For those who owe the IRS back taxes, the decision as to how to pay the IRS raises a number of concerns. One such concern for those who owe taxes for several different tax years or several different types of taxes, is what year and tax account the payments are applied to. Typically taxpayers get to pick which tax year and type of tax their payments are applied to. But they can lose this right if they do not act before the IRS does. The recent Melasky v. Commissioner, No. 19-60084 (5th Cir. 2020) provides an example of this.
Facts & Procedural History
The taxpayers owed back taxes for several years. The taxpayers had worked with the IRS collection function to resolve the taxes. This included submitting an offer in compromise and a partial pay installment agreement.
At issue in this post, the taxpayers delivered a $18,000 check to the IRS office in Houston, Texas. The taxpayers asked that the funds be applied to their 2009 tax year. The IRS’s Houston office reflected the payment on the taxpayer’s account, but it did not immediately cash the check. Instead, it sent the check to the IRS’s office in Philadelphia for processing.
Later efforts at resolving the back taxes with the IRS failed. The IRS levied on the taxpayer’s bank account and took the $18,000 in the account. The IRS applied the funds to the taxpayers 1995 tax year.
The U.S. Tax Court concluded that the IRS could apply the $18,000 to the 1995 tax year. The taxpayers did not agree, which is the subject of this appeal.
Voluntary Payments to the IRS
The general rule is that taxpayers are able to designate what tax periods monies are applied to. This general rule applies to voluntary payments. Voluntary payments are those that the taxpayer makes themselves. For reference, involuntary payments are those the IRS secures by levy or seizure or other legal proceeding.
For involuntary payments, the IRS is able to select what tax periods the payments are to be applied to.
These rules are set out in Rev. Proc. 2002-26 § 3.01, 2002-1 C.B. 746.
Given these rules, one may wonder why the IRS didn’t have to apply the funds as instructed by the taxpayer. The taxpayer made a voluntary payment and instructed the IRS to apply the funds to their 2009 tax year.
Yet the IRS applied the funds to their 1995 tax year.
The court noted that there is a legal difference between presenting or tendering a check and making payment. A payment only occurs when a check is actually cashed by the bank. As such, the taxpayer did not really make a voluntary payment. Rather, the IRS levied the funds and this was an involuntary payment.
Why Voluntary Payments are Important
Why is this issue important? For many taxpayers, they want payments applied to later tax years. This can help if the statute of limitations for the IRS to collect on the older tax year is about to expire. The IRS generally has 10 years from the date a tax return is filed or tax assessed to collect the tax. By applying the payment to future years, that can leave the older years to expire unpaid.
This may be different in some circumstances. Trust fund recovery penalties are an example. With trust fund recovery penalties, taxpayers may want the payments applied to the older tax years. This can help avoid the assessment of trust fund penalties for the older years. The result is avoiding failure to timely pay penalties and interest on the trust fund penalty.
In both instances, the taxpayer may benefit from being able to designate what year the payment is applied to. But as this case shows, the taxpayer has to act first to retain the right to designate payments. If the IRS levies or takes the funds before they are processed, the taxpayer loses this right.