Interest-Free Adjustments with Respect to
Underpayments of Employment Taxes

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 31 [REG-110374-00] RIN 1545-
AY21

TITLE: Interest-free adjustments with respect to underpayments of
employment taxes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains a proposed amendment to the
regulations relating to interest-free adjustments with respect to
underpayments of employment taxes. The proposed amendment reflects
changes to the law made by the Taxpayer Relief Act of 1997. The
proposed amendment affects employers that are the subject of IRS
examinations involving determinations by the IRS that workers are
employees for purposes of subtitle C or that the employers are not
entitled to relief from employment taxes under section 530 of the
Revenue Act of 1978 (section 530).

DATES: Written and electronic comments and requests for a public
hearing must be received by April 17, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-110374-00), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to: Unit
CC:M&SP:RU (REG-110374-00), Courier's Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC.
Alternatively, taxpayers may submit comments electronically via the
Internet by selecting the "Tax Regs" option on the IRS Home Page, or
by submitting comments directly to the IRS Internet site at

FOR FURTHER INFORMATION CONTACT: Concerning the proposed
regulations, Lynne Camillo of the Office of Associate Chief Counsel
(Tax Exempt and Government Entities), (202) 622-6040.

SUPPLEMENTARY INFORMATION:

Background

      This document contains a proposed amendment to the Employment
Tax Regulations (26 CFR part 31) under section 6205. Section 6205
allows employers that have paid less than the correct amount of
employment taxes to make adjustments without interest, provided the
error is reported and the taxes are paid by the last day for filing
the return for the quarter in which the error was ascertained.
However, no interest-free adjustments are permitted pursuant to
section 6205 after receipt of notice and demand for payment thereof
based upon an assessment. §31.6205-1(a)(6).

      The Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat.
788), effective August 5, 1997, created new section 7436 of the
Internal Revenue Code (Code), which provides the Tax Court with
jurisdiction to review determinations by the IRS that workers are
employees for purposes of subtitle C, or that the employer is not
entitled to relief from employment taxes under section 530. Section
7436 resulted in a change in the way employment tax examinations
involving worker classification and section 530 issues are conducted
insofar as notice and demand for payment of an employment tax
underpayment based upon an assessment cannot be made until after the
taxpayer under examination receives notice of the IRS's
determination and has been given an opportunity to file a petition
in the Tax Court contesting such determination.

Explanation of Provisions

      This document contains a proposed amendment to the regulations
under section 6205. The proposed amendment clarifies the period for
adjustments of employment tax underpayments without interest under
section 6205 following the expansion of Tax Court review to certain
employment tax determinations.

      As a general rule, under section 6601, all taxpayers who fail
to pay the full amount of a tax due under the Code must pay interest
at the applicable rate on the unpaid amount from the last date
prescribed for payment of the tax until the date the tax is paid.
However, section 6205 allows employers that have paid less than the
correct amount of certain employment taxes1 with respect
to any payment of wages or compensation to make adjustments to
returns without interest pursuant to the regulations. The employment
tax regulations under section 6205 generally allow employers to make
adjustments to returns without interest until the last day for
filing the return for the quarter in which the error was
ascertained. An error is ascertained when the employer has
sufficient knowledge of the error to be able to correct it.
§31.6205- 1(a)(4). Section 31.6205-1(a)(6) provides that no
interest-free adjustments can be made after receipt of a statement
of notice and demand for payment based upon an assessment.

      In Revenue Ruling 75-464 (1975-2 C.B. 474), the IRS further
clarified the time for adjustments under section 6205. The ruling
clarifies that employers can still make interest-free adjustments
where the underpayment is discovered during an audit or examination
(i.e., where the employer has not independently ascertained the
underpayment). The ruling sets forth situations illustrating when an
error is ascertained with respect to returns under audit by the IRS.
Under the facts in the revenue ruling, an error is ascertained when
the employer signs an "Agreement to Adjustment and Collection of
Additional Tax", Form 2504, either at the examination level or the
appeals level, when the taxpayer pays the full amount due so as to
file a refund claim (if paid prior to notice and demand), or at the
conclusion of internal IRS appeal rights if no agreement is reached.
Under the factual situations in Revenue Ruling 75-464, the
employment taxes can be paid free of interest at the time the
employer signs Agreement Form 2504 or at the time it pays the tax
preparatory to filing a claim to contest the liability in court,
after having exhausted all appeal rights within the IRS, provided
the payment is made before the taxpayer receives notice and demand
for payment.

      The Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat.
788), created new section 7436 of the Code which provides the Tax
Court with jurisdiction to review determinations by the IRS that
workers are employees for purposes of subtitle C of the Code, or
that the organization for which services are performed is not
entitled to relief from employment taxes under section 530. Section
7436(a) requires that the determination involve an actual
controversy and that it be made as part of an examination.
Subsequent to enactment of section 7436 of the Code, the IRS created
a standard notice, the "Notice of Determination Concerning Worker
Classification Under Section 7436" (notice of determination) to
serve as the "determination" that is a prerequisite to invoking the
Tax Court's jurisdiction under section 7436. Notice 98-43 (1998-33
I.R.B. 13).

      Section 7436(d)(1) provides that the suspension of the
limitations period for assessment in section 6503(a) applies in the
same manner as if a notice of deficiency had been issued. Thus,
pursuant to section 6503(a), the mailing of the notice of
determination by certified or registered mail will suspend the
statute of limitations for assessment of taxes attributable to the
worker classification and section 530 issues.

Generally, the statute of limitations for assessment of taxes
attributable to the worker classification and section 530 issues is
suspended for the 90-day period during which the taxpayer can begin
a suit in Tax Court, plus an additional 60 days thereafter.
Moreover, if the taxpayer does file a timely petition in the Tax
Court, the statute of limitations for assessment of taxes
attributable to the worker classification and section 530 issues is
suspended under section 6503(a) during the Tax Court proceedings,
and for sixty days after the Tax Court decision becomes final.

      Current IRS guidance provides for interest-free adjustments
under section 6205 prior to assessment and notice and demand.
Because of the prohibition on assessment for cases pending in the
Tax Court, this creates a potential for inconsistent application of
interest depending upon whether an employer files a claim in the Tax
Court or in another court of Federal jurisdiction. The legislative
history of section 7436 shows no intent to create an advantage for
taxpayers who choose to litigate their cases in Tax Court as opposed
to another court of Federal jurisdiction. H.R. No. 105-148, 105
Cong., 1 Sess., at 639-640 (1997). Taxpayers who choose to petition
the Tax th st Court under section 7436 still have the benefit of all
of the inherent advantages of litigating in the Tax Court, including
the ability to obtain judicial review without prior payment of the
additional tax the IRS has determined to be due.

      Judicial and administrative precedents provide that an error
is ascertained for purposes of section 6205 (ending the period for
interest-free adjustments) when the taxpayer has exhausted all
internal appeal rights with the Service. Eastern Investment Corp. v.
United States, 49 F. 3d 651 (10 Cir. 1995); Rev. Rul. 75-464 (1975-2
C.B. th 474). In the context of refund litigation, where a taxpayer
whose erroneous underpayment of employment taxes is discovered
during an examination pays only the required divisible portion of
employment tax prior to filing a claim for refund in order to
satisfy the jurisdictional requirements for filing suit in district
court, interest continues to accrue on the unpaid portion of
employment tax from the date upon which the tax is assessed after
the taxpayer has exhausted all appeal rights within the IRS until
the date such tax is paid. See Eastern Investment Corp., supra
(rejecting taxpayer's argument that the error could not have been
"ascertained" until a decision was made by the court and the
liability was no longer being contested). Moreover, in Tax Court
deficiency proceedings that do not involve employment taxes, unless
the taxpayer makes a deposit to stop the running of interest,
interest continues to accrue on the deficiency during the course of
the Tax Court proceeding. Rev. Rul. 56-501 (1956-2 C.B. 954).

        In employment tax examinations that do not involve worker
classification or section 530 issues, the taxpayer has exhausted all
internal appeal rights by the time a notice and demand for payment
thereof based upon an assessment is received. Similarly, in
employment tax examinations involving worker classification or
section 530 issues, the taxpayer has already had the benefit of all
of the same internal appeal rights by the time a notice of
determination is received.

        These proposed regulations provide that, in employment tax
examinations involving worker classification or section 530 issues,
as in other types of employment tax examinations, the error is
ascertained for purposes of section 6205 when the employer has
exhausted all internal appeals within the IRS. The fact that notice
and demand for payment based upon an assessment cannot be made in
cases involving worker classification and section 530 issues until
the suspension of the statute of limitations is lifted, following
issuance of a notice of determination, does not result in an
extension of the period during which interest-free adjustments can
be made under section 6205. Accordingly, in order to clarify that
the error is ascertained for purposes of section 6205 once a
taxpayer has exhausted all internal appeal rights with the IRS, the
existing regulations would be modified by prohibiting interest-free
adjustments after receipt of the notice of determination.

       However, if, prior to receipt of a notice of determination, a
taxpayer makes a remittance which is equal to the amount of the
proposed liability, the IRS considers the remittance a payment and
assesses it. Rev. Proc. 84-58 (1984-2 C.B. 501). In such a
situation, no notice of determination would be sent to the taxpayer.
If a taxpayer wants to stop the running of interest and contest the
adjustment in the Tax Court, the taxpayer may make a remittance,
designating it in writing as a deposit in the nature of a cash bond.
If the taxpayer makes such a deposit, the IRS does not consider the
remittance a payment. Id. at §4.02. The deposit stops the
running of interest and, if the taxpayer does not waive the
restrictions on assessment, the IRS will send the taxpayer a notice
of determination, thus permitting the taxpayer the option of Tax
Court review.

       In order to provide a mechanism for taxpayers to make a
remittance to stop the accrual of interest, yet still receive a
notice of determination and retain the right to petition the Tax
Court, these proposed regulations would further modify the existing
regulations to provide that, prior to receipt of a notice of
determination, the taxpayer may, in lieu of making a payment, make a
cash bond deposit which would have the effect of stopping the
accrual of any interest, but would not deprive the taxpayer of its
right to receive a notice of determination and to petition the Tax
Court under section 7436.

Proposed Effective Date

       These regulations are proposed to be applicable with respect
to notices of determination issued on or after March 19, 2001.
Interest will be computed under the rule in this regulation on any
claims for refund of interest pending on January 17, 2001. No
inference is intended that the rule set forth in these proposed
regulations is not current law. Taxpayers may rely on these proposed
regulations for guidance pending the issuance of final regulations.
If, and to the extent, future guidance is more restrictive than the
guidance in the proposed regulations, the future guidance will be
applied without retroactive effect. Special Analyses

       It has been determined that this notice of proposed
rulemaking is not a significant regulatory action as defined in
Executive Order 12866. Therefore, a regulatory assessment is not
required. It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations and, because these regulations do not impose on
small entities a collection of information requirement, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the 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 electronic and
written comments that are submitted timely to the IRS. The IRS and
Treasury Department specifically request comments on the clarity of
the proposed regulations and how they may be made easier to
understand. All comments will be available for public inspection and
copying. A public hearing may be scheduled if requested in writing
by any 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 proposed regulations is Lynne
Camillo, Office of the Associate Chief Counsel (Tax Exempt and
Government Entities). 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 THE
SOURCE

      Paragraph 1. The authority for part 31 continues to read in
	  part as follows:

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

      Par. 2. In §31.6205-1, paragraph (a)(6) is revised to
read as follows: §31.6205-1 Adjustments of underpayments.

      (a) * * *

      (6) No underpayment shall be reported pursuant to this section
after the earlier of the following--

      (i) Receipt from the Commissioner of notice and demand for
payment thereof based upon an assessment; or

      (ii) Receipt from the Commissioner of a Notice of
Determination Concerning Worker Classification Under Section 7436
(Notice of Determination). (Prior to receipt of a Notice of
Determination, the taxpayer may, in lieu of making a payment, make a
cash bond deposit which would have the effect of stopping the
accrual of any interest, but would not deprive the taxpayer of its
right to receive a Notice of Determination and to petition the Tax
Court under section 7436).

Robert E. Wenzel   
Deputy Commissioner of Internal Revenue
____________________________________________________________________

1 Section 6205 applies to underpayments of taxes under the Federal
Insurance Contributions Act (FICA), the Railroad Retirement Tax Act
(RRTA), and income tax withholding. Section 6205 does not apply to
underpayments of taxes under Federal Unemployment Tax Act (FUTA), as
such underpayments are not subject to interest under section
6601(i).

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