount of the tax required to be deposited over the amount, if any, thereof deposited on or before the date prescribed therefor.” Because it fully deposited its taxes—albeit in the wrong manner—Commonwealth argues that, in the case at bar, “the excess of the amount of the tax required to be deposited over the amount… thereof deposited…” equals zero. Accordingly, Commonwealth contends that no penalty should have been imposed based on an alleged “underpayment.”
The district court found in favor of the government as to whether there was an underpayment, though did not rule on the bank’s reasonable cause/good faith argument. In finding for the government, it cited and quoted a couple of cases that considered the same issue. For example, in Fallu Productions v US (involving actor Joe Pesci’s film production company which also failed to use EFT to deposit the withholdings) the district court in NY rejected the taxpayer’s argument:
Such an interpretation, however, ignores the subsection’s parenthetical statement. Its placement immediately following “failure… to deposit” emphasizes that the deposit itself must satisfy the requirements of the Code and applicable Treasury Regulations. Even narrowly construed, the statute authorizes FTD penalties for violating a regulatory requirement that deposits be made electronically, even if payment is made in full and on time by other means. That § 6656(a) is titled “Underpayment of deposits” does not alter this conclusion because “[t]he caption of a statute… cannot undo or limit that which the statute’s text makes plain.” Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241, 256 (2004) (citation omitted).
This plain reading of § 6656(a) also fits with the broader statutory scheme. Section 6302(h) of the Code states that the Secretary of the Treasury “shall prescribe such regulations as may be necessary for the development and implementation of an electronic fund transfer system which is required to be used for the collection of depository taxes.” 26 U.S.C. § 6302(h) (emphasis supplied). The statute further explains that the electronic system should “ensure that such taxes are credited to the general account of the Treasury on the date on which such taxes would otherwise have been required to be deposited under the Federal tax deposit system.” Id. With its direction that the Treasury Department implement an electronic tax deposit system and prescribe regulations to govern its operation, Congress expressed its intent that the system be utilized and made obligatory for certain depository taxes. The reading that Fallu advocates, however, would leave the choice of deposit method to the taxpayer.
For good measure in Commonwealth, the court noted that in the Taxpayer Relief Act of 97, Congress provided a limited time frame when taxpayers could not be penalized for an EFT failure. The inference the court drew from the limited exception was that later mistakes were to be penalized.
This is a tough result, especially in light of the IRS sending the very forms that Commonwealth used to make the deposits. While the taxpayer has another bite at the penalty relief apple through its reasonable cause claim, courts are generally not sympathetic to taxpayers who argue that they relied to their detriment on unsolicited documents the IRS issued. While I have not extensively researched the issue, a similar case a few years ago involving a failure to use EFT from a district court in Georgia (Heartland Automotive v US) stated that the documents that taxpayer received which provided for non EFT procedures (e.g., a Form 941) did not specifically state that the taxpayer did not have to use EFT and did not amount to a reasonable cause defense:
“Simply put, no reasonable taxpayer exercising ordinary business care and prudence would abstain from familiarizing themselves with the regulations and other published guidance in reliance upon the contents of the documents put forth in this case.”
Absent more, and in light of the sophistication of the taxpayer in Commonwealth (and banks may be the least sympathetic of all taxpayers), it seems like a long shot on my admittedly limited knowledge of the particular facts.
The fundamental purpose of penalties is to encourage voluntary compliance. Though I am not privy to all the facts in the case, these are the kinds of cases which suggest perhaps that the IRS should have exercised its inherent discretion to not impose the penalty and educate the taxpayer for future compliance. While the government has a strong interest in the efficient collection of taxes, this strikes me as a no harm no foul case especially since the government’s conduct in sending the forms might have contributed to the taxpayer thinking it could use the forms and comply—even if the actions do not rise to the level of reasonable cause. While sophisticated taxpayers should be held to a high standard of conduct, the penalty here seems disproportionate to the offense.