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Over the last year our office has handled the defense of a number of attorneys acting as FIRPTA withholding agents facing FIRPTA withholding penalties. These cases have generally occurred due to late submission to the IRS (Service) of the withheld funds. This article will briefly address the FIRPTA withholding rules, the penalties for violating the rules, the handling of proposed penalties, and provide some practitioner tips. It is suggested that a tax controversy attorney handle the actual penalty appeal.
A. Under IRC §1445 there is a withholding obligation that is generally imposed on the buyer or other transferee (withholding agent) when a US real property interest (USRPI) is acquired from a foreign person. In order to report and transmit the amount withheld, the taxpayer needs to use Form 8288. This obligation to report also applies to foreign and domestic corporations, qualified investment entities, and the fiduciary of certain trusts and estates. Generally, 15% of the amount realized on the disposition of the USRPI must be withheld. For dispositions that occurred before February 17, 2016, the withholding amount was 10% of the amount realized on the disposition of the USRPI by the transferor. It is possible to obtain a reduction or elimination of this withholding requirement by applying to the IRS for a withholding certificate.
B. The transferee must file Form 8288 and transmit the tax withheld to the Service by the 20th day after the transfer. If an application for a withholding certificate has been submitted to the Service on or before the date of transfer the transferee is still required to withhold the required 15%. However, if an application for a withholding certificate is submitted to the Service, the time periods change. Under Regulation §1.1445-1(c)(2)(i)(A), the withholding agent/transferee is not required to report and pay over to the Service the withheld amount “until the 20th day following the Service’s final determination with respect to the application.” The Regulation continues to explain that the final determination “will be deemed to occur on the day when the copy of the withholding certificate or the copy of the notification denying the request for a withholding certificate is mailed by the Service to the transferee.” While this extends the time to file Form 8288 and pay the amount determined on the withholding certificate, the original 15% MUST be withheld from the date of the transfer. (NOTE: the instructions for Form 8288 state that “if the principal purpose for filing the application for a withholding certificate was to delay paying the IRS the amount withheld, interest and penalties will apply to the period beginning on the 21st day after the date of transfer and ending on the day
full payment is made.”)
C. Under IRC §6651, penalties apply for failure to file Form 8288 when due and failure to pay the withholding when due. Additionally, if someone is required to, but fails to withhold tax under §1445, the tax including interest may be collected from them. Under §7202 there is a penalty of up to $10,000 for willful failure to collect and pay the tax. Corporate officers or other responsible persons may be subject to a penalty under §6672 equal to the amount that should have been withheld and paid over to the IRS.
1. Under IRC §6651(a)(1), if there is a failure to file on the date prescribed for the specific tax, “there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 months, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent”
2. Under IRC §6651(a)(2) if there is a failure to pay the amount shown on the tax return on or before the date prescribed for payment so the specified tax, “there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.”
3. Under IRC §6651(f) if the failure to file any return is fraudulent, the taxpayer should substitute “15 percent” for “5 percent” each place it appears, and substitute “75 percent” for “25 percent”.
D. It is the use of the reasonable cause exception that has caused most of the penalties we have seen to have been abated. In our experience, the Service seems to be open to hearing reasonable cause arguments as to why these penalties should not be imposed. Some of the arguments could include:
1. If there is a dispute as to when the payment/return was actually sent, it is helpful to remember that IRC 7502 explains that required returns and payments mailed within the allowed time period, if received, are considered timely made regardless of whether the Service receives them within that period. The statute specifically states that “the date of the US postmark stamped on the cover in which such return, claim, statement or other document, or payment, is mailed shall be deemed to be the date of delivery or the date of payment, as the case may be.”
Practice Tip: Make sure to send the payment/return via certified mail and to physically take the package to the post office and have them put a date stamp on the
certified receipt. If any other delivery service is used, make sure it is on the Service’s approved list.
Practice Tip: After the withholding payment clears, put a copy of the cleared check (preferably front and back) into the file. Sometimes the Service will credit the buyer/transferee and the withholding agent with the payment of the withheld funds but not “connect up” the payment to the Seller’s income tax return when filed. Having a copy of the properly notated check readily available will make it easier to respond to the Seller’s request for back up. It can be helpful to simply send the Seller a file copy of the cleared check upon receipt.
2. Sometimes the Service will mix up the dates if a withholding certificate was requested. For example, we have seen them mix up the withholding notice date with the response date (date submitting of the withheld funds is required). In this case it is important to remember that the payment and return are not due until 20 days AFTER the withholding certificate is issued or denied. If the taxpayer failed to actually receive a copy of the withholding certificate this could also be a potential argument for reasonable cause.
3. If you are (or are representing) a withholding agent who is also an attorney or CPA who has timely withheld, but not timely paid the withheld amount to the Service, it could be helpful to include an argument that taxpayer never received any benefit from this withheld money as it was kept in the law firm’s (or CPA firm’s) trust account.
Practice Tip: If using this argument for an attorney, include Rule 5-1.1 of the Florida Bar Rules regulating attorney trust accounts, Florida attorneys are not allowed to receive benefit from interest on funds held in trust. This tends to show that there was no added incentive for taxpayer (the attorney withholding agent) to keep the funds in its trust account.
4. We have had cases where a staff person of the withholding attorney simply did not mail the withholding check to the Service. Once again, in this case use all the information you have to argue that it was reasonable cause (i.e. money was withheld, check was cut to the IRS (U.S. Treasury), the employee was to timely mail the check, but hid the fact they did not, while showing how the withholding attorney/withholding agent appropriately supervised, etc.).
E. The structure of the withholding certificate application process is somewhat faulty. Typically the seller applies for a withholding certificate, but it is not granted prior to closing. The withholding agent (often the buyer’s attorney or the closing title company) holds the withheld amount pending receipt of the withholding certificate. The certificate is issued in full or in part as determined by the Service. However, the Service notifies the seller or the seller’s CPA or attorney who handled the filing of the withholding certificate. The escrow agent is often not notified by the actual recipient of the withholding certificate until well after the Service’s notification regarding the withholding certificate is sent to the seller/seller’s CPA or
attorney who prepared and filed for the withholding certificate. The amount due to the Service is late - resulting in a penalty. Fortunately the escrow agent has the underlying funds, or the escrow agent could be liable for that amount too.
Trap: The first time abatement of penalty defense does not apply.
Practice Tip: When acting as withholding agent, if someone else filed for the withholding certificate:
These steps can help to avoid a penalty situation and bolster a reasonable cause argument if there is a penalty