By Robert S. Schriebman
In this 2-part series of articles, I almost feel like a member of the crew of Star Trek as I may be going, “Where no man has gone before.” This series of articles will attempt to provide a framework for effectively obtaining innocent spouse relief when the EDD pierces the corporate or LLC veil and issues an assessment against the so-called responsible person individually. Before getting into specifics, allow me to discuss the basics of CUIC § 1735 as well as that of general innocent spouse relief.
CUIC § 1735 – The Basics
There are several articles on this website that go into great detail about CUIC § 1735. But for now it is important that you understand that the EDD does have the right to go after those individuals who own and operate corporations and LLCs. EDD auditors are not particularly concerned about issuing these 1735 assessments. A portion of the audit report requires the auditor to give his/her opinion on whom should be personally assessed if and when the corporation or LLC is no longer in business or unable to pay the corporate/LLC level assessment due to the lack of cash flow or insufficient assets for purposes of seizure. The assessment against the responsible individual is dollar for dollar and dime for dime – exactly what the entity owes plus accruing interest.
A CUIC § 1735 assessment is a true “100% penalty” compared to the IRS version of the Trust Fund Recovery Penalty (TFRP) at only about 60% maximum of the underlining entity assessment. With the IRS you have the “Trust Fund” and “Non-Trust Fund” portions. The individual is not personally liable for the entity non trust fund portion. Nor is the individual personally liable for 940 FUTA assessments. Accrued interest on the TFRP does not begin to run unless and until the individual assessment is made and recorded on the IRS books.
So you see, relatively speaking, that while the EDD payroll tax assessment is usually smaller than the IRS counterpart, percentage wise, the EDD version is much harsher.
Innocent Spouse Relief – The Basics
Generally, married taxpayers may elect to file a joint Federal income tax return. Section 6013(a). After making the election, each spouse is jointly and severally liable for the entire tax due. Section 6013(d)(3); see section 1.6013-4(b), Income Tax Regs. §6015 provides three avenues for relief from that liability (often referred to as innocent spouse relief) to a taxpayer who has filed a joint return: (1) section 6015(b) allows relief for understatements of tax attributable to certain erroneous items on a return; (2) section 6015(c) provides relief for a portion of an understatement of tax to taxpayers who are separated or divorced; and (3) section 6015(f) more broadly confers on the Commissioner discretion to grant equitable relief to taxpayers who otherwise do not qualify under section 6015(b) or section 6015(c). (See California Revenue and Taxation Code §§ 18533 and 18534.)
Innocent Spouse Rules Do Not Apply to State or Federal Employment Taxes
I am often asked by clients who have been assessed personally under CUIC § 1735, if it possible to get out of the assessment by arguing that he/she is an innocent spouse. The legal answer is “NO!” Why? Innocent spouse rules cannot be used in EDD matters because these rules, both the IRS and FTB versions, only apply to income tax deficiencies. They do not apply, and cannot be used, as a defense to employment tax exposure.
In this series of articles, I will attempt to show that while the letter of the law regarding innocent spouse relief cannot be used against the EDD, the spirit of innocent spouse relief may be available. This will be shown in Part 2.
EDD CUIC §1735 Assessments Are Often Random
Why are many CUIC Sec 1735 assessments random and made without a thorough investigation of the facts by the EDD? IRS revenue officers, assigned to the task of making a TFRP assessment, take much time to investigate the facts and make certain they have the right individual as the target for the TFRP. IRS revenue officers routinely question those individuals whom they believe are in charge of the day-to-day fiscal affairs of the corporation or LLC. They often send summonses to banks to obtain records, especially copies of bank signature cards, so they can prove who had check writing authority. Once the IRS revenue officer concludes who is responsible, letters are sent affording the selected target of the TFRP an opportunity to file an appeal with the IRS Appeals Division. All of this can take many months before the targeted individual is personally assessed. (See IRC §6672.)
CUIC § 1735 assessments, on the other hand, are made not by EDD auditors, but by the assigned EDD collector. Collectors usually have a large case load and do not have either the time or the opportunity to be thorough and accurate. Accordingly, the collector will take the quickest and easiest approach because it is both time and cost effective. The EDD may send out one or two letters to targeted individuals informing them that they are indeed the target of a potential 1735 assessment. The letter asks that the individual so called responsible person to contact the collector to discuss the matter. This is a trap for the unwary! Many people, who do not respond to these contact letters, never get assessed and the collector is too busy or overworked to chase them. Along with the contact letter will usually be a document entitled, “Corporate Questionnaire.” Those who complete and sign the questionnaire have signed, in reality, a confession of guilt. Just try defending yourself in a judge hearing and have the EDD introduce in evidence your signed confession.
Again, most selected targets receiving these letters and questionnaire; but not responding, rarely get personally assessed. Having said this, there is nothing to stop the collector from issuing the assessment even when the target does not respond – it’s all quite random.
The Finger-Pointing Contest
Potential targets of both EDD 1735 assessments as well as IRS TFRP assessments, can easily point to others within the corporation or LLC as being the “real” responsible person. And the so-called “real” responsible person will usually point the finger of blame back at the accuser. Both the EDD and the IRS know this defense very well. That is why the EDD and the IRS will make a “shotgun” approach to the assessment. They will assess anyone whom they believe may have had some control over the entity’s fiscal affairs. If your signature appears on the bank signature records; if you sign checks; if you signed quarterly and annual payroll tax returns; and if you made the decision to pay the rent or the employees instead of paying the EDD – you can count on being a target for the CUIC § 1735 assessment.
An Innocent Spouse Gets Targeted and Assessed
In small corporations and LLCs, so called ‘mom and pop’ operations, a potential innocent spouse most likely will be assessed by the EDD for the CUIC § 1735 assessment. He/she may have helped do the books, occasionally signed checks, or signed payroll tax returns. The real day-to-day fiscal affairs of the business were decided by the other spouse. In a situation where the marriage is stable and long-lasting, these unfortunate assessments are not contested, and the assessment is paid. However, when the couple becomes separated or divorced, the CUIC § 1735 assessment may fall upon a truly innocent spouse.
In this Part 1, I discussed the background and the mechanics of assessing the CUIC § 1735 assessment. We also learned that a targeted spouse cannot legally apply IRS and FTB innocent spouse rules to avoid these assessments because these rules of relief do not apply to employment taxes. In Part 2, we will learn that what we cannot do directly, we may do indirectly and provide a realistic innocent spouse defense to EDD employment tax assessments.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Web Site Article 359