From Tax Until Eternity

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Professor James Edward Maule, Esq.  

Villanova University School of Law, Villanova, PA

Suppose a person owes $2.5 million to another person. How much would be an appropriate monthly payment to pay off the debt plus interest accumulating while the debt is being serviced? The answer depends on two factors. First, the interest rate makes a difference. Second, the term of the loan payoff matters. For example, with a 5% interest rate and a 30-year term, the monthly payment would be $13,420.54.

In a recent case, Johnson v. U.S., No. 8:98-cv-03050 (D. Md. 2/15/12), the court approved an installment payment arrangement proposed by the IRS for a taxpayer who owed roughly $2.5 million in unpaid taxes and accumulated interest. The taxpayer had objected, claiming that requiring him to make installment payments of his debt would be a hardship. The taxpayer did not dispute the existence of the debt, which arose from the taxpayer's failure as responsible person to cause his corporation to pay employment and withholding taxes.

The taxpayer's evidence showed that he had annual income of almost $64,000. It was in the form of payments from his corporation to the lessor of his family's home. The taxpayer arranged to take income in this manner because it is not subject to garnishment.  In addition, the corporation paid his wife, who is not liable on the debt, a salary of between $130,000 and $140,000. The corporation's salary decisions were made by taxpayer as president. The taxpayer resided in a home with his wife, adult son, niece, and sister-in-law.  No information was provided with respect to the income of, or contribution to household expenses by, the other three, aside from the taxpayer's explanation that he supported his adult son who has Asperger's syndrome.

The taxpayer argued that the amount requested by the IRS "would impose an undue hardship on [the taxpayer], and by extension, his wife and children." He also argued that the amount requested by the IRS was unreasonable, but did not offer an alternative amount.

So how much was the IRS requesting the taxpayer remit under its proposed installment agreement? It was $400 a month.  That amount is 7.5% of the taxpayer's income, and 2.35% of the combined income the taxpayer and his wife were pulling out of the corporation.  The court, not surprisingly, held for the IRS. The court noted that the taxpayer's adult son is not the taxpayer's dependent alone, that the taxpayer is not supporting anyone other than paying rent on the home, that the annual salary of the taxpayer's wife is double the taxpayer's income even though she works substantially fewer hours than does the taxpayer, that the taxpayer controls how the corporation's money is paid out in salaries, and that the intent of the installment payment provisions cannot be circumvented by the structure the taxpayer adopted for compensation.

I agree with the taxpayer that the amount requested by the IRS was unreasonable. It was unreasonably low. The court, however, could do nothing more than approve the IRS request. I tried to use a loan amortization calculator to determine how many years would be required to repay the $2.5 million debt if the monthly payment is $400, using a 5% interest rate. The calculator replied: "Error: The loan cannot be repaid using the parameters that you provided, probably because the Payment Amount is not sufficient to cover the periodic interest that is due. Try increasing the Payment Amount, or perhaps increase the Balloon Payment." It did, however, permit me to make the computation using a zero percent interest rate.  It would take 521 years. Even at a 1% rate of interest, the loan would grow despite the $400 monthly payments. At 1%, annual interest, ignoring compounding, is $25,000. At 5%, the annual interest would be $125,000. Annual payments of $4,800 aren't going to make a dent.  The loan would continue to grow. It would grow infinitely. It would exist eternally.

Of course, someone else is paying off this taxpayer's debt. Either other taxpayers are paying higher taxes to make up the difference, or the budget deficit is growing because of the unpaid debt, shifting the burden to whomever it is that ultimately pays the deficit. Surely, there are five-person families who know how to live on far less than the taxpayer and his wife are making. Surely there are households of five who manage to provide themselves with housing for less than $64,000 a year. Why the IRS did not push for something more realistic, along the lines of $2,000 a month, puzzles me. I wonder how many other eternal tax installment payments are on the books. What does not puzzle me is why this taxpayer had the audacity to complain about a meager $400 monthly payment. The answer to that one is easy. Very easy.

 For more information, in the Tax Management Portfolios, see Mather and Weisman, 638 T.M., Federal Tax Collection Procedure - Defensive Measures,  and in Tax Practice Series, see ¶3870, Collection of Tax.

© 2012 James Edward Maule

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