Liability of Third Parties Paying or Providing for Wages: Suit Period and Its Extension and Maximum Amount Recoverable

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 31

[GL-32-REG-94]

RIN 1545-AS22

Liability of Third Parties Paying or Providing for Wages: Suit

Period and Its Extension and Maximum Amount Recoverable

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed amendments regarding the

liability of lenders, sureties, or other third persons for withholding

taxes when those persons have supplied funds, either directly to

employees or to or for the account of an employer, for the specific

purpose of paying wages of the employees of that employer.

The amendments revise the regulations under section 3505(b) with

regard to the maximum liability of third parties who supply funds for

wages. The amendments also revise the regulations under section 3505 to

increase the period of limitations for collection after assessment of

third-party liability, consistent with the statutory extension of

general limitation on collections the Internal Revenue Code, and to

permit the third party to consent to extend that period of limitations.

The proposed amendments affect third parties paying or providing for

wages.

DATES: Written comments and requests for a public hearing must be

received by January 23, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (GL-32-REG-94), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered to: CC:DOM:CORP:T:R (GL-32-REG-94), Courier's Desk, Internal

Revenue Service, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Robert A. Walker, (202) 622-3640 (not

a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This notice of proposed rulemaking contains proposed changes to

Sec. 31.3505-1. Section 3505 of the Internal Revenue Code (Code) was

added by section 105(a) of the Federal Tax Lien Act of 1966, Pub. L.

89-719 (1966). Treasury regulations were issued with an effective date

of August 19, 1976 (TD 7430). Neither the Code section nor the

regulations has been amended since enactment or issuance, respectively.

Since the issuance of the regulations, courts have consistently

determined the maximum liability of third parties who supply funds for

wages in a manner that is contrary to the existing regulations.

Administrative difficulties have also arisen because the self-imposed

period of limitations on collection of these liabilities differs from

the Code's general limitation on collections, and there is no provision

in the regulations to extend this period by agreement.

The proposed amendments revise the regulations with regard to the

maximum liability of third parties who supply funds for wages to

conform to judicial interpretation of the statute. To aid

administration of this provision, the proposed amendments also (i)

increase the self-imposed period of limitations for collection of

section 3505 liabilities, consistent with the 1990 extension of the

Code's general limitation on collections (See section 6502), from 6

years to 10 years and (ii) add a provision allowing this period to be

extended with the consent of the third party.

Explanation of Provisions

Under section 3505(b), if a lender, surety, or other person (the

lender) supplies funds to or for the account of an employer for the

specific purpose of paying wages of the employees of that employer, and

the lender has actual notice or knowledge (within the meaning of

section 6323(i)(1)) that the employer does not intend or will not be

able to make timely payment or deposit of the required withholding

taxes, the lender shall be liable to the United States in a sum equal

to the taxes (together with interest) that are not paid over to the

United States by the employer with respect to those wages. The lender's

liability for withholding taxes, in lieu of the employer, is limited to

an amount equal to 25 percent of the amount of wages so supplied to or

for the account of the employer. Code section 3505(b) (final sentence).

Existing regulations provide that the 25-percent limitation applies

only to the tax, and not the interest on that tax, with the result that

the lender could be held liable for more than 25 percent of the amount

of funds it supplied. The courts that have addressed this issue,

however, have held that the 25-percent limitation on the amount of

wages supplied by a third party is an absolute cap with respect to the

recovery of withholding taxes and prejudgment interest. United States

v. Metro Constr. Co., Inc., 602 F.2d 879 (9th Cir. 1979); United States

v. Intercontinental Ind., Inc., 635 F.2d 1215 (6th Cir. 1980); United

States v. Hannan Co., 639 F.2d 284 (5th Cir. 1981); Taubman v. United

States, 449 F. Supp. 520 (E.D. Mich. 1978). See also O'Hare v. United

States, 878 F.2d 953 (6th Cir. 1989); United States v. Security Pacific

Business Credit, Inc., 956 F.2d 703 (7th Cir. 1992); United States v.

Vaccarella, 735 F. Supp. 1421 (S.D. Ind. 1990).

The proposed amendments conform the existing regulations to

judicial interpretation and clarify that interest will continue to be

computed in addition to any withholding tax liability, but only to an

overall maximum of 25 percent of the amount of the funds supplied by

the lender.

The proposed revisions to the regulations also change the period of

limitations for collection of the withholding taxes and interest from

six years to ten years. This revision will conform the period of

limitations for the purposes of section 3505 with the general rule on

limitations on collection. See Internal Revenue Code section 6502,

amended by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-

508, Sec. 11317(a)(1) (1990).

Finally, Sec. 31.3505-1(d)(3) has been added to the regulations to

provide for extensions of the period of limitation for collection

because, on occasion, the IRS or the lender requires additional time

for compliance with the regulation.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It has also been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and, therefore, a Regulatory

Flexibility Analysis is not required. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (preferably a

signed original and eight (8) copies) that are submitted timely to the

IRS. All comments will be available for public inspection and copying.

A public hearing may be scheduled if requested in writing by a person

that timely submits written comments. If a public hearing is scheduled,

notice of the date, time, and place for the hearing will be published

in the Federal Register.

Drafting Information

The principal author of these regulations is Robert Walker, Office

of Assistant Chief Counsel (General Litigation). However, other

personnel from the IRS and Treasury Department participated in their

development.

List of Subjects in 26 CFR Part 31

Employment taxes, Income taxes, Penalties, Pensions, Railroad

retirement, Reporting and recordkeeping requirements, Social Security,

Unemployment compensation.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 31 is proposed to be amended as follows:

PART 31--EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Paragraph 1. The authority citation for part 31 continues to read

in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 31.3505-1 is amended as follows:

1. Paragraph (b) is amended by:

a. Removing ``for such taxes'' from the second sentence of

paragraph (b)(1)(ii).

b. Removing ``, plus interest thereon'' from the last sentence of

paragraph (b)(2), Example (1).

c. Removing a ``for withholding taxes'' from the fifth sentence of

paragraph (b)(2), Example (2).

d. Removing ``plus interest thereon'' from the last sentence of

paragraph (b)(2), Example (2).

2. Paragraph (d) is amended by:

a. Revising the last sentence in paragraph (d)(1).

b. Revising the last sentence of paragraph (d)(2)(iii).

3. Paragraph (d)(3) and (g) are added.

The additions and revisions read as follows:

Sec. 31.3505-1 Liability of third parties paying or providing for

wages.

* * * * *

(d) * * *

(1) * * * In the event that the lender, surety, or other person

does not satisfy the liability imposed by section 3505, the United

States may collect the liability by appropriate civil proceedings

commenced within 10 years after assessment of the tax against the

employer.

(2) * * *

(iii) * * * Thus, after the second payment by the employer, the

lender's liability under section 3505(b) is $75 ($250 less $175), plus

interest due on the underpayment for the period of underpayment, to a

maximum of $250, 25 percent of the funds supplied.

(3) Extensions of the period for collection. Prior to the

expiration of the 10-year period for collection after assessment

against the employer, the lender, surety, or other third party may

agree in writing with the district director, service center director,

or compliance center director to extend the 10-year period for

collection. The period so agreed upon may be extended by subsequent

agreements in writing made before the expiration of the period

previously agreed upon. If any timely proceeding in court for the

collection of the tax and any applicable interest is commenced, the

period during which such tax and interest may be collected shall be

extended and shall not expire until the liability for the tax (or a

judgment against the lender, surety, or other third party arising from

such liability) is satisfied or becomes unenforceable.

* * * * *

(g) Effective date. This section is effective on the date of

publication of the final regulations in the Federal Register. For

regulations in effect prior to the date final regulations are published

in the Federal Register, see Sec. 31.3505-1 (as contained in 26 CFR

part 31, revised April 1, 1994).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 94-27792 Filed 11-21-94; 8:45 am]

BILLING CODE 4830-01-P