Letter 903 and Section 7512: The IRS's Last Warnings Before Injunctions

When an operating business keeps accruing payroll tax debt and ordinary collection tools are not working, the IRS moves from collecting money to changing behavior. Two tools sit at that stage: Letter 903 and the special trust account rules of IRC 7512.

Neither is common. Both are serious. If you have received either one, the IRS is building a record for something more than a levy.

Letter 903: What It Is

Letter 903 is titled "You Haven't Deposited Federal Employment Taxes." IRM 5.7.2 governs it. According to IRM 5.7.2.1.2, Revenue Officers use Letter 903 to alert taxpayers to IRC 7402(a), which gives federal district courts jurisdiction to issue civil injunctions.

IRM 5.7.2.1 states the stakes plainly: issuance of Letter 903 is required before a taxpayer can be recommended for civil injunction or criminal prosecution.

In other words, Letter 903 is the formal warning that makes the next steps possible.

When the IRS Issues It

IRM 5.7.2.2 says Revenue Officers should consider Letter 903, together with Notice 931, Deposit Requirements for Employment Taxes, once levy sources have been exhausted and the repeater or pyramiding taxpayer has no assets to resolve or offset the liability. The IRM describes these procedures as reserved for egregious noncompliance where other collection procedures have been exhausted, are unproductive, or would be futile.

The IRM lists conditions for considering Letter 903:

• the taxpayer is an in-business trust fund violator;
• levy on property of the business or its responsible persons would be ineffective to reduce pyramiding; or
• the taxpayer is a repeater, with no assets or exhausted levy sources, in which case Letter 903 may be issued along with Letter 1058 at initial contact.

A group manager must review and approve it.

How It Is Delivered

IRM 5.7.2.2 says Revenue Officers must hand deliver Letter 903 and Notice 931 at a scheduled appointment. Certified mail to the last known address is allowed when the Revenue Officer cannot hand deliver it because office space is unavailable, there are safety concerns, or the taxpayer fails to appear.

Once delivery is recorded, the IRS places a transaction code on the account. The IRM explains that any later balance due, delinquent return or deposit alert is then coded and accelerated to the field. A business that receives Letter 903 and then misses another deposit should expect a Revenue Officer, not a notice.

What the Revenue Officer Tells You

IRM 5.7.2.2.1 tells Revenue Officers to inform the taxpayer that failure to comply may result in:

• prompt assessment of unpaid liabilities;
• assessment based on a return executed by the IRS under IRC 6020(b); and
• possible civil or criminal referral.

The coded status can be reversed when the case closes, depending on the taxpayer's current compliance. That is something to ask about once the business is back on track.

Civil Injunctions

IRM 5.7.2.3 describes civil injunction referrals under IRC 7402(a) for repeated failure to comply with employment tax provisions. The IRM says this is normally appropriate for taxpayers with minimal or no equity, or where seizure may not resolve the problem, and that Revenue Officers should be able to show the taxpayer knows the deposit laws and that more administrative effort would be futile.

The IRM lists examples of proof of knowledge:

• the taxpayer received a Letter 903 in the past;
• the taxpayer was previously assessed a Trust Fund Recovery Penalty;
• the taxpayer has used multiple entities to avoid paying trust fund taxes; and
• the taxpayer has a history of filing bankruptcies to avoid collection of employment taxes or pyramids employment taxes while in bankruptcy.

The recommended injunction, per the IRM, seeks to prohibit the incurrence of future unpaid trust fund obligations. IRM 5.7.2.2 adds that where the taxpayer has previously abandoned other business ventures with unpaid tax, the Revenue Officer should consider seeking a civil injunction to stop further pyramiding.

Section 7512: The Special Trust Account

Before Letter 903 took its current role, Congress gave the IRS a different tool. IRC 7512 applies when a person required to collect, account for and pay over employment taxes under subtitle C, or certain excise taxes under chapter 33, fails to collect, truthfully account for, pay over, deposit, or file returns at the times required, and is notified by notice delivered in hand.

Once that notice is delivered, section 7512(b) requires the person to:

• collect the taxes that become collectible after the notice;
• deposit them, not later than the end of the second banking day after collection, in a separate account in a bank; and
• keep them there until paid over to the United States.

The account must be designated as a special fund in trust for the United States, payable to the United States by the person as trustee.

For a corporation, partnership or trust, section 7512(a) says notice delivered in hand to an officer, partner or trustee is treated as notice to the entity and to all of its officers, partners, trustees and employees.

Section 7512(c) lets the IRS cancel the notification when it is satisfied the requirements will be complied with going forward.

The deposit regulations connect to this. Treasury Regulation 31.6302-1(k)(1) refers to the separate accounting procedures in Regulation 301.7512-1 that apply once the IRS gives notice of failure to comply with employment tax requirements.

Section 7215: The Misdemeanor Behind It

IRC 7215(a) makes failure to comply with section 7512(b) a misdemeanor, punishable by a fine of not more than $5,000, imprisonment of not more than one year, or both, plus costs of prosecution.

Section 7215(b) provides two defenses: reasonable doubt as to whether the law required collection of the tax or who was required to collect it, and failure due to circumstances beyond the person's control. But it adds a pointed limit: a lack of funds existing immediately after the payment of wages, whether or not created by paying them, is not a circumstance beyond the person's control.

In other words, "we made payroll and had nothing left for the taxes" is not a defense.

How the Two Fit Together Today

IRM 5.7.2.1.1 explains the history. Letter 903 used to be given to pyramiding taxpayers before the Revenue Officer required monthly Form 941 filing or a special bank account under section 7215. The IRM states that although section 7215 remains in the Code, Form 941-M monthly filing and special deposit procedures are no longer required before proceeding to the next collection action.

The practical reading: today, Letter 903 is primarily the gateway to civil injunctions and criminal referrals. Section 7512 remains law and remains available, but the IRM no longer treats it as a mandatory step.

Criminal exposure is a separate subject, but the statutes are worth knowing. Section 7202 makes willful failure to collect or truthfully account for and pay over tax a felony. IRM 5.7.2.4 describes how a Revenue Officer consults a manager and a Fraud Enforcement Advisor before any referral to Criminal Investigation.

If You Received Letter 903

1. Treat it as a final warning. The IRS has documented that you know the rules.
2. Make every deposit from now on, on time, and keep proof. Any new delinquency goes straight to the field.
3. Consider moving withholding to a separate account voluntarily. It is the behavior section 7512 would require.
4. Get counsel before the next IRS meeting. If criminal referral is a possibility, how you communicate matters.
5. Ask about reversal of the coding when the case is resolved and compliance is established.

Our guide on pyramiding explains how the IRS gets to this stage and how to get out of it. For more on the firm's payroll tax practice, visit the main site's payroll tax page.

Letter 903 is the IRS saying it has run out of patience. You still have options. Fewer than before. Call (813) 229-7100. Let's talk.