When the IRS attempts to collect a tax

January 2014 By William D. Elliott Tax Collection Against Independent Contractors William D. Elliott practices tax law in Dallas, Texas, with particular expertise in tax procedure and controversy and IRS conflict resolution. Bill is author of the leading treatise, FEDERAL TAX COLLECTION, LIENS & LEVIES and a Fellow of the American College of Tax Counsel. When the IRS attempts to collect a tax delinquency against an independent contractor, the practitioner representing the tax delinquent independent contractor confronts a bumpier road than usually encountered in tax collection matters. First, a tax levy on income earned by the independent contractor is not a continuous levy, in contrast to a levy on employee salary and wages. When the IRS levies on employee s salary and wages, only one levy is required since all future salary and wages are captured by the levy, until the levy is released. Against independent contractors, the tax levy has a one-time effect. Second, when the practitioner advises on a levy on an independent contractor, the practitioner s focus is on the independent contractor s property or rights to property. The rule, of course, is that a tax levy on property of or income earned by an independent contractor only captures what property and rights to property exist when the levy is served. The rule is easily enough stated, but the difficulty is applying it. For an independent contractor providing services, the issue turns on the contractor s rights under the contract for services at the precise moment of levy. To understand, the practitioner will enter the lesstraveled road of fixed and determinable income. This article is not discussing several closely related situations. Contractors for federal construction contracts are subject to a continuous levy, but these types of contractors are not discussed here. Lien priority questions abound in construction contractor cases, but these interesting issues are left for another day. TAXES THE TAX MAGAZINE CCH Draft 13

Brief Review of Basics of Levies Tax practitioners are familiar, of course, with tax levies, but the legal basis of the fixed and determinable concept is less known. The primary Internal Revenue Code (the Code ) provision in any tax levy is Code Sec. 6331(a), which provides that a levy is effective against: all property and rights to property belonging to such person or on which there is a lien provided in this chapter for the payment of such tax. 1 The property rights of the independent contractor will need to be determined. The next subsection, Code Sec. 6331(b), importantly, limits the reach of the levy to what exists at the moment of levy: Except as otherwise provided in subsection (e), a levy shall extend only to property possessed and obligations existing at the time thereof. 2 The property rights of the independent contractor are to be measured on the date of the levy. This inquiry necessarily focuses on the contract for services, the work completed during the contract pay period, contingencies applicable to the obligation to pay the contractor and a number of other uncertainties. In contrast to employees, payments due contractors are not usually consistent from pay period to pay period. The IRS has authority to file levies repeatedly, as much as necessary, to collect the tax delinquency, as indicated in the following Code Sec. 6331(c): Whenever any property or right to property upon which levy has been made by virtue of subsection (a) is not sufficient to satisfy the claim of the United States for which levy is made, the Secretary may, thereafter, and as often as may be necessary, proceed to levy in like manner upon any other property liable to levy of the person against whom such claim exists, until the amount due from him, together with all expenses, is fully paid. 3 The legal authority for continuous levies over employee salary and wages is Code Sec. 6331(e), which provides: The effect of a levy on salary or wages payable to or received by a taxpayer shall be continuous from the date such levy is first made until such levy is released under Code Sec. 6343. 4 Since independent contractors are not paid salary and wages, this provision is not applicable to income earned by independent contractors. Fixed and Determinable Rights The phrase fixed and determinable is not found in the tax levy statute Code Sec. 6331. The combination of Code Sec. 6331(a) and (b) provide that a levy will reach taxpayer s property and rights to property and will extend to an obligation if the obligation exists. The IRS uses the phrase fixed and determinable in the regulation in defining when an obligation exists: If any person liable to pay any tax neglects or refuses to pay the tax within ten days after notice and demand, the district director to whom the assessment is charged... may proceed to collect the tax by levy.... Except as provided in 301.6331-1(b) (1) with regard to a levy on salary or wages, a levy extends only to property possessed and obligations which exist at the time of the levy. Obligations exist when the liability of the obligor is fixed and determinable although the right to receive payment thereof may be deferred until a later date. 5 [Emphasis added.] When considering levies on the income earned by independent contractors, the issue often encountered is whether what the contractor is entitled to is fixed and determinable income. The phrase fixed and determinable is conjunctive. The connecting word and indicates that something must be both fixed and determinable. Merely having one condition, but not the other, would prove insufficient, legally speaking, to permit a levy to reach the property right. 6 The word fixed suggests an unconditional obligation without regard to the amount, but rather focuses on the nature of the payment obligation. When something is fixed, the preconditions have been cleared away or satisfied, or all events have occurred fixing liability, leading only to the payment obligation, which would be deferred. The connotation of fixed is that the obligation is unconditional. The word determinable suggests a known amount or that the amount of the payment obligation can be computed; the amount is known or can 14 2013 CCH Incorporated. CCH Draft All Rights Reserved.

January 2014 be known through a mathematical calculation. The word is not determined but determinable. The amount of the obligation can be determined through some process. Whether the original concept of fixed and determinable was reasonably precise is doubtful, but as the concept exists today, and most certainly as viewed by the IRS, the fixed and determinable bundle of rights is elastic and malleable. 7 The lack of precision is not necessarily a bad outcome, but requires the tax practitioner to be alert to various factual situations. The classic and seminal case on levies on income from services is Long Island Drug Co., Inc., a 1940 decision of the Second Circuit. 8 Decided 73 years ago, the Long Island Drug Co. case continues to resonate in the realm of tax levies, especially on levies on income from services. The Long Island Drug Co. case establishes the marker for earned income. For a levy to reach income from services, the case holds that the right to income has to have accrued. Stated another way, the services rendered by the independent contractor have to have been rendered (or completed) for the right to the income to be accrued sufficiently to enable the levy to reach it. Levies will not reach future earnings because [t]hey are contingent upon performance of a contract for service and represent no existing rights of property. 9 The delinquent taxpayer in the Long Island Drug Co. worked for the drug company. Tax levies at two periods of time were issued: April 15, 1936, and March 7, 1939. At the moment of the first tax levy, taxpayer owed the drug company $4,711 on account of overdrawn salary. By March 7, 1939, taxpayer s salary had accrued in the amount of $32,450. By the time of the second levy, the drug company had also loaned $40,677 to taxpayer s wife. Taxpayer agreed that he would guarantee the loan and that any salary would be applied toward loan repayment. Following the levy, the drug company declined to satisfy the levy telling the IRS that it did not have any property belonging to the taxpayer. The court held that the notice of levy did not attach to the taxpayer s right to money that was contingent Whether the original concept of fixed and determinable was reasonably precise is doubtful, but as the concept exists today, and most certainly as viewed by the IRS, the fixed and determinable bundle of rights is elastic and malleable. upon the performance of future services. On the date of the 1939 levy, the drug company had not accrued any earnings owing to the employee. The court held that for income contingent upon performance of future services, the right to income did not represent existing rights of property. The property right has to exist for the levy to reach it; the right to property must have accrued. 10 On the date of the second levy, the taxpayer had accrued $32,450 in wages, but the court also upheld the set-off right of the drug company so that the accrued salary of the taxpayer offset the indebtedness owed. The discussion that follows considers a spectrum of contract rights starting with IRS collection against pure executory contract and then moving into levies when the services have been performed, but the right to payment remains subject to contingent obligations. Executory Contracts The executory contract is a contract when one side of the contract has not been performed. In a contract for services, an executory contract would mean that a contract for future services has been entered into, but the services have not been rendered. All performance under the executor contract is in the future. Example 1. Person A contracts to sell widgets for Person B for a commission of five percent of the sale price. At the moment of the contract, and prior to any sales, the contract is executory. Person A had not performed the services the sales. Thus, Person B did not owe Person A any money until the widgets were sold. Starting at the moment of the contract and continuing until there were sales of widgets, a levy on Person B for monies owed to Person A would not be effective. Person A has not performed any of the services, the sales, and thus there are no commissions owing. Person B has nothing that could be reached by levy that is property of Person A. Levies on compensation before the services are rendered have been ruled, for a good many years, as TAXES THE TAX MAGAZINE 15 CCH Draft

ineffective to capture future compensation payments, which are dependent upon services, i.e., the sales. Thus, the principle is firm that levies cannot reach property rights if the services giving rise to those rights remain to be performed. 11 One court has confirmed that a levy on this executory contract would not be effective: But to call an obligation both fixed and determinable when there has been no sale at all, no prospective buyer, no final determination of what will be sold, and no notion of the price is to strip the words fixed and determinable of all meaning. 12 As mentioned in the previous Example, prior to May 1st there was no agreement and thus nothing to which a levy could attach since the agreement was executory. Levy After Services Rendered The following Example introduces the idea that services have been rendered at the point in time when the levy is served: Example 2. On May 1st, Person A sold widgets to customers to which Person A is now entitled to a commission. Person A and Person B have agreed that commissions earned will be computed monthly, with payment made on the 10th of the succeeding month. Thus, all sales in May will be computed on May 31st and paid to Person A on June 10th. A tax levy made on Person B after May 1st requires Person B to pay to the IRS monies owed Person A. Person A s right to income accrued on May 1st. 13 In the above Example, when the levy is served after May 1st, Person A has earned commissions for sales made on May 1st. The obligation of Person B to pay Person A is seemingly fixed and determinable. If the levy attempts to reach a contract right after services are rendered, the IRS has enjoyed mixed success. Example 3 introduces the idea that services have been rendered at the point in time when the levy is served: E xample 3. On May 1st, Person A made a sale under which the customer will commence ordering widgets regularly. Every time the customer orders a widget, Person A accrues a sales commission. Person A and Person B have agreed that commissions earned will be computed monthly, with payment made on the 10th of the succeeding month. Thus, all sales in May will be computed on May 31 and the commission paid to Person A on June 10th. A tax levy was made on Person B on June 11th designed to require Person B to pay to the IRS monies owed Person A. This Example is based upon Ruble Murray, 14 when the IRS levied on the income earned by an independent contractor, who had sold a product manufactured in exchange for a commission of five percent of gross sales. After the first sale, the sales commission was paid, after which the IRS issued its levy, and the levy was aimed at the commission income earned by the first sales. More payments were expected as there were additional sales under the sale contract, but at the time of levy, no specific amounts were due. All that stood in the way of future commissions were additional sales. Since the purchaser had performed under the sales agreement, the sales commission was earned. The contract providing for the sales commission was no longer executory. The sales commission was earned. The district court therefore found that the levy attached to the salesman s right to future commissions, as they were payable or paid. The court found the right to the commission was fixed and determinable and subject to levy. One could quarrel with the court s conclusion concerning future sales. There is no certainty that there will be future sales. At the moment of levy, no commission income was accrued. Therefore, to say that future commission income was fixed and determinable seems a reach. Another troublesome case involving a levy on payment obligations arising after services were rendered is Stephen C. Hemmen, 15 which involves whether there would be funds available to pay the compensation. The case arose in a bankruptcy context. The delinquent taxpayer was the president of the debtor company, who had filed a claim in the bankruptcy proceeding for his services rendered to debtor company. Early in the bankruptcy proceeding, the IRS levied the bankruptcy trustee to attempt to capture on the president s income attributable to his filed claim. At the moment of levy, the president s claim had been adjudicated, but unpaid until the bankruptcy court so ordered. The contingency was the court order, which turned over whether there would be 16 2013 CCH Incorporated. CCH Draft All Rights Reserved.

January 2014 sufficient funds in the bankruptcy estate with which to pay the approved president s claim. The payment of the president s claim depended upon various factors, including administrative costs of the bankruptcy estate, creditors claims having higher priority and subsequent court orders. Despite this uncertainty over payment, the Ninth Circuit nevertheless concluded that the claim was fixed and determinable. In the key passage in the decision, the court said: Although what sum, if any, would be ultimately paid to [the president] on his allowed claims was uncertain at the time the notice of levy was served, this uncertainty does not defeat the fact that the estate s obligation was determinable. Unlike a requirement that the extent of an obligation be determined, the term determinable requires only that the sum be capable of precise measurement in the future.... This determination was in fact readily made at the moment the bankruptcy court approved the proposed distribution. 16 The problem with the Hemmen case is that the bankruptcy court expressly made payment of the president s claim subject to further court orders. There was no certainty that there would be monies available to pay the claim. The court approved the claim but did not allow payment until after the bankruptcy trustee determined available funds in the bankruptcy estate, after expenses of administration of the estate and payment of creditors claims had a higher priority. Ultimately, of the $30,000 claim, the trustee paid $13,535 to the former president which was captured by the levy. At the time of the court award, and when the levy was served, there was no certainty that any money would be available to pay the former president. Hemmen differs from a salesman having made a sale and awaiting payment of the commission. The bankruptcy claim, while approved, was not authorized to be paid, and the amount to be paid was in doubt. Yet, the court found the president s claim to be fixed and determinable. The third case to be considered, Robert C. Reiling, Jr., 17 also involves the idea that an obligation can The IRS has through administrative rulings pushed this interpretation to the outer reaches of the fixed and determinable doctrine. be fixed and determinable without being able to compute the amount. This statement seems counterintuitive. If the deferred payment amount is unknown, then how could a right be determinable? In the case, construction funds owed to a subcontractor, the delinquent taxpayer, were held pending resolution of a lawsuit over the construction project. The performance by the subcontractor was completed, and the amount owed the subcontractor was fixed by contract. A suit for wrongful levy was brought, and the court held that the IRS could levy the amounts owed the subcontractor, despite the dispute in the courts over the monies owed pursuant to the construction contract. In the words of the court, the fact that a contract right is disputed does not prevent a levy on it: When the notice of levy was served, the amount of its obligation was determinable even if it was the subject of a dispute in the circuit court. Any other conclusion would prevent the IRS from serving its notice of levy in any case where a petty dispute existed between the obligor and the obligee. This was not the intendment of the statute. A requirement that the amount of an obligation be beyond dispute and be calculated to the last penny would thwart all IRS attempts to satisfy a taxpayer s obligations and would nullify its power to levy. Under these circumstances, an obligation existed at the time the notice of levy was served, rendering the service proper. 18 The court s conclusion that levy could reach the disputed amounts were based on the completeness of performance and the fixed nature of the amounts owed. Another court has stated similarly that for a levy to reach contract rights, It is not necessary that the amount of the obligation be beyond dispute. 19 The Murray, Hemmen and Reiling cases have been relied upon by the IRS in various Chief Counsel Advisories, which are expansive and perhaps even wrong. In CCA 200023005, 20 the levy sought construction funds in litigation owed to a subcontractor. Despite the fact that the amount owed was disputed, the IRS reasoned that the subcontractor was entitled to be paid something although the amount of the liability TAXES THE TAX MAGAZINE 17 CCH Draft

was not determined until years later when the lawsuit against Y was settled. In reaching this conclusion, the IRS relied upon the Reiling case. In CCA 200836002 21 the IRS concluded that (1) a levy served upon a limited liability company will attach to property or rights to property belonging to X, the sole owner of the LLC, who practices law and receives income from the LLC as a result of contingent fee agreements between the LLC and clients; and (2) net profits X receives from the LLC are subject to a continuing wage levy. Relying on Hemmen, in part, the IRS reasoned that: [T]he Service can serve a notice of levy upon the LLC to require it to turn over to the Service income in the LLC s possession to which X is entitled as a result of legal services rendered prior to the service of the notice of levy. Under the rationale of Hemmen, Antonio, CPS Electric and other cases, the LLC s obligation to X is fixed and determinable when the LLC receives a contingent fee sum following successful litigation and after setting aside a reserve for overhead expenses. Conclusion Tax collection against independent contractors differs from tax collection against employees because the levy is not continuous. The concept of fixed and determinable income rights has been introduced by judicial decisions (and adopted in the Regulations), but the contours of the expression are imprecise, thus setting the stage for additional litigation and debate. The cases have declined to permit levies to reach contract rights if the services have not been rendered. After services are performed, even if the right to the income is disputed, the cases have been more willing to find a levy reaching these rights. The IRS has through administrative rulings pushed this interpretation to the outer reaches of the fixed and determinable doctrine. ENDNOTES 1 Code Sec. 6331(a). 2 Code Sec. 6331(b). The sentence, a levy shall extend only to property possessed and obligations existing at the time thereof, was added to Code Sec. 6331(b) in 1966, as part of the larger reform of tax liens. Code Sec. 6331(b), as amended by the Federal Tax Lien Act of 1966 (P.L. 89-719), 80 Stat. 11125 (1966), 104(a), codified in scattered sections of the Code. The first phrase in Code Sec. 6331(b) creating an exception for continuous levies did not exist in 1966 since continuous levies on salary and wages were added later. See William D. Elliott, FEDERAL TAX COLLECTION, at 13.07 for discussion of levies on salaries and wages. 3 Code Sec. 6331(c). 4 Code Sec. 6331(e). 5 Reg. 301.6331-1(a)(1). 6 The phrase fixed and determinable is only used twice in the Code; more frequently is fixed or determinable : (1) Code Sec. 130(c)(1)(A) ( fixed and determinable ) defining qualified assignment ; (2) Code Sec. 168(h)(1)(B)(ii)(II) ( fi xed or determinable ) defining disqualified use in the context of tax exempt use property ; (3) Code Sec. 306(f) ( fixed or determinable ), Code Sec. 404A(b)(3)(A) (i) ( fixed or determinable ) concerning limitations for plan contribution; (4) Code Sec. 415(c)(3)(C) ( fixed or determinable ) providing special rule for disability; (5) Code Sec. 423(c) ( fixed or determinable ) determining option price; (6) Code Sec. 871(a) imposing withholding tax for payments from U.S. sources; (7) Code Sec. 881 ( fixed or determinable ), comparable to Code Sec. 871; (8) Code Sec. 1441 ( fixed or determinable ) concerning withholding; (9) Code Sec. 6041(a) ( fixed or determinable ) concerning information returns; and (10) Code Sec. 7701(e)(4) ( fixed and determinable ). 7 See, e.g., Long Island Drug Co., CA-2, 41-1 USTC 9140, 115 F2d 983; Mercantile Trust Co., DC-MD, 45-1 USTC 9124, 58 FSupp 701(levy on spendthrift trust). See William D. Elliott, FEDERAL TAX COLLECTION, at 9.09[2][l] (discussion of attachment of Federal tax liens on beneficial interests in spendthrift trusts), and at 13.07[9] (levies on spendthrift trusts). 8 See Long Island Drug Co., supra note 7 (Hand, A., along with Hand, L. and Swan, T. on panel). 9 Id., at 115 F2d at 986. 10 Accord, Rev. Rul. 55-210, 1955-1 CB 544. 11 Harry Penn, DC-AZ, 67-1 USTC 9402, 266 FSupp 655, 656 ( At the time all the levies were made Boucher was still obligated to defendants for some work to satisfy salary advances theretofore made. Since a levy... does not affect future earnings, the defendants had no property or rights in property which they were obligated to surrender...). See also Richard D. Wagner, CA-7, 78-1 USTC 9340, 573 F2d 447, 454 ( Haughton s future wages and commissions were contingent on his continued employment and thus did not represent an existing property right to which a lien could attach. Haughton had no pre sent right to the wages and commissions. ). 12 Jacklyn Tull, CA-9, 95-2 USTC 50,602, 69 F3d 394. 13 Example more or less based upon Reg. 301.6331-1(a)(1). 14 Ruble Murray, DC-TN, 86-1 USTC 9467, 640 FSupp 89, 90-91. 15 Stephen C. Hemmen, CA-9, 95-1 USTC 50,210, 51 F3d 883. 16 Id., at 51 F3d at 890. 17 Robert C. Reiling, Jr., DC-IN, 77-1 USTC 9269 (unreported). 18 Id. 19 See, e.g., Ralph Antonio, DC-HI, 91-2 USTC 50,482 (unreported). 20 CCA 200023005 (June 9, 2000). 21 CCA 200836002 (Sept. 5, 2008). 18 2013 CCH Incorporated. CCH Draft All Rights Reserved.