In paying less than all of the tax assessments that are due, it may become critical for the taxpayer to designate how the tax payment should be applied among the tax, penalties and interest, as a recent decision of the Sixth Circuit reminds us.
In re: Southeast Waffles, LLC v. United States, 2012 U.S. App. LEXIS 24991 (6th Cir. 2012),
here. In that case, the employer sent in undesignated payments to be applied against assessments for the employer's withholding tax obligations, penalties and interest. As undesignated payments, the IRS applied the payments to the employers penalties. The employer then went into bankruptcy. In the bankruptcy proceeding, the employer argued that the application of the payments to the penalties was voidable because the penalties would have had a lower priority and would have been discharged, vis-a-vis the employer, in the bankruptcy proceeding. (Note that these are penalties for the employer's direct payment obligation and are not trust fund recovery penalties (TFRP) under Section 6672 even though they relate to the trust fund liability; as to responsible persons, TFRP are not dischargeable.)
In my Federal Tax Procedure Text I discuss the issue of designating payment as follows (footnotes omitted):
We focus now on the issues confronting the taxpayer in making the payment of less than the amount of the IRS assessment. The question here is whether the taxpayer can designate as among the various components of aggregate tax owed (e.g., as among years or within the same year as among taxes, penalties and interest).
The taxpayer is permitted generally to so designate a voluntary payment to the IRS. Voluntary for this purpose means any payment not resulting from the Government’s compulsory collection measures (e.g., levy), that we discuss later in this chapter. If, however, the taxpayer fails to designate the application of the payment, the IRS can apply the payment as it sees fit.
Designation may be critical in certain cases. We shall give examples which are by no means exhaustive, but should illustrate the concepts:
