Interest is often seen as a good thing, such as in a bank account that grows steadily over time. However, when it comes to the IRS, interest is anything but positive.
While interest often accrues slowly, every tax practitioner knows that it’s the interest, not the tax burden itself, that can lead to untenable expenses in long-drawn audits, examinations, or other cases. And yet, the inability to abate interest is one of the most commonly believed myths among professionals and lay people alike. In reality, it’s possible to abate tax debt under Code Sections 6404, 7508, and 7508A, providing ample opportunity to say goodbye to interest if the circumstances are right. With the ability to lead to significant savings, interest abatement can certainly be worth fighting for.
When Does Interest Begin?
In U.S. taxation, interest does not always begin accruing on the day a tax liability is due. In reality, it depends heavily on the class of tax or penalty in question. These classes can range from withholding tax to employment tax, none of which are exempt from interest. Per the IRS, interest can accrue at any point during the tax period to which the interest is related. Further, for employment taxes and income taxes, interest can be charged without regard to any extensions that may or may not have been filed.
In some cases, interest can be related to withholdings. The IRS requires employers to withhold things like Social Security and Medicare. If this isn’t done properly, or is withheld in the wrong amounts, penalties may be incurred. In fact, a personal liability penalty applies for those who willfully fail to withhold appropriately and often begins to accrue on the date payment was due yet not made. Interest on a trust fund recovery penalty begins to accrue on the date a notice for payment is sent to the responsible person. Due to this mismatch, it’s possible for wires to cross in the accrual of interest on an employment tax liability and a related trust fund recovery penalty.
The landscape is a little different for employment taxes. For both Form 1065, U.S. Return of Partnership Income, and Form 1120S, U.S. Income Tax Return for an S Corporation, interest on a failure to file penalty only begins when a demand or assessment is received. Things are even more flexible for FBAR penalties; the penalty is triggered by the receipt of Letter 3709 and Form 13449, FBAR Agreement to Assessment and Collection, and no interest is accrued until an assessment is made or if payments are made in 30 days.
This may sound arbitrary, but in reality, it’s important to understand when penalties begin in order to apply for abatement.
Abatements of Interest
Abatement of interest can be done in a few different ways, following the guidance under Sections 6404, 7508A, and 7508.
This section of the code permits the IRS to postpone the accrual of interest for up to one year for all tax debts owed by those who are affected by a disaster declared by the federal government, or terroristic or military action.
Under Section 7508(a), the IRS prescribes a period of time in which the liability of individuals serving in the armed forces or in combat zones, including interest, can be disregarded. This section also applies to those serving in a contingency operation or who are injured in such performance, during the current time and the following 180 days.
Under 6404(a), the IRS is given the freedom to abate any tax liability or penalty, including interest, that is assessed – or erroneously assessed – during the period of limitations that is deemed to be excessive in amount. 6404(c) to (g) provide further clarification on abatement, including the reasons that can be used to argue interest abatement. This option is not permitted for tax assessed on income, gift, or estate taxes.
Despite these varied reasons, the most applicable to the average taxpayer is the opportunity for abatement under Section 6404, and the various options contained within. These are summarized as follows:
Unreasonable Delays or Errors by the IRS
The IRS isn’t perfect, despite the reputation the agency likes to tout. As such, errors do happen, and in some cases, these errors lead to unfair interest charges on top of an unfair tax case. If the IRS is willing to admit to their mistakes – although this isn’t guaranteed – it can be possible to be granted abatement if a managerial or ministerial act caused a delay or error. A managerial act is defined as any administrative act that results in the temporary or permanent loss of records or a discretionary decision that is related to personnel management.
This sounds a little confusing, so here’s a common example. Say you turned in your tax return several years ago, and it showed a balance due that you decided not to pay. However, an audit uncovered even more penalties, but an error in the audit process delayed this determination, resulting in more interest than appropriate. Under these circumstances, the IRS will consider abating interest, but only the interest that accrued on the audit liability as a result of the error, not on your original non-payment.
A ministerial act is a little different, referring instead to a mechanical or procedural act that doesn’t involve discretion or judgment. For example, an IRS case is to be transferred from one district office to another but, despite a timely response by the taxpayer, there is a delay in moving the process along. Should this kind of delay lead to the accrual of interest, this interest can be abated. However, if the taxpayer was the cause of the delay, interest will likely be maintained.
This tends to hold true in most applicable circumstances, but the proceedings surrounding a partnership-level return are a little more nuanced. Partnership TEFRA examinations are covered in 6404(e)(1), essentially stating that if an issue occurs in regards to one partner, a determination may be applicable to every partner. If a managerial or ministerial act occurs to one partner, the abatement request should be made in connection with a separate partner-level proceeding, and each partner’s request for abatement will be decided on a case by case basis.
Mathematical Errors by the IRS
Despite the importance of math in the IRS’ daily responsibilities, not all numbers are crunched properly. Covered under 6404(d), if an IRS officer provides calculations to a taxpayer that result in a mathematical error causing less than the proper amount of tax to be reported or paid, the IRS can abate interest for any period within 30 days of the date of notice and payment of the deficiency.
These kinds of mathematical errors can happen for a variety of reasons but are defined in Section 6213(g)(2) and include:
- Computational errors
- Use of an incorrect IRS table
- An inconsistent entry on a return
- The omission of information to substantiate a part of a return
- Use of a deduction or credit in an amount that exceeds the statutory limit
Some of these errors, including those related to an incorrect SSN or other taxpayer ID, can be critically important to low-income taxpayers who rely on the earned income credit, deductions for dependent care services, the child care credit, or deductions related to tuition and other educational expenses. If this kind of error results in interest, a notice of abatement can prevent assessment while the issue is rectified.
Erroneous Written Advice by the IRS
The IRS publishes significant advice for taxpayers, including countless updates and clarifications in any given year. With so much information, it’s not unsurprising that not every word published is perfect. If a taxpayer attaches support to a return to prove a point that is determined to contain erroneous advice, interest related to an incorrect conclusion is required to be abated. To protect against this kind of challenge, it’s best to keep track of all support documentation used to prepare returns, no matter how useless you think it may be.
Small Tax Balances
What is small, exactly? With any luck, your definition matches that of the IRS. The Secretary of the Treasury is authorized to abate unpaid amounts, including interest, if it is determined that the administration and collection costs wouldn’t be worth actually pursuing an amount due. While “small” is left open-ended under Section 6404(c), an amount of, say, $5 or $10 could be considered immaterial enough to qualify for abatement.
Suspension of Penalties and Limitations
In addition to the abatement of interest, it’s also possible to suspend penalty and interest accrual under Section 6404(g). In general, the IRS has three years from the time a return is filed to assess additional tax. However, if a taxpayer files in a timely manner and the IRS fails to send a notice stating the additional liability within 36 months of the date the return, or an extension for a return, was filed, the interest and penalties associated with the suspension period will not be applied. This suspension period begins the day after the end of the three years and concludes 21 days after the IRS mails a notice of the amount of an unpaid liability. This suspension period applies separately to each notice sent.
This suspension policy isn’t without caveats, however. Interest can’t be suspended for any failure to file or failure to pay penalty or in any criminal or fraud cases. In addition, interest related to deficiencies on a filed tax return or any listed transactions that should be disclosed on Form 8886, Reportable Transaction Disclosure Statement, are also unable to be suspended. In spite of this, interest can be suspended in cases in which the IRS fails to contact the taxpayer in a timely manner under Treas. Reg. Section 301.6404-4.
Employers who paid less than the correct amount of employment taxes are allowed to make interest-free adjustments under Section 6205, provided the error is noted and all taxes are paid by the last day for filing in the quarter in which the error was identified. If a notice is sent to this effect, no interest-free changes are permitted. Section 6205 covers underpayment for all taxes under the Federal Insurance Contributions Act, the Railroad Retirement Tax Act and withholding from income tax. It does not apply to underpayments related to the Federal Unemployment Tax Act, as these are not subject to interest at all, per Section 6601(i).
Interest netting is another unfortunate occurrence prone to error by the IRS, particularly in cases with multiple periods or partner-level adjustments. Interest netting often occurs when the taxpayer owes interest to the IRS due to an underpayment while the IRS owes interest to the taxpayer due to an overpayment. In these cases, the IRS will figure out the total interest using the same interest rate, with a total interest rate of zero applying up to the amount of the overpayment.
This can also come up when there is an underpayment in one period but an overpayment in another. When this happens, the IRS utilizes the net interest rate per Section 6621(d), which in essence eliminates the interest when underpayments and overpayments occur in overlapping periods. In addition, interest netting may be required when a taxpayer is facing adjustments from partnership-level proceedings in which some adjustments result in overpayment while others lead to underpayment. When this occurs, adjustments should be netted at the partnership level with the U.S. Treasury providing a final verdict as to total interest. In some cases, the taxpayer is encouraged to advise the IRS as to which amounts are overlapping and which periods should be considered when calculating interest. The situation worsens with corporate taxpayers; due to the wider interest rate variations, it’s far easier for computations to go wrong.
This all sounds quite complicated, and it often is, leading to improperly imputed interest. In these kinds of cases, it’s suggested that practitioners and taxpayers, if possible, confirm all interest calculations to ensure everything is by the book.
Issues of Interest Computation
Double-checking the IRS’ math is a little less straightforward than it sounds, opening up another can of worms in an already complex and often costly process. However, for taxpayers who do not wish to erroneously fork over too much interest, this is the price that must be paid.
Tackling the task goes beyond simply using one of the online or software tools available for calculating interest; instead, some situations require interpretation and application of the tax code. It’s important for those facing these situations to understand this, as well as to know the basics of the common areas of IRS errors. Take, for example, large corporate underpayment (LCU) issues, in which interest is charged at a rate 2% higher than normal. Known as “hot interest,” this amount should only apply if the underpayment is more than $100,000 and the deficiency isn’t paid within 30 days – but many taxpayers find themselves charged this amount in error. Due dates can also prove problematic, so always confirm interest charges start and end according to IRS policies.
Collection Due Process
For those facing the Collection Due Process phase, it’s important to speak up sooner rather than later, preferably through the use of Form 12153, Request for a Collection Due Process or Equivalent Hearing. This suspends the 10 year period the IRS has to collect taxes as well as opens the door to challenge the settlement officer’s decisions in court should the need arise. This Form must be postmarked by the date included in a lien notice, levy notice, or actual levy. This process should also include a request for evidence that a notice of demand of payment was correctly issued. If this is unavailable, it may be reasonable to request full abatement of the penalty.
To bring up interest abatement at this time, taxpayers must provide a statement that includes:
- The type of tax
- When an initial notice of deficiency of payment was provided
- The period in question
- The circumstances
- The reasons why abatement is necessary
Submitting an FOIA request can assist in getting the ball rolling with IRS Appeals Officers, particularly in challenging any part of the process. This can provide insight into agent notes, notice timelines, and even examiner thoughts to determine how and why a case is proceeding in a particular manner, or to highlight any discrepancies or errors.
Requesting Interest Abatement
The procedure behind requesting an abatement of interest is actually quite simple, but there are innate complications in every interaction with the IRS.
The first step in requesting abatement often involves submitting Form 843, Claim for Refund and Request for Abatement, but any signed correspondence that contains the same fields will be considered. When requesting an abatement of interest, write “Request for Abatement of Interest Under I.R.C. § 6404” at the top of the form, or the applicable Code Section should other circumstances lead to abatement. Be sure to outline all factual and legal support for an abatement request in as much detail as possible. Reasonable cause isn’t good enough; taxpayers need a solid case backed by evidence.
While submitting the paperwork isn’t a challenge, getting an abatement approved can be. Not all requests will be considered. Any issue not completely covered under Sections 6404, 7508A, and 7508 is likely to be ignored.
Appealing a Denial of Abatement
If your abatement request is denied – and, speaking frankly, many will be – there is an opportunity to appeal. Those who wish to press forward should send a protest statement detailing the reasons the IRS should reconsider to the same office that sent the abatement disallowance letter.
Tax Court Review
If an appeal doesn’t work, a trip to Tax Court just might. The Tax Court has jurisdiction to review and potentially overturn an abatement refusal, assuming a timely petition was filed. Interestingly, there are also net worth requirements here; per Section 2412(d)(2)(B), net worth cannot exceed $2 million for individuals, $7 million for unincorporated businesses, partnerships, and corporations with fewer than 500 employees, or any amount for 501(c)(3) organizations.
As long as procedural requirements are followed, positive outcomes are more likely in this venue. In Corbalis v. Commissioner, for example, the IRS rejected a loss carry-back, creating an underpayment in future years, thus triggering associated interest. However, the Court ruled in favor of the taxpayer, stating that the Court has the ability to review or amend interest suspension under Section 6404(g).
The Changing Landscape of Interest
Taxes in the U.S. are rarely constant, and that includes the wide world of interest. In 2015, the House Ways and Means Committee approved reforms leading to 6404(h), which allows a taxpayer to seek Tax Court review regarding interest abatement should the IRS fail to provide a final determination. Further, under the newly-created 7463(f)), the Tax Court’s jurisdiction was expanded to include reviews of IRS decisions to reject interest abatement in small tax cases with under $50,000 under dispute.
To Request Abatement – or to Stay Quiet
Successfully securing interest abatement isn’t a walk in the park, but it’s not the completely impossible task it is often made out to be, either. When a clear and reasonable case exists with plenty of support, submitting a request may be worth the effort, particularly when the amounts at stake are sufficiently large. While there’s no guarantee of a win, there’s no harm in trying, either.