Reaffirming my long-held belief that everything in life can be related back to The Simpsons, there’s an episode in which Homer is investigated by the IRS for tax fraud. In lieu of prosecution, Homer is told that he will “work for the IRS” to help the Service bring down Homer’s boss, Mr. Burns. Homer’s reply to the proposed arrangement?
“Sure, but can you pay me under the table?….I’ve got a little tax problem.”
As you might imagine, the government is not in the habit of showing sympathy for one’s self-imposed tax mess, a fact we were reminded of earlier this week with the Tax Court’s decision in May v. Commissioner, 137 T.C. 11 (2011). In May, the IRS refused to show leniency when an individual argued that his tax liability was created as a result of being ripped off. By himself.
Mark May (May) was the CEO and sole shareholder of Marantha Financial Group (Marantha), a corporation with 100 employees. May controlled the finances of Maranatha; he had sole check signature authority on the corporate bank account and was the sole signatory on payroll checks issued by Paychex on Maranatha’s behalf.
During 1994 through 1996, Maranatha withheld all of the proper taxes from employee paychecks (including May’s) but failed to remit these withholdings to the Federal, State, or local governments. Though Marantha was the employer, May was the person responsible for remittance of these withholdings; a point driven home by the U.S. District Court, which had earlier convicted May on six counts of tax evasion charges related to Marantha’s payroll tax indiscretions.
The case in front of the Tax Court, however, focused on the individual income tax aspects of Marantha’s failure to remit employee withholdings. On May’s 1994, 1995, and 1996 tax returns, May attached his W-2 and claimed the full amount of federal withholding each year as an offset to his tax liability despite his knowledge that the government had never received the funds. Compounding his transgressions, May also claimed federal tax deductions each year for the “withheld” state income taxes that were never actually paid to the state.
The IRS denied both the federal credit for withholding and the federal deduction for the state withholding, assessing an underpayment of tax and fraud penalties averaging nearly $80,000 for each year from 1994 through 1996.
To May’s credit, he came up with a rather compelling argument to support his position that there could be no fraud penalty because there was no underpayment of tax. May contended that because taxes were actually withheld from his paychecks, he was entitled to the withholding credits even though the tax withholdings were never paid to the government. As support, May pointed to Treas. Reg. Section 1.31-1(a), which states in part that “If the tax has actually been withheld at the source, credit or refund shall be made to the recipient of the income even though such tax has not been paid over to the Government by the employer.”
Compelling as this argument may have been, for obvious reasons the Tax Court was not persuaded. The regulations cited under Section 31 contemplate a scenario where an employer fails to remit the withholdings of an employee without that employees knowledge; without some type of relief, the employee would unwittingly be subjected to underpayment penalties through no wrongdoing of their own.
In the instant case, however, it was May who ripped off May. The Tax Court explained it this way:
May was not only an employee of Maranatha; he was also president and CEO. He was the person responsible for Maranatha’s failure to remit tax withholdings(including his own) to the Government and knew that those withholdings were not being remitted. Mr. May had sole check signature authority on Maranatha’s corporate bank account, giving him full control of its finances.
Because Mr. May was responsible for the nonremittance and fully controlled the corporate finances, we conclude that the funds never left Mr. May’s functional control and were therefore not “actually withheld at the source” from his wages for purposes of section 1.31-1(a), Income Tax Regs. Section 1.31-1(a), Income Tax Regs., is therefore inapplicable, and petitioners’ reliance on it is misplaced.
Thus, the Tax Court upheld the fraud penalties assessed by the IRS, and Mr. May will now be asked to cut several very large checks from the comfort of his jail cell.