Background. It can happen to anyone. You write a check to the IRS for your year-end tax liability, and your checking account does not have enough funds to cover the check. You may have intended to transfer funds to your checking account, but did not do so quickly enough. Or, you may have mistakenly believed there were sufficient funds to cover the check. What are the consequences in such a case? A recent Tax Court case provides the answer. The case involved a taxpayer who wrote a check to the IRS for a tax liability, but had the check returned due to insufficient funds. The IRS assessed the taxpayer a “dishonored check penalty.”
Section 6657 of the tax code gives the IRS the authority to assess a penalty against any taxpayer who issues the IRS a check that is not paid. For checks of $750 or more, the penalty is 2 percent of the amount of the check. For checks under $750, the penalty is the lesser of $15 or the amount of the check. The penalty can be waived if a taxpayer “tendered such check in good faith and with reasonable cause to believe that it would be duly paid.”
The taxpayer who issued the IRS the bad check was assessed a penalty of $10,000. He insisted that he was entitled to the “good faith” defense, on two grounds. First, while his checking account did not have enough funds to cover the check in question, his savings account did, and it was the bank’s responsibility to transfer funds from the savings account to cover the IRS check. Second, he claimed that his accountant assured him that it would take about 14 days for the check to the IRS to clear.
The taxpayer appealed the IRS-imposed penalty to a federal court. On appeal, the IRS noted that it was undisputed that the taxpayer did not have sufficient funds in his account when he wrote the check to the IRS, and therefore his actions could not be construed as reasonable. Waiting until the last minute to transfer sufficient funds to cover a check is not reasonable, the IRS insisted. The court agreed, noting that “writing checks out of accounts containing insufficient funds cannot be considered ordinary business care and prudence.”
The court rejected the taxpayer’s claim that the bank should have notified him that there were insufficient funds in his checking account to cover the IRS check. It noted that reliance upon a bank’s notification policy, especially when the taxpayer intends to wait until after notification to transfer funds to cover the check, “cannot be considered ordinary business care and prudence.”
The court also rejected the taxpayer’s claim that his reliance on his accountant’s advice (that checks to the IRS do not clear for about 14 days) qualified him for the “reasonable cause” defense to the dishonored check penalty. The court pointed out that the IRS did not deposit the check for 19 days, and that even at this late date the taxpayer’s accountant failed to contain sufficient funds. The court pointed out that “forgiveness of penalty assessments levied against taxpayers who write checks with insufficient funds planning to cover the checks at the last minute before the IRS deposits them, would only encourage this type of behavior in the future.”
What is the significance of this case to church leaders? Note the following:
1. You may be liable for a dishonored check penalty in the event that a check to the IRS is returned due to insufficient funds. This is in addition to interest and penalties that may also apply.
2. Do not assume that the penalty can be avoided because your bank failed to notify you that your checking account did not have sufficient funds to cover the check to the IRS, or failed to transfer funds from your savings account to cover the check. Neither may constitute “reasonable cause.”
3. A church that sends checks to the IRS to cover payroll or other tax liabilities is subject to the same penalties. Gregory v. United States, 97-2 USTC para. 50,741 (D. Mich. 1997).
This article originally appeared in Church Treasurer Alert, January 1999.