DEPARTMENT OF STATE REVENUE
03-20181740.SLOF
Supplemental Letter of Findings: 03-20181740
Withholding Tax
For the Years 2013, 2014, and 2015
NOTICE: IC § 6-8.1-3-3.5 and IC § 4-22-7-7 require the publication of this document in the Indiana Register. This document provides the general public with information about the Department's official position concerning a specific set of facts and issues. This document is effective on its date of publication and remains in effect until the date it is superseded or deleted by the publication of another document in the Indiana Register. The "Holding" section of this document is provided for the convenience of the reader and is not part of the analysis contained in this Supplemental Letter of Findings.
HOLDING
On rehearing, the Department concluded that Indiana Restaurant failed to establish that it followed the withholding tax priority "order" in calculating its employees' withholding tax liability; Indiana Restaurant failed to establish that it withheld Indiana tax liabilities before withholding the employees' federal tax liabilities.
ISSUE
I. Withholding Tax - Imposition.
Authority: I.R.C. § 451; I.R.C. § 3101; I.R.C. § 3102; I.R.C. § 3401; I.R.C. § 3402; I.R.C. § 6053; IC § 6-3-4-8; IC § 6-8.1-5-1;
Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289 (Ind. Tax Ct. 2007);
Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463 (Ind. 2012);
Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138 (Ind. Tax Ct. 2010);
Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480 (Ind. Tax Ct. 2012);
Indiana Dep't of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579 (Ind. 2014); Treas. Reg. § 31.3401(a)-1; Treas. Reg. § 31.3401(a)(16)-1; Treas. Reg. § 31.3401(f)-1; Treas. Reg. § 31.3402(k)-1; Treas. Reg. § 31.3402(k)-1(a)(1); Treas. Reg. § 31.3402(k)-1(a)(2); Treas. Reg. § 31.3402(k)-1(a)(3); Treas. Reg. § 31.3402(k)-1(c)(1); Treas. Reg. § 31.3402(k)-1(c)(2);
45 IAC 3.1-1-97; I.R.S. Publication 15; I.R.S. Tax Topic 761 Tips - Withholding and Reporting; Letter of Findings 03-20170238 (November 29, 2017).
Taxpayer argues that the audit's adjustment of Indiana and county withholding tax was overstated because it was not required to withhold taxes in excess of the actual amount of wages and tips it reported on its wage statements.
STATEMENT OF FACTS
Taxpayer is an Indiana restaurant selling food items, beer, and liquor. The Indiana Department of Revenue ("Department") conducted a withholding tax audit of Taxpayer's business and wage records. In reviewing the records, the Department concluded that Taxpayer failed to withholding income tax on behalf of certain of its employees. The resulting audit report explained:
The review of the [T]axpayer's W-2's revealed that the state and county tax was not being withheld for some of the [T]axpayer's employees. An audit adjustment is being made to assess the [T]axpayer the state and county income taxes which were not withheld from employee wages or remitted following IC § 6-3-4-8.
As explained in the audit report, the Department assessed Taxpayer approximately $13,000 in additional withholding tax. Taxpayer disagreed with the assessment and submitted a protest to that effect. An administrative hearing was conducted by telephone during which Taxpayer's representatives explained the basis for the protest.
The Department issued Letter of Findings 03-20170238 (November 29, 2017), 20180228 Ind. Reg. 045180083NRA, addressing Taxpayer's initial protest. The Letter of Findings "sustained" Taxpayer's protest subject to a supplemental review of Taxpayer's records. As explained in the November Letter of Findings:
Taxpayer's protest is sustained subject to verification of Taxpayer's supporting documentation by the Department's Audit Division regarding the proper ordering procedures.
The Department conducted the supplemental review and issued a decision dated April 2018. The supplemental audit report stated:
Taxpayer has failed to establish that it complied with the withholding tax ordering requirements. Taxpayer instead provided various payroll reports and withholding tax documents that did not demonstrate the withholding tax order was followed . . . The original audit results remain the same and there was not a reduction of the [T]axpayer's base tax.
Taxpayer disagreed with the results of the "no-change" review and requested a rehearing. The rehearing was conducted during which Taxpayer's representatives explained the basis for the protest. This Supplemental Letter of Findings results.
I. Withholding Tax - Imposition.
DISCUSSION
Taxpayer disagrees with the Department's decision that it owes additional withholding tax. Taxpayer frames the issue as follows:
The main issue/question is what is this Taxpayer supposed to do when otherwise required withholding exceeds the wages that are within the control of the Taxpayer? The Taxpayer believes that it has an[d] continues to be in compliance with the withholding tax order requirements. In particular, by the time that the Taxpayer withholds (i) Social Security and Medicare taxes on the employee's wages and/or (ii) federal income taxes on the employees, there are insufficient funds left for a number of employees to then withhold (iii) state and local taxes impose[d] on the employee's wages.
Taxpayer explains that it pays its employees a base wage of approximately $2.00 per hour. It also pays its employees the amount of tips which are paid by means of the restaurant patron's credit card. For example, if a customer grants an employee a $5.00 tip, that employee's wage statement - upon which Taxpayer calculates the withholding liability - states that employee earned $7.00. Cash tips, which are shared with each employee, are not listed on the wage statement.
A. Original Audit Report.
The audit report states that a "review of the taxpayer's records was conducted for calendar years 2013, 2014, and 2015" and that the review of Taxpayer's W-2's "revealed that the state and county tax was not being withheld for some of the taxpayer's employees." The audit report cited to IC § 6-3-4-8 as authority for Taxpayer's responsibility to "withhold, collect, and pay over income tax on wages paid by such employer to such employee."
Taxpayer argued that "[t]he audit adjustments and, thus, the proposed assessments of Indiana withholding tax are in error . . . ." Taxpayer argued that, "The tax is being assessed on the wages plus tips of the employees. Per state and federal law–tips belong to the employee, not the employer. As an employer [Taxpayer is] not obligated to report the tips on the employee's w2." Taxpayer, citing "IRS Topic 761," stated:
[Y]ou collect the employee's portion of these taxes from the wages you pay your employee, or from funds the employee gives you. If you don't have enough money from the employee's wages and funds your employee gives you, withhold taxes in the following order:
A. Social security and Medicare taxes on the employee's wages.
B. Federal income taxes on the employee's wages.
C. State and local taxes imposed on the employee's wages. (Internal quotation marks omitted).
Taxpayer then stated that it "attached employee records" showing that the "ordering and procedures were applied." Additionally, for the year 2013, Taxpayer stated that one of its employees provided a copy of his 2013 Indiana income tax form, which according to Taxpayer verified "that his taxes were paid and that the taxpayer is not obligated to pay his taxes again."
B. Statement of the Law.
For federal withholding tax purposes, income tax is generally collected at the source unless specifically exempted. I.R.C. § 3402(a)(1) requires "every employer making payment of wages to deduct and withhold upon such wages a tax determined in accordance with prescribed tables" or a prescribed mathematical formula. Likewise, every employer is required to withhold state income tax on payments of wages it pays to its employees pursuant to IC § 6-3-4-8(a) (as in effect during the Tax Years at Issue), which states in part as follows:
Except as provided in subsection (d), every employer making payments of wages subject to tax under this article, regardless of the place where such payment is made, who is required under the provisions of the
Internal Revenue Code to withhold, collect, and pay over income tax on wages paid by such employer to such employee, shall, at the time of payment of such wages, deduct and retain therefrom the amount prescribed in withholding instructions issued by the department. The department shall base its withholding instructions on the adjusted gross income tax rate for persons, on the total rates of any income taxes that the taxpayer is subject to under
IC 6-3.5, and on the total amount of exclusions the taxpayer is entitled to under
IC 6-3-1-3.5(a)(3) and
IC 6-3-1-3.5(a)(4). However, the withholding instructions on the adjusted gross income of a nonresident alien (as defined in Section 7701 of the Internal Revenue Code) are to be based on applying not more than one (1) withholding exclusion, regardless of the total number of exclusions that
IC 6-3-1-3.5(a)(3) and
IC 6-3-1-3.5(a)(4) permit the taxpayer to apply on the taxpayer's final return for the taxable year. Such employer making payments of any wages:
(1) shall be liable to the state of Indiana for the payment of the tax required to be deducted and withheld under this section and shall not be liable to any individual for the amount deducted from the individual's wages and paid over in compliance or intended compliance with this section; and
(2) shall make return of and payment to the department monthly of the amount of tax which under this article and
IC 6-3.5 the employer is required to withhold.
IC § 6-3-4-8(a) requires an employer to "withhold, collect, and pay over income tax on wages paid by such employer to such employee . . . [in] the amount prescribed in withholding instructions issued by the department." IC § 6-3-4-8(a)(1) provides that the employer is "liable to the state of Indiana for the payment of the tax required to be deducted and withheld." (Emphasis added). IC § 6-3-4-8 specifically provides that the employer is liable for the amount that it was required to withhold.
45 IAC 3.1-1-97 further explains in relevant part:
Employers who make payments of wages subject to the Adjusted Gross Income Tax Act, and who are required to withhold Federal taxes pursuant to the Internal Revenue Code (USC Title 26), are required to withhold from employees' wages Adjusted Gross and County Adjusted Gross Income Tax. (Emphasis added).
The employers are "withholding agents [who] . . . shall make return of and payment to the Department . . . tax due, for either County and State." Id. "All amounts deducted and withheld by an employer shall immediately upon deduction become the money of the State." Id. The regulation further states, "In the case of delinquency or nonpayment of withholding tax, the employer is liable for such tax, penalties, and interest." Id.
Unless specifically exempted by statute, an employer is required to withhold state and county income tax from amounts it pays to individual employees who reside and/or work in Indiana, including an adopting or non-adopting county. The employer is responsible for the tax when it fails to do so as required by Indiana law.
The Department assessed Taxpayer additional withholding taxes under IC § 6-3-4-8 and
45 IAC 3.1-1-97, which require Taxpayer to withhold state and county income taxes (collected at the source) on wages paid to employees. To correctly examine an employer's income taxes withholding responsibility, we must refer to I.R.C. § 3401
et. seq., which is under "Employment Taxes" for the purpose of "Collection of Income Tax at Source on Wages." I.R.C. § 3402(a)(1) which requires an employer to withhold income tax on wages it paid to its employees. I.R.C. § 3401 defines what constitutes "wages" for income tax purposes, which in relevant part, provides:
(a) Wages.--For purposes of this chapter, the term "wages" means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash; except that such term shall not include remuneration paid–
. . .
(16)(A) as tips in any medium other than cash;
(B) as cash tips to an employee in any calendar month in the course of his employment by an employer unless the amount of such cash tips is $20 or more;
. . .
(f) Tips.--For purposes of subsection (a), the term "wages" includes tips received by an employee in the course of his employment. Such wages shall be deemed to be paid at the time a written statement including such tips is furnished to the employer pursuant to section 6053(a) or (if no statement including such tips is so furnished) at the time received.
. . .
Treas. Reg. § 31.3401(f)-1(a) further explains that, unless specifically excluded such as I.R.C. § 3401(a)(16)(A), (B), or Treas. Reg. § 31.3401(a)(16)-1, "[t]ips received after 1965 by an employee in the course of his employment are considered to be wages, and thus subject to withholding of income tax at source." See Treas. Reg. § 31.3401(a)-1(b)(11); 31.3402(k)-1; See also I.R.C. § 451(c)(stating "tips included in a written statement furnished an employer by an employee pursuant to section 6053(a) shall be deemed to be received at the time the written statement including such tips is furnished to the employer").
I.R.C. § 3402(k) specifically requires the employer to withhold income tax on tips, which provides, in relevant part, as follows:
In the case of tips which constitute wages, subsection (a) shall be applicable only to such tips as are included in a written statement furnished to the employer pursuant to section 6053(a), and only to the extent that the tax can be deducted and withheld by the employer, at or after the time such statement is so furnished and before the close of the calendar year in which such statement is furnished, from such wages of the employee (excluding tips, but including funds turned over by the employee to the employer for the purpose of such deduction and withholding) as are under the control of the employer; and an employer who is furnished by an employee a written statement of tips (received in a calendar month) pursuant to section 6053(a) to which paragraph (16)(B) of section 3401(a) is applicable may deduct and withhold the tax with respect to such tips from any wages of the employee (excluding tips) under his control, even though at the time such statement is furnished the total amount of the tips included in statements furnished to the employer as having been received by the employee in such calendar month in the course of his employment by such employer is less than $20. Such tax shall not at any time be deducted and withheld in an amount which exceeds the aggregate of such wages and funds (including funds turned over under section 3102(c)(2) or section 3202(c)(2)) minus any tax required by section 3102(a) or section
3202(a) to be collected from such wages and funds.
Treas. Reg. § 31.3402(k)-1(a)(1) details the general rules which apply to tips, as follows:
Subject to the limitations set forth in paragraph (a)(2) of this section, an employer is required to deduct and withhold from each of his employees tax in respect of those tips received by the employee which constitute wages. (For provisions relating to the treatment of tips as wages, see §§ 3401(a)(16) and 3401(f).) The employer shall make the withholding by deducting or causing to be deducted the amount of the tax from wages (exclusive of tips) which are under the control of the employer or other funds turned over by the employee to the employer (see paragraph (a)(3) of this section). For purposes of this section the terms "wages (exclusive of tips) which are under the control of the employer" means, with respect to a payment of wages, an amount equal to wages as defined in section 3401(a) except that tips and noncash remuneration which are wages are not included, less the sum of–
(i) The tax under section 3101 required to be collected by the employer in respect of wages as defined in section 3121(a) (exclusive of tips);
(ii) The tax under section 3402 required to be collected by the employer in respect of wages as defined in section 3401(a) (exclusive of tips); and
(iii) The amount of taxes imposed on the remuneration of an employee withheld by the employer pursuant to State and local law (including amounts withheld under an agreement between the employer and the employee pursuant to such law) except that the amount of taxes taken into account in this subdivision shall not include any amount attributable to tips.
Treas. Reg. § 31.3402(k)-1(a)(2) explains further:
An employer is required to deduct and withhold the tax on tips which constitute wages only in respect of those tips which are reported by the employee to the employer in a written statement furnished to the employer pursuant to section 6053(a). The employer is responsible for the collection of the tax on tips reported to him only to the extent that the employer can, during the period beginning at the time the written statement is submitted to him and ending at the close of the calendar year in which the statement was submitted, collect the tax by deducting it or causing it to be deducted as provided in [Treas. Reg. § 31.3402(k)-1(a)(1)].
Treas. Reg. § 31.3402(k)-1(a)(3) provides that employees may furnish funds to employers to be withheld, as follows:
If the amount of the tax in respect of tips reported by the employee to the employer in a written statement furnished pursuant to section 6053(a) exceeds the wages (exclusive of tips) which are under the control of the employer from which the employer is required to withhold the tax in respect of such tips, the employee may furnish to the employer, within the period specified in subparagraph (2) of this paragraph, an amount of money equal to the amount of such excess.
Recognizing that an employer may not be able to fully deduct and withhold all taxes on tip income from the wages under the employer's control or from the funds turned over by the tipped employees, Treas. Reg. § 31.3402(k)-1(c)(1) further establishes a priority of the taxes to be withheld, which provides:
In the case of a payment of wages (exclusive of tips), the employer shall deduct or cause to be deducted in the following order:
(i) The tax under section 3101 and the tax under section 3402 with respect to such payment of wages.
(ii) Any tax under section 3101 which, at the time of payment of the wages, the employer is required to collect–
(a) In respect of tips reported by the employee to the employer in a written statement furnished to the employer pursuant to section 6053(a), or
(b) By reason of the employer's election to make collection of the tax under section 3101 in respect of tips on an estimated basis, but which has not been collected by the employer and which cannot be deducted from funds turned over by the employee to the employer for such purpose. (See § 31.3102-3, relating to collection of, and liability for, employee tax on tips.)
(iii) Any tax under section 3402 which, at the time of the payment of the wages, the employer is required to collect–
(a) In respect of tips reported by the employee to the employer in a written statement furnished to the employer pursuant to section 6053(a), or
(b) By reason of the employer's election to make collection of the tax under section 3402 in respect of tips on an estimated basis, but which has not been collected by the employer and which cannot be deducted from funds turned over by the employee to the employer for such purpose. For provisions relating to the withholding of tax on the basis of average estimated tips, see paragraph (b) of § 31.3402(h)(1)-1. (Emphasis added).
Treas. Reg. § 31.3402(k)-1(c)(2) further offers some examples to illustrate the application of the priority. In short, an employer is required to first withhold the taxes on the non-tip wages it paid to the tipped employees. Thereafter, if there is any remaining amount available, the employer is required to withhold the taxes on tips in the following order: (1) FICA taxes under I.R.C. § 3101, (2) federal income tax under I.R.C. § 3402, and (3) state and local taxes. In other words, after the statutorily required withholding taxes from the non-tip wages has been satisfied, the employer must then deduct and withhold federal taxes imposed on tip income from the remaining non-tip wages, which are under its control. Under the federal procedures, if the amount of remaining wages is not sufficient to cover the federal amount required to be withheld on tip income, the amount of tax which remains unsatisfied should be withheld from the wages under the control of the employer the following pay period. I.R.S. Publication 15, at 17-18; see also Form 8027 and instructions.
As noted previously, Taxpayer cites to I.R.S. Tax Topic 761, which tracks the analysis above. As Tax Topic 761 states in relevant part:
You collect the employee's portion of these taxes from the wages you pay your employee, or from funds the employee gives you. If you don't have enough money from the employee's wages and funds your employee gives you, withhold taxes in the following order:
1. Social security and Medicare taxes on the employee's wages,
2. Federal income taxes on the employee's wages,
3. State and local taxes imposed on the employee's wages,
4. Social security and Medicare taxes on the employee's reported tips, and
5. Federal income taxes on the employee's reported tips.
I.R.S. Tax Topic 761 Tips - Withholding and Reporting, https://www.irs.gov/taxtopics/tc761?vm=r (last visited September 23, 2018).
C. Taxpayer's Burden of Proof.
As a threshold issue, all tax assessments are prima facie evidence that the Department's claim for the unpaid tax is valid; the taxpayer bears the burden of proving that any assessment is incorrect. IC § 6-8.1-5-1(c); Lafayette Square Amoco, Inc. v. Indiana Dep't of State Revenue, 867 N.E.2d 289, 292 (Ind. Tax Ct. 2007); Indiana Dep't of State Revenue v. Rent-A-Center East, Inc., 963 N.E.2d 463, 466 (Ind. 2012). Thus, the taxpayer is required to provide documentation explaining and supporting its challenge that the Department's assessment is wrong. Poorly developed and non-cogent arguments are subject to waiver. Scopelite v. Indiana Dep't of Local Gov't Fin., 939 N.E.2d 1138, 1145 (Ind. Tax Ct. 2010); Wendt LLP v. Indiana Dep't of State Revenue, 977 N.E.2d 480, 486 n.9 (Ind. Tax Ct. 2012). When an agency is charged with enforcing a statute, the courts defer to the agency's reasonable interpretation of that statute "over an equally reasonable interpretation by another party." Indiana Dep't of State Revenue v. Caterpillar, Inc., 15 N.E.3d 579, 583 (Ind. 2014).
D. Analysis and Conclusion.
The original Letter of Findings concluded that Taxpayer provided documentation establishing "that the proper ordering procedures were applied" and asked the Department's Audit Division to review the documentation. The Letter of Findings concluded that "To the extent that the documentation shows that the proper ordering procedures were used for the issues being protested from the audit, Taxpayer is sustained."
However, as a result of that supplementary review, the Audit Division concluded that the documentation did not buttress Taxpayer's argument. The Supplementary Audit Report found:
Taxpayer has failed to establish that it complied with the withholding tax ordering requirements. Taxpayer instead provided various payroll reports and withholding tax documents that did not demonstrate the withholding tax order was followed . . . . The original audit results remain the same and there was not a reduction of the [T[axpayer's base tax.
Taxpayer concludes that the issue is whether there may not be sufficient employee wages on any wage statement to satisfy the total withholding liability. Taxpayer explains that the "main issue/question is what this Taxpayer [is] supposed to do when otherwise required withholding exceeds the wages that are within the control of the Taxpayer?" In the example cited above where the employee was paid $2.00 in base wages and $5.00 in tips, what is the Taxpayer to do when the withholding liability exceeds $7.00? The law in that instance is clear, Taxpayer is required to withhold taxes in a specific "order" starting with Social Security and Medicare Taxes and ending with Federal income taxes as documented in the wage statement issued each employee. Indiana's income taxes and the local county income taxes fall in the middle of that order but they are prioritized before Federal income taxes. There is no suggestion that an employee is required to withhold taxes in excess of the wage and tip benefits received by its employees.
Nonetheless, Taxpayer is bound by the requirement that it withhold - and document - that taxes are withheld in the order mandated by law. In this case, a review of the documents provided by Taxpayer do not establish that this requisite order was followed. In other words, Taxpayer has failed to meet its statutory burden under IC § 6-8.1-5-1(c) of establishing that the assessment was "wrong."
FINDING
Taxpayer's protest is respectfully denied.
Posted: 11/28/2018 by Legislative Services Agency
DIN: 20181128-IR-045180493NRA
Composed: Apr 29,2024 6:23:45AM EDT
A
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