ASK THE EDD LAWYER – WHAT ARE “ADEQUATE PROTECTION” PAYMENTS WHEN YOU OWE THE EDD AND IRS?
By Robert S. Schriebman
May 27, 2015
Payments for “Adequate Protection” — sounds like something out of a gangster movie, doesn’t it? But in the world of tax law it means a way to designate a specific payment to certain portions that compose what you may owe the EDD or the IRS. Most delinquent IRS and FTB income tax debts are composed of three elements: the penalty portion, the interest portion, and the tax portion. When it comes to IRS Corporate or LLC payroll delinquent taxes you have the basic three elements plus the trust fund and non trust fund portions. This can get complicated.
This article will explain adequate protection payments as they apply to both income taxes and payroll taxes in light of the US Tax Court’s decision of Kathy L. Riggs v. Commissioner published on May 26, 2015.
The Riggs Case
On May 26, 2015 the US Tax Court published the case of Kathy L. Riggs v. Commissioner, T.C. Memo. 2015-98 (the Riggs case). The Riggs case involved an adverse IRS decision against Riggs in a Collection Due Process (CDP) matter. Riggs was assessed the Trust Fund Recovery Penalty (TRFP) formerly known as the 100% penalty. The IRS assessed the “responsible person” within a corporation for the trust fund portion, i.e. those portions of an employee’s payroll that should have been withheld by the employer, and paid over to the IRS. These portions are withheld income taxes and the employee’s portion of social security taxes. Riggs was deemed to be responsible for payroll tax compliance and thus assessed the TRFP. Riggs tried to convince the IRS to place her account on a hardship suspension. However, the IRS found that she had more equity in property than she owed in taxes. The Court held that Riggs did not qualify for hardship suspension due to this equity.
Riggs’ Corporation filed for bankruptcy protection. The corporation had a formal payment arrangement with the IRS. Riggs made 7 monthly payments to the IRS. Each check sent to the IRS stated “for” the trust fund recovery penalty. Riggs asked the Tax Court to reduce her personal trust fund exposure by the amounts of the 7 payments. For reasons discussed below, the Court refused Riggs’ request.
The EDD does not have trust fund and non trust fund portions. The so-called “responsible person” is totally liable for every penny owed by the corporation or the LLC.
The Benefit of Adequate Protection Payments
You may owe the IRS income taxes, but you believe that the penalties should be removed for reasonable cause. You want to pay the income tax portion and the interest portion of those taxes, but not the penalty portion. You are allowed to designate how the IRS should apply your partial payment. This is known as an adequate protection payment. There are specific internal IRS rulings that allow you to make this type of payment. These rules are stated in Rev. Proc. 1984-58 and Rev. Proc. 2002-26.
NOTE: You must state where you want your payment to apply on the face of your check. You should also state your social security number together with payment designation. I always make my designations in red ink and yellow highlighter. The designation must be on the face of the check itself and not just stated in any letter accompanying the payment.
If you own a small corporation that is behind in its payroll tax payments you can be sure that you will soon be targeted by the IRS for TFRP. In that event you should plan ahead and start making adequate protection payments to reduce your personal exposure. You may send a partial payment to the IRS and designate that payment to apply to the trust fund portion.
NOTE: It is a common mistake to designate your payment to the trust fund portion solely in the cover letter that accompanies your partial payment. The designation must be on the face of the check. Use language such as, “Apply to the Trust Fund Portion ONLY for the quarter ending 12/31/2014 per Rev. Proc.1984-58 and Rev. Proc. 2002-26.” You should also state the name and EIN of the corporation. You might have to write small, but all of this information is essential for a proper adequate protection payment.
Voluntary vs Involuntary Payments
The adequate payment procedures only apply to “voluntary” payments. This means a payment made not under a written payment agreement. If you have a formal written installment agreement with the IRS you are not allowed to designate the application of that payment. In the Riggs case the corporation had an installment payment agreement with the IRS when Riggs made her 7 designated payments to the trust fund portion in an attempt to reduce her personal exposure. The Court ruled that each payment was involuntary and as such could not be so designated.
Adequate Protection Payments When You Owe the EDD
The EDD does not have Rev. Proc. designations. However, California Civil Code Sec. 1479 allows a debtor to designate the application of any payment. For example, if you wish to challenge EDD penalties, but you want to pay an EDD tax and interest on the tax portion, you are allowed to designate that application on the face of the check. When making your payment I recommend you also state that the designation is made pursuant to Civil Code § 1479. By the way, Civil Code § 1479 also applies to debts owed to the FTB and BOE.
Adequate protection payments can be very useful in avoiding a payment portion of any tax assessment you feel you do not owe. You cannot be compelled to pay a portion of an assessment you are contesting administratively (with the exception of certain EDD penalties). In the event you miss a time deadline to file your administrative challenge you may first have to pay the designated portion and go through the refund claim process.
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.
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.