Sunday, May 03, 2015

IRS Plans to Shift Risk of Withholding Agent Fraud to the Taxpayer for Foreign Withholding

Chapter 3 of the Internal Revenue Code requires payors (and recipients) of certain types of U.S. source income to withhold tax if the beneficial owner or recipient is a non-U.S. person for income tax purposes. Chapter 4 also imposes similar withholding under FATCA for payments to foreign financial institutions and other foreign entities. The taxpayer who is withheld again can credit the withheld tax against their final U.S. income tax liability – if too much tax was withhold they can file a tax return and seek a refund. These are withholding mechanisms to help the IRS collect taxes, since collection and enforcement from non-U.S. person can be difficult, if not impossible, for the IRS.

Sometimes, the withholding agent will withhold the tax but wrongfully not pay it over to the IRS. The IRS has now announced that it is the taxpayer who will bear the risk of loss of such stolen or misappropriated tax money, not the IRS. Under regulations to be issued, the taxpayer will not be able to take credit for, or seek a refund of, withheld taxes if the withholding agent did not pay them over to the IRS. Thus, in those circumstances, the taxpayer will either lose its refund, or still owe tax to the IRS even though the withholding agent withheld the tax. The injured taxpayer could always sue the withholding agent and seek to recover the lost taxes – yeah, good luck with that. Alternatively, perhaps the IRS may pursue the withholding agent and obtain payment – yeah, good luck with that, too.

So let’s say a well-advised taxpayer, aware of this new risk, makes sure that the taxes are paid to the IRS by involving a third party agent to withhold and pay over the taxes. That should obviate the risk, right? Not so fast. The new regulations will indicate that if a withholding agent had obligations to withhold for other taxpayers and did not meet those obligations, any given taxpayer against whom the agent withheld would receive credit for amounts actually paid to the IRS, BUT ONLY on a pro rata basis. That is, a taxpayer whose tax money made its way to the IRS would only receive partial credit for such payment if the withholding agent did not pay over to the IRS withholding taxes for other taxpayers, even if all of the taxpayer’s withholdings did make it to the IRS. The IRS says it considered allowing for some type of “tracking” to allow full credit for taxpayers whose money did make it to the IRS, but that is impractical.

So let’s sum this up:

a. The Internal Revenue Code requires taxpayers to have part of their income withheld, as credit against their taxes. Not much a taxpayer can do about that – the taxes never even reach the taxpayer.

b. The withholding agent becomes a statutory agent of the government, and is obligated to conduct such withholding or suffer personal liability for un-withheld taxes.

c. The government’s agent defrauds the government by withholding the taxes, but not delivering them to the IRS.

d. The government says – you, Mr. Innocent Taxpayer, we are going to hold you responsible for the fraud you had nothing to do with, for a tax obligation we imposed on you, for the fraud of OUR agent.

Something is VERY wrong with this.

Perhaps this liability of the taxpayer will ultimately be found not to be allowable under the terms of the Internal Revenue Code, but who the heck knows? This has been out only a few days, but a quick Internet search sees no other comments. Please comment below if you feel otherwise – perhaps I am misreading something, but if not, then this liability seems absolutely crazy and overreaching.

Notice 2015-10

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