Resolving Sales and Use Disputes in by Matthew A. Morris, LL.M., Esq.+ for National Business Institute (NBI) Presentation Date: June 11, 2014 Boston, Massachusetts

Introduction

Representing clients in sales and use tax disputes in Massachusetts can be a daunting task. Not only does the representative have to familiarize himself with almost every aspect of the client’s business and financial practices, but he also needs to be well-versed in the most recent developments in both Massachusetts and federal law regarding issues such as nexus and streamlined use tax. The purpose of this article is not to identify the various legal bases that the taxpayer’s representative may rely upon to challenge a particular sales or use tax assessment, but rather to provide a general overview of the various procedural considerations at stake in any Massachusetts sales or use tax controversy.

1. Audit Procedures

The first step of any sales and use tax dispute in Massachusetts is to help the client through the audit process. Typically a taxpayer will be notified that the Massachusetts Department of Revenue (hereafter “DOR”) has initiated an audit against a particular taxpayer for a particular tax type and a particular tax period. What the taxpayer may not initially understand, however, is that the scope of the audit set forth in the auditor’s first document request is merely the DOR’s initial negotiating position; the auditor always reserves the right to expand the scope of the audit to additional tax types, tax periods, and even taxpayers if the auditor senses the potential for underreporting.

A. Audit “Triggers”

Both the IRS and the DOR are notoriously reluctant to provide any information regarding their audit selection criteria. There are, however, several “red flags” or

+ Matthew A. Morris, LL.M., Esq., recently joined Kerstein, Coren & Lichtenstein, LLP—a full-service law firm in Wellesley, Massachusetts—as a Partner in the Tax and Estate Planning Department. Prior to joining Kerstein, Coren & Lichtenstein, Attorney Morris was an Associate at M. Robinson & Company, P.C., a boutique tax firm in downtown Boston specializing in the resolution of federal and state tax controversies. Attorney Morris received his LL.M. in Taxation in 2009 from the Boston University School of Law Graduate Tax Program, where he was awarded the Dean Ernest M. Haddad Award for academic achievement, character, and potential to serve the public interest. In 2008, Attorney Morris received his J.D., cum laude, from University of Maine School of Law, where he served as Executive Editor of the Maine Law Review and was presented with the Student Bar Association Distinguished Service Award. He also holds a M.A. in Slavic Languages and Literatures from Stanford University (2004), and a B.A. in Russian Language and Literature from Brown University (2000). You may contact Attorney Morris at (781)997-1600 or via email at mmorris@kcl- law.com. “triggers” that signal to the DOR that a particular taxpayer should be audited. The following is a partial list of these “audit triggers”:

 The company’s Massachusetts property reported on its Form 355: Corporate Excise Tax Return does not correlate with its sales and use tax returns. Every corporation doing business in Massachusetts must file a Form 355 (or 355S for S Corporations). On both the Schedule A: Balance Sheet and Schedule F: Income Apportionment of the Form 355, taxpayers are required to disclose details regarding the motor vehicles, machinery, and equipment that the company maintains in Massachusetts. For companies with motor vehicles or other equipment in Massachusetts (such as an interstate freight company with Massachusetts terminal locations), the original cost and book value of these assets could be significant. For these companies with a significant property presence in Massachusetts, the DOR can easily retrieve their Massachusetts sales and use tax returns to see if the companies are paying their fair share of sales and use tax.

 The company’s Massachusetts sales factor does not correlate with its returns. For companies that generate a significant amount of income from sales of tangible property (such as retailers), the DOR can easily cross- reference these companies’ sales tax returns against the tangible property sales attributable to Massachusetts and reported on Form 355 (or 355S), Schedule F, line 3 (the sales factor). If there is a discrepancy between the sales of tangible property reported on Form 355, Schedule F and the company’s sales tax returns, that company will likely be audited for income tax purposes (if the sales per the sales tax returns are higher), sales tax purposes (if the sales per the income tax returns are higher), or both.

 The company’s IFTA (International Fuel Tax Agreement) or IRP (International Registration Plan) returns do no correlate with the company’s sales and use tax returns. In what is likely to become a growing concern for interstate trucking companies with nexus in Massachusetts (following a recent ATB decision, opinion forthcoming), companies who pick up or deliver a significant amount of freight to locations in Massachusetts may be subject to an unapportioned use tax on the purchase price of the tractors and trailers delivering that freight. Interstate trucking companies report the mileage travelled by their tractors in each state on IFTA and IRP returns, which are designed to allocate fuels and registration fees, respectively. If the DOR determines that the percentage of Massachusetts mileage reported on these returns is high enough to justify audit costs, then it may initiate sales and use tax audits against these taxpayers.

 The taxpayer is suffering from a “cash-T” problem1, which means that his or her total monthly expenses exceed his or her total monthly income. In other words, the taxpayer must be under-reporting gross receipts or over- reporting expenses in order to simply break even for a particular month. This “audit trigger” is only applicable to income tax, but it could be the first step of a gradually-expanding audit scope that will eventually encompass sales and use tax.

 A company registers its property (e.g. motor vehicles) in Massachusetts, but that company pays no sales or use taxes to the Commonwealth. The DOR can easily check with the Registry of Motor Vehicles to see whether a particular company has any vehicles registered in the Commonwealth, and then cross- reference that company’s inventory of Massachusetts-registered vehicles against its sales and use filings in prior years in order to determine whether sales or use tax was ever paid on these vehicles.

 A company owns real estate in Massachusetts, but that company pays no sales or use taxes to the Commonwealth. If a company owns substantial parcels of real estate in Massachusetts (also easily determined by searching the online Registries of Deeds for the various Massachusetts counties) but has not filed any Massachusetts sales or use tax returns, it is likely that this company has purchased various items of business property outside of Massachusetts that are intended for use within Massachusetts, thereby subjecting this property to a use tax.

It is often helpful for the representative to try to determine the nature of the particular “audit trigger” for his or her client. Identifying this trigger will not only assist the representative in recognizing “red flags” for other taxpayers, but will also help him or her to sharpen the focus of the present audit.

B. Audit Types

The following is a description of the three main audit types: desk audits, field audits, and Computer Assisted Audit Techniques (CAATS).

i. Desk Audits

Desk audits are relatively straightforward and can usually be resolved through exchanges of correspondence between the auditor and the taxpayer.2 If a taxpayer

1 This is referred to as a “cash-T” problem because the auditor will prepare a simple T-shaped chart that lists income on one side of the T and expenses on the other. If this analysis suggests that the taxpayer is operating at a significant net deficit, then this indicates that the taxpayer suffers from a “cash-T” problem. 2 See MASSACHUSETTS DEPARTMENT OF REVENUE, Common Questions About Audits, available at http://www.mass.gov/dor/audit-info/audit-questions.html#why_selected (last visited May 6, 2014). receives correspondence from the DOR Bureau of Desk Audit, this typically means that the scope of the issues that the DOR is concerned about is relatively narrow, and that the case can be resolved in a matter of weeks rather than a matter of months.

ii. Field Audits

In a field audit, the DOR auditor will contact the taxpayer (or the taxpayer’s representative) to arrange a mutually convenient time to meet to review the taxpayer’s books and records.3 If the taxpayer is a business, then the DOR auditor will likely want to meet at the taxpayer’s business location so that he or she can review the taxpayer’s books and records on-site. This gives the auditor the opportunity to get a better sense of the taxpayer’s business. For example, if the taxpayer is a retailer, the auditor may want to see how much inventory the taxpayer keeps in stock. The auditor may also want to take a first-hand look at the taxpayer’s point of sale system and how many customers frequent the business during a typical day. The taxpayer’s representative should make every effort to shift the location of the audit from the taxpayer’s business location to the representative’s office or another off-site location. The reasons for shifting the location off-site are to (1) keep the scope of the audit as limited as possible and (2) prevent unnecessary interference with the taxpayer’s business operations.

iii. Computer-Assisted Audit Techniques (CAATS)

Computer-Assisted Audit Techniques (CAATS) is a method that the DOR will use in order to generate a “statistically valid sample of transactions on which to base [its] audit.”4 The scope of the information that is requested using CAATS is just as comprehensive as the scope of information that might be requested during a field audit. The main differences between CAATS and a traditional field audit is that (1) the data in a CAATS audit will be analyzed by software rather than manually analyzed by the DOR auditor and (2) the taxpayer-provided electronic data in a CAATS audit can be analyzed remotely at the DOR office rather than at the taxpayer’s business location.5

Although both of these differences might initially appear to be distinct advantages over a traditional field audit, serious problems can result from relying on a computer-generated “random” sample of sales and use tax transactions. The most obvious potential problem with the CAATS system is that the sample set of transactions selected by the software program might produce a distorted estimate

3 Id. 4 MASSACHUSETTS DEPARTMENT OF REVENUE, A Guide to Computer Assisted Audit Techniques, p. 3 (April 1, 2006), available at http://www.mass.gov/dor/docs/dor/publ/pdfs/caat.pdf (last visited May 6, 2014). 5 Id. of the taxpayer’s sales and use tax liability for the entire period under audit. Therefore, the taxpayer’s representative must have a solid understanding of the taxpayer’s exposure to additional sales and/or use taxes for the entire audit period before accepting the statistical sample selected by CAATS.

C. Determining the Scope of the Audit

It is critical for taxpayers and their representatives to understand the scope of the audit. The following are some of the questions that taxpayers and their representatives should be comfortable answering before providing any documentation to the DOR auditor:

 Is the audit limited to sales and use tax, or does it also include other tax types such as income tax and/or payroll tax?

 What tax periods are involved in the audit?

 Have sales and/or use tax returns been filed for the periods at issue (in which case the DOR has three years from the date of filing or the due date of the return, whichever occurs later, to assess additional tax6), or have no returns been filed (in which case the statute of limitations on assessment does not apply)?

It is important to note that what may initially appear to be a relatively narrow scope at the outset of an audit (for example, sales tax returns for a single year) can gradually expand to include other tax periods and tax types. If the taxpayer provides the auditor with sufficient supporting documentation in response to the auditor’s first document request, then the auditor is unlikely to expand the scope of the audit. If the auditor detects underreporting after reviewing the taxpayer’s response to the first document request, however, then the auditor will likely inquire about other tax periods and/or tax types.

Generally speaking, the scope of an audit has the potential to expand, but not contract. In other words, a desk audit regarding one or two discrete issues has the potential to develop into a more comprehensive field audit depending on the auditor’s discretion, but a comprehensive field audit will rarely contract into a desk audit with a narrow focus on a limited number of issues.

2. Administrative Review and Appeals

After the conclusion of the audit, the taxpayer will have the opportunity to challenge the proposed or actual assessment of additional sales and/or use tax. The procedure for challenging the proposed or actual assessment is highly dependent on the timing of the appeal.

6 M.G.L. c. 62C, sec. 26(a).

A. Appeals Form: Form DR-1

Typically, taxpayers only have one chance to appeal a proposed or actual sales or use tax assessment to the Massachusetts Department of Revenue Appeals Office. Taxpayers can file a Form DR-1: Appeals Form either (1) after receiving a Notice of Intent to Assess (NIA) (pre-assessment) or (2) after receiving a Notice of Assessment (NOA) (post-assessment). The Form DR-1 entitles the taxpayer to a pre- assessment or a post-assessment settlement conference and asks the taxpayer to propose a good-faith settlement of the contested tax assessment (or proposed assessment).

B. Alternative Dispute Resolution: Early Mediation Program

The early mediation program is currently available for taxpayers with proposed assessments of tax in excess of $250,000, but it is likely that this program will soon become available to taxpayers with lower amounts of tax liability.

There are several criteria for participation in the DOR Early Mediation Program:

 The issues and facts in the case must be fully developed and documented;

 The taxpayer must have presented its position to the Audit Division; and

 Both parties must be willing to resolve all (or in exceptional cases, substantially all) disputed and undisputed issues.7

If the above criteria are met, then the taxpayer will have the opportunity to resolve the case with the assistance of a “neutral mediator” from the Office of Appeals.8 The advantage of the early mediation program is that it allows taxpayers and the DOR to focus on and attempt to resolve a limited number of disputed issues instead of wasting valuable time and professional resources on “red herring” audit matters.

The timeframe for requesting participation in the early mediation program is generally before the Notice of Intent to Assess (discussed below) is issued, but early mediation can still be requested if the request is received within 30 days after a Notice of Intent to Assess has been issued (or postmarked within 25 days). 9

7 AP 635: Early Mediation Program, available at http://www.mass.gov/dor/businesses/help-and- resources/legal-library/administrative-procedures/ap-635.html (last visited May 6, 2014). 8 Id. 9 Id. at 635.3.2.2: Filing an Application for Mediation After the Issuance of a Notice of Intent to Assess. C. Notice of Intent to Assess (NIA)

The auditor will issue a Notice of Intent to Assess (NIA) to taxpayers at the conclusion of an audit. Taxpayers have 30 days from the date of the NIA to respond to the notice, either by discussing the Notice with the auditor, paying the liability, or submitting the Form DR-1: Appeals Form to the auditor.10 The taxpayer’s response to the NIA must be received within 30 days of the notice date, or postmarked within 25 days from the notice date.11

D. Notice of Assessment (NOA)

A taxpayer will receive a Notice of Assessment (NOA) (1) if he or she does not respond to the NIA or (2) of he or she files a pre-assessment appeal (via Form DR-1) and the Appeals Office finds that some additional sales or use tax is due (either through a partial abatement or a refusal to abate any tax).12

E. Form CA-6: Application for Abatement

The purpose of the Form CA-6 is for taxpayers to request an appeal after an assessment has been made. A Form CA-6 must be filed post-assessment; it cannot be filed pre-assessment. The Form CA-6 must be filed within the following statutes of limitation on claims for refund:

 Within three years from the date of filing (without regard to extensions);

 Within two years from the date of the assessment (or deemed assessment); or

 Within one year from the date of payment or levy.13

The above statute of limitations on claims for refund will hereafter be referred to as the “3-2-1 rule.”

10 See MASSACHUSETTS DEPARTMENT OF REVENUE, Notice of Intent to Assess, available at http://www.mass.gov/dor/individuals/bills-collections-and-audits/types-of-bills-and- notices/nia.html (last visited May 6, 2014). 11 See AP 609: Verification of Returns Through Audit, available at http://www.mass.gov/dor/businesses/help-and-resources/legal-library/administrative- procedures/ap-609-verification-of-returns-through-audit.html (last visited May 6, 2014). 12 See MASSACHUSETTS DEPARTMENT OF REVENUE, Common Questions Regarding Collections, available at http://www.mass.gov/dor/how-do-collections-work/how-do-collections-work/common-question- regarding-collections.html (last visited May 6, 2014). 13 M.G.L. ch. 62C, sec. 37. F. Petitioning a Denial of a Form CA-6 to the Appellate Tax Board

After receiving an adverse decision from the Appeals Office on a Form CA-6, the taxpayer has the option of filing a petition with the Appellate Tax Board. The taxpayer has (1) 60 days from the date of the notice of abatement denial or (2) six months from the date of the “deemed denial” of his or her Form CA-6 to file a petition appealing the Commissioner’s decision to the Appellate Tax Board.14

3. Penalties and Pre-Assessment Interest

The following is a description of the various penalties that may be assessed on a taxpayer in connection with a sales and/or use tax audit.

A. Failure to File/Failure to Pay Penalties

Failure to file penalties are assessed at the rate of one percent of the amount required to be shown as tax on such return for each month (or fraction thereof) that the return has not been filed, not to exceed 25 percent of the tax.15 Failure to pay penalties are assessed at same rate (one percent) for each month that the tax remains unpaid, not to exceed 25 percent of the tax.16 Both the failure-to-file and failure-to-pay penalties can be waived or abated on the basis of reasonable cause.17

B. Section 35A Penalties for Negligence or Substantial Understatement

A penalty equal to 20 percent of the underpayment of tax will be imposed on a vendor who underpays the sales/use tax due to negligence or disregard of the tax laws, or who substantially understates a tax liability on a return.18

i. “Negligence”: This term is defined as “any failure to make a reasonable attempt to comply with the law or public written statements.”19

ii. “Disregard of the tax laws”: This is defined as “any careless, reckless, or intentional disregard [for the tax laws].”20

iii. “Substantial understatement of tax”: A substantial underpayment of tax is defined as the greater of 10 percent of the tax required to be shown on the return or $1,000.21

14 Id. sec. 39 15 M.G.L. c. 62C, sec 33(a). 16 Id. sec. 33(b). 17 Id. sec. 33(f). 18 Id. sec. 35A(a); see also TIR 06-5, New Penalties under G.L. c. 62C, §§ 35A-35E 19 M.G.L. c. 62C, sec 35A(c). 20 Id.

The section 35A penalties for negligence and substantial understatement can be waived or abated on the basis of reasonable cause22, but the standards for what constitutes “reasonable cause” are different than the reasonable cause standards set forth in AP 633 (applicable to failure to file and failure to pay penalties)23.

C. Civil Fraud Penalty

In order to establish that the taxpayer is liable for a civil fraud penalty, the DOR must prove by a preponderance of the evidence (the “more likely than not” standard) that the taxpayer (1) failed to file a return within 30 days after the DOR notified the taxpayer of the requirement to file, or (2) “filed a false or fraudulent return or has filed a return with a willful attempt in any manner to defeat or evade the tax.”24 If the DOR determines that it is more likely than not to prevail in establishing that the taxpayer willfully filed a false return, or failed to file a return within 30 days of notification, then the DOR is entitled to assess the tax due “at not more than double the amount so determined.”25 Thus, the Massachusetts “civil fraud” penalty can be as much as 100 percent of the tax due, not including other penalties such as the failure-to-file, failure- to-pay, and section 35A negligence or substantial understatement penalties.

D. Pre-Assessment Interest

Interest in Massachusetts for sales and use tax purposes is computed on the basis of the amount of sales and/or use tax that should have been reported on the taxpayer’s timely-filed sales and/or use tax return.26 In other words, interest runs not from the date of assessment, but from the date that the tax was due, without regard to extensions. For sales tax assessments, interest will start to accrue from the due date of the sales and/or use tax return (for

21 Id. 22 See id. sec. 35B(a). 23 See DOR Directive 12-7: Section 35A Penalty for Underpayment of Tax Required. 24 M.G.L. c. 62C, sec. 28. For further details regarding the elements of civil fraud, see Part 4: Criminal Penalties, below. 25 Id. 26 MASSACHUSETTS DEPARTMENT OF REVENUE, Assessment of Interest: Interest Due on Unpaid Tax, available at http://www.mass.gov/dor/individuals/filing-and-payment-information/guide-to- personal-income-tax/assessments-interest-and-penalties/assessment-of-interest.html (last visited May 6, 2014). taxpayers who collect $1,201 or more in sales tax on an annual basis, starting on the 20th day of the following month27).

The DOR does not have the authority to abate interest that has accrued on unpaid tax, but can abate the interest that has accrued on unpaid penalties if those penalties have been abated.28

4. Criminal Penalties

Willful evasion of taxes is a felony punishable by a fine up to $100,000 for individuals or $500,000 for corporations and/or imprisonment for up to five years.29 Willful failure to collect and pay over taxes is also a felony and is punishable by a fine up to $10,000 and/or imprisonment for up to five years.30

There are two requirements for any criminal penalty: (1) mens rea (guilty mind) and (2) actus reus (guilty act). Tax evasion or “tax fraud” is a specific intent crime: the taxpayer must specifically intend to deliberately avoid tax and must willfully submit materially false statements, documents, and/or returns in connection with that intent. The intent to defraud without false statements is not tax evasion, neither is the submission of false returns and/or statements without the intent to defraud (evade tax).

There are both civil and criminal penalties for tax fraud. The elements of civil and criminal fraud are the same: there must be a tax due and owing combined with a fraudulent intent. In a criminal tax fraud case, however, the government must prove beyond a reasonable doubt that the taxpayer specifically intended to evade tax. In contrast to this demanding burden of proof, the government in a civil case only needs to establish that the taxpayer more likely than not intended to evade tax (referred to as the “preponderance of the evidence” standard).

The following are some examples of affirmative acts of fraud:

 Omissions of specific items where similar items are included. If a taxpayer includes some, but not all receipts for a particular category of sales, then this may be an affirmative act of fraud. For example, a hotel that fails to report all of the gross receipts from all sales from the gift shop may argue that it made

27 MASSACHUSETTS DEPARTMENT OF REVENUE, Sales and Use Tax: Payment of the Sales Tax, available at http://www.mass.gov/dor/businesses/current-tax-info/guide-to-trustee-taxes/sales-and-use- tax.html (last visited May 6, 2014). 28 See AP 612: Interest and Penalties at 612.2: Adjustment of Interest or Abatement of Penalties, available at http://www.mass.gov/dor/businesses/help-and-resources/legal- library/administrative-procedures/ap-612-interest-and-penalties.html. 29 Id. sec. 73(a). 30 Id. sec. 73(b). it a good faith error, whereas the clothing store that only reports two-thirds of its gross receipts from clothing sales may be accused of tax fraud.

 Concealment of bank accounts or other assets. Does the taxpayer have a secret account into which he or she is siphoning a portion of its receipts? Does the taxpayer have a large cache of precious metals, coins, antiques, and collectibles? If the answer to either or both of these questions is “yes,” the taxpayer may be found liable for tax fraud.

 Failure to deposit receipts to business accounts. The failure to deposit receipts into business accounts—either by retaining a large reserve of cash or depositing these receipts into personal or “secret” accounts—are considered affirmative acts of fraud. Commingling of personal and business accounts does not, in itself, constitute fraud. It is not a crime to deposit business receipts into personal accounts or vice versa, but a commingling of business and personal accounts combined with other evidence of willful underreporting could result in a finding of fraud.

 Covering up sources of receipts. If a taxpayer falsifies the source of receipts (for example, by erroneously characterizing a large deposit as a non-taxable transfer or gift), that taxpayer has committed an affirmative act of fraud.

5. Abatement of Penalties

The Massachusetts Department of Revenue relies on Administrative Procedure 633: Guidelines for the Waiver and Abatement of Penalties (hereafter “AP 633”)31 to determine whether the particular facts and circumstances of a taxpayer’s case warrant a pre-assessment waiver or a post-assessment abatement of penalties.

A. Factors that Support a Claim for Reasonable Cause

The following are the factors set forth in AP 633 that support a finding of reasonable cause:

i. The delay was the direct result of a death or serious, incapacitating illness that impacted the taxpayer's ability to file or pay timely. In order for the taxpayer to be entitled to relief on the basis of death or serious illness, the person who dies or suffers a serious illness can either have a direct or indirect connection with the taxpayer’s sales and use tax compliance. For example, a taxpayer who “spent several months caring for a terminally ill person with whom she lived” who later discovered that she failed to file an income tax

31 Available at http://www.mass.gov/dor/businesses/help-and-resources/legal- library/administrative-procedures/ap-633-guidelines-for-the-waiver-and-abatement.html (last visited May 4, 2014). return or extension is entitled to an abatement of penalties because “her delay was reasonable . . . [and] her prompt resolution of the matter demonstrates that she attended to her tax obligations as would an ordinary taxpayer.”32 Similarly, a husband and wife who own a business together are entitled to a waiver of penalties during the time that one of their children became seriously ill.33 However, this example contains an important caveat: the husband and wife are the only employees, and “no additional staff or bookkeepers maintain the business operations.”34 Thus, this example suggests that death or serious illness will only support a claim for abatement of penalties when the sales or use tax compliance responsibilities could not have been delegated to another employee within the company.

ii. The delay was caused by an unavoidable absence of the party responsible for filing and payment. Consideration will be given to whether such person should have delegated authority or otherwise ensured timely compliance in his or her absence. Did the taxpayer, within a reasonable period of time, take steps to ensure that sales or use taxes would be paid in a timely fashion after the party who used to be in charge of paying these taxes became unavailable? If so, then any penalties imposed in the interim period between the absence of the first professional and the appointment of the second should be abated. There is no clear definition of “reasonable period of time”: this is a facts and circumstances test rather than a bright-line rule.

iii. The delay was caused by the destruction of property or records by natural disaster, fire or other casualty. Since sales tax returns are supposed to be filed on a monthly basis for taxpayers with annual sales tax liabilities of $1,201 or more , the destruction of property or records for these taxpayers is probably not a persuasive rationale (beyond perhaps one or two months of penalties).

iv. The delay arose from the taxpayer's inability to obtain the records or information necessary to determine the amount of tax due. The taxpayer’s inability to obtain the records or information must stem from reasons beyond the taxpayer's control in order for a taxpayer to obtain an abatement on the basis of an inability to obtain records. For example, if a retailer provides all of its gross receipts documentation to its bookkeeper, and that bookkeeper then loses all of the original documentation or refuses to provide this

32 Id. at Part A.1, Example 1a. 33 Id., Example 1b. 34 Id. documentation to the taxpayer in time for the taxpayer to file its monthly, quarterly, or annual sales tax return, then this taxpayer may be entitled to an abatement of penalties. v. A taxpayer who had furnished all necessary and relevant information to DOR received erroneous, written information from DOR personnel acting in their official capacity which prevented taxpayer's compliance. In a situation in which a DOR official provides written advice to a taxpayer stating that the taxpayer is not liable for Massachusetts sales and/or use tax, and the taxpayer relies on this advice, the taxpayer should be entitled to an abatement of penalties if the DOR representative’s advice later proves to be incorrect. Practically speaking, DOR representatives, especially customer service representatives, are unlikely to provide written advice to a taxpayer stating that the taxpayer would not be liable for sales and use tax, regardless of the details of the situation. vi. The taxpayer was incorrectly advised by a tax professional competent in applicable tax matters after furnishing such advisor all necessary and relevant information. This situation is more likely to be encountered in income tax audits than in sales and use tax audits. The main reason for this is that CPAs are not as likely to prepare the monthly (if annual sales/use tax liability over $1,201) sales and use tax returns as the company’s bookkeeper, CFO, or even CEO (for smaller businesses). Thus, in cases where corporate officers prepare the monthly sales or use tax returns, and the amount of sales or use tax is underreported, these companies cannot rely on the defense that they provided all the relevant information to a competent tax professional. vii. The delay stems from a lack of clarity in the law or its interpretation. In a recent case before the Appellate Tax Board, we were successful in obtaining an abatement of penalties on the basis that the area of law surrounding the imposition of use tax on interstate tractors and trailers was so unclear that it would be unfair to impose penalties in that particular case. The auditor’s notes in that case suggested that he was unaware whether a prior DOR Letter Ruling (Letter Ruling 80-22) was still the applicable law regarding the imposition of sales and use tax penalties. Letter Ruling 80-22 stated that a vehicle would qualify for an exemption from sales and use tax in Massachusetts if (1) the vehicle was licensed by the Interstate Commerce Commission (ICC) as an interstate commercial vehicle, (2) delivery or possession of the motor vehicle was taken outside Massachusetts, and (3) the tractor or trailer was brought to Massachusetts for the first time carrying passengers or freight in interstate commerce. The ATB agreed to abate the penalties (although they have not yet released an opinion explaining its rationale), and the resulting penalty savings was approximately $400,000.

viii. The taxpayer relied upon a person to file returns and pay the tax and the person failed to file returns and misappropriated the taxpayer's funds. Penalties should not be imposed in a case where a person was instructed to file sales or use tax returns and provided with the money to pay these taxes, but then used the taxpayer’s funds for his or her own benefit.

B. Additional Factors that Support a Reasonable Cause Determination

The following are the additional factors set forth in AP 633 that support a finding of reasonable cause. None of the following factors, in itself, will be sufficient to abate penalties, but each of these factors helps to provide additional context that may strengthen or weaken the taxpayer’s reasonable cause argument.

i. The relative expertise and knowledge of the taxpayer. Should the taxpayer have known better? Is the taxpayer a sophisticated businessperson, or a new business owner who has only recently been placed in charge of collecting and paying sales and use tax? The DOR assumes that a “ordinary taxpayer operating a business should reasonably consult with the DOR or a tax professional.”35

ii. Whether the taxpayer took reasonable steps to become familiar with tax obligations. Was the taxpayer willfully blind to his or her sales and use tax requirements? Or did he or she take reasonable steps to determine the extent of his or her filing responsibilities but made a good faith error based on all available information?

iii. Whether the taxpayer voluntarily disclosed the delinquency and cooperated with any subsequent (or ensuing) DOR investigation. The taxpayer’s cooperation during the audit process is an important factor in determining whether the DOR will consider abating penalties. If the taxpayer has not cooperated in the audit, then it is highly unlikely that the DOR will grant a request to abate penalties.

iv. The compliance history of the taxpayer. The DOR routinely grants waivers or abatements of penalties to first-time offenders—those taxpayers who have a relatively unblemished history of timely filing and paying before the delinquent tax filings. This rationale is

35 Id. at Part B, Example b. more likely to be effective with other types of tax audits—such as income tax—in which the tax period is one year instead of one month and the proposed or actual tax assessment is likely to be higher than for a single monthly sales or use tax assessment. In other words, the DOR will consider waiving or abating sales and/or use taxes for a single period (one month) on the basis of the taxpayer’s “first time offender” status, but is unlikely to consider waiving or abating penalties for 12 straight periods (one year of sales/use tax filings).

v. The number of tax periods involved in the delinquency. A taxpayer who has been assessed penalties for additional sales or use taxes over a six-month period (assuming an unblemished compliance history) is in a much better position for penalty abatement than a taxpayer with 18 months of additional sales or use tax assessments.

vi. Whether a financial benefit arose from the delinquency. Some tax compliance problems do not result in any financial benefit to the taxpayer. For example, a taxpayer may fail to file sales tax returns for a short period of time and for a relatively small component of the taxpayer’s cash flow (such as a hotel that sells small items in its gift shop and fails to file sales tax returns to report those sales). On the other hand, the DOR would likely argue that a taxpayer such as a convenience store that fails to remit sales tax on a monthly basis would financially benefit from this delinquency since nearly 100% of its gross receipts are subject to sales tax.

vii. Whether the taxpayer should have requested an extension of time for filing. This factor is inapplicable to sales and use tax cases because there is no extension to file sales and use tax returns in Massachusetts.

6. Dealing with Responsible Party Assessments and Aggressive Collection Activity

The following is a non-exclusive list of some of the ways in which taxpayer representatives can defend against responsible party assessments and aggressive collection activity by the DOR.

A. Responsible Party Assessments

In the case of sales and use tax assessments that remain unpaid by a corporation or partnership, the DOR will file a “responsible party” assessment against those officers, employees, or partners whom the DOR deems to be personally responsible for collecting and paying over the required amount of sales and/or use tax.36 Massachusetts DOR Directive 02-6 provides that “[o]fficers and employees of a corporation, and partners and employees of a partnership, may be held personally and individually liable for sales and use taxes assessed against the corporation or partnership if that entity fails to pay these taxes to the Commonwealth.”37 The “responsible person” is liable for all of the corporation’s or partnership’s unpaid sales and use taxes, “regardless of whether the entity collected the tax or failed to do so.”38

In order to defend a taxpayer against a “responsible party assessment,” a taxpayer representative must establish that his client was not an officer, employee, partner, or member of the entity responsible for collecting and paying over sales and use taxes to the Commonwealth. The DOR will presume, in the “absence of any other relevant factors,” that the following persons are responsible parties:

 The president, secretary, and treasurer of a corporation,

 Any other principal officer or officers, whatever their titles, of a corporation,

 All or any one of the active partners of a partnership,

 All or any one of the managers of a limited liability company, and

 All or any one of the members of a limited liability company involved in managing the company.39

Thus, if an individual falls into one of the above categories, he or she will be presumed to be a responsible party (jointly and severally liable with other responsible parties) unless it can be definitively established that the individual had no duty to collect and pay over taxes.

B. Obtaining Holds on Collection

In certain situations, taxpayer representatives when first getting involved in a case can obtain holds on collection activity for a reasonable amount of time (typically not longer than 60 days) in order to provide the representative with adequate time to familiarize himself or herself with the details of the case. Although the IRS routinely grants holds on collection, the DOR is more reluctant to grant such holds and are

36 See M.G.L. c. 62C, sec 31A; c. 64H, sec. 16; c.64I, sec. 17 (addressing personal liability for those persons responsible for collecting and paying over sales and use taxes). 37 DOR Directive 02-6: Responsible Person Liability for Sales and Use Taxes, available at http://www.mass.gov/dor/businesses/help-and-resources/legal-library/directives/directives-by- years/2000-2009-directives/directive-02-6-responsible-person-liability.html (last visited May 6, 2014). 38 Id. 39 830 CMR 62C.31A.1(5)(c). more likely to instruct taxpayers to file a Form CA-6 as soon as possible in order to avoid involuntary collection activity.

C. Defending Against Involuntary Collection Activity—In General

If a taxpayer has been assessed additional sales and use tax as the result of an audit, the taxpayer will have 90 days from the date of the Notice of Assessment to pay the additional income tax before the DOR can initiate involuntary collection activities.40 If the taxpayer does not agree with the amount of the additional tax assessed, then he or she should file a Form CA-6 to contest the assessment within the applicable statute of limitations on claims for refund (the “3-2-1 rule,” discussed in Part 2.E, above). A Form CA-6 places a hold on collection activity until 60 days after a decision has been rendered on the appeal.41 Filing a petition to the Appellate Tax Board will also stay any involuntary collection proceedings.42

D. Defending Against Tax Liens

Defending against the filing of tax liens is perhaps the most difficult aspect of representing taxpayers in the collections process. The DOR routinely files liens against taxpayers with outstanding liabilities, regardless of the amount of the liability or the taxpayer’s promise to pay the liability within a certain timeframe. Unless it is prohibited from pursuing involuntary collections activity under one of the circumstances addressed in Part 6.A, above, the DOR will invariably file a lien to protect its interest in the underlying tax, interest, and penalties. The DOR will release the lien in whole if the taxpayer fully pays the liability43, and will partially release or subordinate the lien in special circumstances44, but will only withdraw the filing of the lien if it made an error in filing the lien (such as filing the lien against the wrong taxpayer).

E. Defending Against Tax Levies

If the DOR has levied a taxpayer (either through a bank levy or a wage garnishment), that taxpayer often has no other choice but to come into current tax compliance and enter into an installment agreement or other payment agreement with DOR in order

40 MASSACHUSETTS DEPARTMENT OF REVENUE, Your : A Guide to the Department of Revenue at 25 (2005), available at http://www.50statelegalforms.com/files/form2/form23555.pdf (last visited May 6, 2014). 41 M.G.L. c. 62C, sec. 32(e)(3) (“The amount of tax in dispute . . . shall be required to be paid only after . . . (iii) the date on which any right of appeal from a refusal or a deemed refusal by the commissioner to grant an abatement of such taxes without any such appeal having been filed . . . .”). 42 Id. sec. 32(e)(1). 43 AP 631: The Collection Process at 631.1.1: Full Release of Lien, available at http://www.mass.gov/dor/businesses/help-and-resources/legal-library/administrative- procedures/ap-631-the-collection-process.html (last visited May 6, 2014). 44 Id. at 631.1.2: Partial Release of Lien and Subordination of Lien. to avoid increasingly more aggressive collection actions (such as seizure and sale of the taxpayer’s property).

F. Statute of Limitations on Collection

Generally speaking, the DOR has 10 years from the date of assessment to collect the tax.45 The statute of limitations on collections is tolled (extended) during (1) the pendency of a Form CA-6 application, (2) an Appellate Tax Board case, and (3) a bankruptcy proceeding.46 It is important to note, however, that any lien that the DOR files against real or personal property owned by the taxpayer within the 10- year statute of limitations on collections will survive the expiration of the 10-year period.47

G. Installment Agreements

A taxpayer may choose to enter into an installment agreement with the DOR in order to avoid any further involuntary collection activity. Before the DOR will consider an installment agreement, however, the taxpayer must be in current filing compliance, which means that he or she cannot have any delinquent tax returns of any type and must stay in current filing and payment compliance for present and future tax years. An installment agreement may extend the statute of limitations on collection for the term of the payment agreement.48 Penalties and interest will continue to accrue until the liability has been paid in full, and the taxpayer will be subject to tax liens during the pendency of the installment agreement unless the DOR agrees to a waiver of the lien (for a 12 month or less installment payment plans).49

H. Offers in Settlement

The taxpayer may want to consider filing an Offer in Settlement in order to compromise his or her Massachusetts sales and/or use tax liability. An Offer in Settlement is the Massachusetts cognate of the IRS Offer in Compromise. Like the federal Offer in Compromise, a Massachusetts Offer in Settlement can be filed on the

45 M.G.L. c. 62C, sec. 65. 46 Id. 47 Id. (“Taxes shall be collected . . . (ii) within any further period after that 10-year period during which the taxes remain unpaid but only against any real or personal property of the taxpayer to which a tax lien has attached and for which a notice of lien has been filed or recorded under section 50 in favor of the commonwealth in accordance with applicable state or federal law within 10 years after the assessment of the tax.”) 48 MASSACHUSETTS DEPARTMENT OF REVENUE, Common Questions Regarding Collections, “What if I am unable to pay my liability in full?”, available at http://www.mass.gov/dor/how-do-collections- work/how-do-collections-work/common-question-regarding-collections.html (last visited May 6, 2014). 49 Id. at “What if I am unable to pay my liability in full?” and “How can I avoid a lien?”. basis of “doubt as to liability” or “doubt as to collectability.”50 The taxpayer needs to prepare a Form M-656: Offer in Settlement and a Form M-433: Statement of Financial Condition in order for the Offer in Settlement to be considered. If the Offer in Settlement is approved, the statute of limitations on collection will be extended for the period during which the offer is pending and for a period ending one year after the due date of the last payment (if the offer is proposed in the form of installments).51

I. A Note Regarding Sales and Use Tax Assessments in Bankruptcy

It is important to note that trust fund taxes such as sales and use taxes are not dischargeable in a bankruptcy proceeding.52

J. DOR Office of the Taxpayer Advocate/Problem Resolution Office

In circumstances in which the taxpayer is being treated unfairly or is facing an immediate hardship as a result of DOR collections activity, the DOR Office of the Taxpayer Advocate may be able to help.53 In situations in which the DOR is not acting in accordance with prescribed statutory, regulatory, or administrative procedures, or in which the taxpayer has tried unsuccessfully on at least two prior occasions to resolve the issue through normal assistance channels, the taxpayer representative should contact the DOR Problem Resolution Office.54

7. Payments Under Protest

There are several strategies that a taxpayer and his or her representative can utilize in order to make a “payment under protest.”

A. Payment Under Protest Followed by a Claim for Refund Within the Statute of Limitations

As mentioned in Part 2.E, above, the “3-2-1 rule” controls the statute of limitations on claims for refund. Thus, to avoid the adverse impact of a lien filing or other collection action, a taxpayer may decide to pay the disputed amount of tax and then file a Form CA-6 to request a refund of the overpaid tax and/or penalties within the

50 Unlike the federal Offer in Compromise, the Massachusetts Offer in Settlement does not address “effective tax administration.” See 830 CMR § 62C.37A.1(1) (discussing doubt as to liability and collectability but not effective tax administration). 51 Id. § 62C.37A.1(3)(c). 52 See 11 U.S.C. §523(a)(1)(A); 11 U.S.C. §507(a)(8)(C). 53 For more information about the DOR Office of the Taxpayer Advocate, see http://www.mass.gov/dor/individuals/taxpayer-help-and-resources/office-of-the-taxpayer- advocate.html (last visited May 6, 2014). 54 For more information about the DOR Problem Resolution Office, see http://www.mass.gov/dor/businesses/help-and-resources/legal-library/administrative- procedures/ap-602-problem-resolution-offices-pro-and.html (last visited May 6, 2014). applicable timeframe. The problem with this strategy is that there is anecdotal evidence that suggests a taxpayer may have a better chance for an abatement of tax and/or penalties that he or she has not yet paid than for a refund of tax and/or penalties that have already been paid. However, for a taxpayer who cannot accept the filing of a lien (such as a licensed professional or politician for whom a lien would have an adverse effect on his or her reputation), he or she may have no other choice but to pay in the disputed tax and/or penalties and then file a Form CA-6 to request a refund of these overpayments.

B. No More “Pay to Play” Rules in Massachusetts

A taxpayer is not obligated to pay the disputed amount “while the matter is under consideration administratively within DOR, with the Appellate Tax Board or the Probate Court.”55

Conclusion

Representing taxpayers in sales and/or use tax controversies before the Massachusetts Department of Revenue involves a variety of complex and interrelated legal and procedural issues. Before taking any position that may jeopardize the client, the taxpayer’s representative should take the time to carefully review all of the facts of the case, including the client’s books and records and all correspondence from the DOR. If the taxpayer’s representative is not confident about his or her ability to secure a positive outcome, he or she should consult with an experienced tax controversy resolution attorney who can help to guide the representative and the taxpayer through the audit, appeals, and collection process.

~End of Article~

55 AP 627: Applications for Abatement, at 627.2: Payment of Taxes Due, available at http://www.mass.gov/dor/businesses/help-and-resources/legal-library/administrative- procedures/ap-627-applications-for-abatement.htm (last visited May 6, 2014).