Rev. Rul. 86-10

1986-1 C.B. 358, 1986-4 I.R.B. 7.

WITHHOLDING; FAILURE TO WITHHOLD TAX OR FILE RETURN

Published: January 27, 1986

Section 6205.-Special Rules Applicable to Certain Employment Taxes, 26 CFR

31.6205-1: Adjustment of underpayments

(Also Sections 3402, 6601: 31.3402(d)-1. 301.6601-1.)

  Withholding; failure to withhold tax or file return. An employer that inadvertently fails to deduct and withhold income taxes may make an interestfree adjustment if the employer files timely supplemental returns reporting the underpayment and the employee files an income tax return and pays the tax due. Rev. Rul. 58-577 modified.

ISSUE

  Is interest due from an employer who failed to deduct and withhold income tax from the wages of an employee if the employee subsequently filed an income tax return and paid the tax due, and the employer filed timely supplemental returns reporting the underpayment?

FACTS

  An employer inadvertently failed to deduct and withhold income tax from the wages of an employee in 1983, as required under section 3402 of the Internal Revenue Code, and did not report any amount as being withheld from the employee

on its Form 941, Employer's Quarterly Federal Tax Return, for any quarter in that year. The employer ascertained the error within the meaning of section

31.6205- 1(a)(4) of the Employment Tax Regulations in May 1984, and filed the necessary supplemental returns for all quarters in 1983 by July 31, 1984. The tax that should have been withheld, plus interest, was then assessed. Meanwhile, the employee had filed a timely income tax return for 1983 and paid the tax due. When the employer presented this information to the Internal Revenue Service, the tax assessed against the employer with respect to the supplemental returns was abated in accordance with section 3402(d).

LAW AND ANALYSIS

  Section 6205(a) of the Code provides that if less than the correct amount of tax imposed by section 3402 is paid with respect to any payment of wages or compensation, proper adjustments of both the tax and the amount to be deducted must be made, without interest, in the manner prescribed by regulations.

  Section 31.6205-1(c)(2)(i) of the regulations sets forth the conditions under which an interest-free adjustment is made if an employer filed a return and reported either no income tax or less than the correct amount of income tax required to be withheld by an employer from the wages of an employee. The employer must adjust the error by either (a) reporting the additional amount due on a return for any quarter in the calendar year in which the wages were paid or (b) reporting the additional amount on a supplemental return for the period in which the wages were paid. Such reporting constitutes an adjustment under section 6205(a) of the Code only if the return or supplemental return is filed on or before the due date for the return for the quarter in which the error is ascertained.

  Under section 31.6205-1(a)(4) of the regulations, an error is ascertained, for purposes of section 31.6205-1(c)(2)(i), when the employer has sufficient knowledge of the error to be able to correct it. An employer has such sufficient knowledge if the employer disregards facts with the knowledge that there is a substantial possibility that further inquiry into such facts would result in the employer discovering the error.

  Section 31.6205-1(c)(3)(ii) of the regulations provides that, except as provided in section 31.3402(d)-1, any amount reported as an adjustment under section 6205(a) of the Code must be paid, without interest, at the time fixed for reporting the adjustment.

  Under section 31.3402(d)-1 of the regulations, if the employer fails to deduct and withhold the tax, but can show that the income tax has been paid against which the tax under section 3402 of the Code may be credited, the tax under section 3402 will not be collected from the employer.

  In this case, the employer made a proper and timely adjustment under section 6205 of the Code and section 31.6205-1(c) of the regulations. The tax required to be withheld that was assessed against the employer was abated because the employee's tax liability had been satisfied.

HOLDING

  The employer is not liable for interest because the requirements for an interest-free adjustment were met.

EFFECT ON OTHER DOCUMENTS

  Rev. Rul. 58-577, 1958-2 C.B. 744, holds, in part, that interest is due from an employer under similar facts. Rev. Rul. 58-577, as modified by Rev. Rul. 66-

113, 1966-1 C.B. 244, is further modified.

Rev. Rul. 86-10, 1986-1 C.B. 358, 1986-4 I.R.B. 7.