[Originally published on Law360]
While the focus in most tax cases is on tax and penalties, statutory interest on any tax deficiency or penalty should not be overlooked. Interest on tax deficiencies and penalties is imposed automatically and, in many instances, can equal or exceed the tax and penalty liabilities.
It is, therefore, critical that taxpayers and their representatives carefully review IRS interest computations. Even where the technical computations themselves are accurate, the IRS still may be overcharging interest. Internal Revenue Code Section 6404 includes two important provisions that offer the potential for substantial interest reductions.
IRC Section 6404(g) provides, for IRS notices issued after Nov. 25, 2007, that in the case of an individual taxpayer, if the IRS fails to notify the taxpayer of a change in his or her liability within three years of the later of the filing date of the tax return in question or the original due date of the return, the IRS must suspend the imposition of interest as of the three-year deadline.
For notices issued prior to Nov. 25, 2007, the IRS was required to suspend interest if it did not provide notice of a change in liability within 18 months of the filing of the return or original due date of the return at issue. If suspension applies due to the IRS’ failure to timely notify a taxpayer of a change in their tax liability, interest does not begin to run again until 21 days after the IRS issues the required notice.
IRC Section 6404(g) has a number of important limitations, including, among others, criminal cases and cases involving fraud, tax liabilities shown on a filed return, and liabilities related to reportable or listed transactions (i.e., “tax shelters”). In these situations, taxpayers are not entitled to the benefit of the interest suspension provision. Suspension applies, however, in all other cases where the IRS has failed to abide by the notification deadline.
While Section 6404(g) is less frequently implicated when the three-year deadline applies (again, effective for notices issued after Nov. 25, 2007), numerous audits involve notices issued subject to the 18-month deadline. Depending upon the size of the tax liability, the amount of interest at issue can be quite substantial where the IRS fails to suspend interest in these cases.
The author has encountered numerous situations where the IRS failed to properly apply IRC Section 6404(g). If noted at the conclusion of an audit, the interest computation can typically be corrected directly with the auditor who can note that IRC Section 6404(g) applies and note the relevant dates so that the service center issues a proper interest assessment.
If an error with regard to Section 6404(g) is not detected until after interest is assessed, taxpayers or their representatives can contact the IRS informally and seek a correction to the assessment. Typically, however, an IRS Form 843, Claim for Refund and Request for Abatement, will have to be filed, formally requesting the interest abatement or refund. While issues can normally be resolved through this process, there are situations where the IRS disputes the applicability of Section 6404(g).
Recently, in Corbalis v. Commissioner of Internal Revenue, 142 T.C. No. 2 (2014), for example, the IRS refused to suspend interest related to deficiencies created by the disallowance of loss carrybacks. Although the court in Corbalis did not decide whether the taxpayers were in fact entitled to interest suspension, it did rule that the Tax Court had jurisdiction under IRC Section 6404(h) to review the IRS’ denial of interest suspension under Internal Revenue Code Section 6404(g).
The decision thus provides a critical litigation option for taxpayers in cases where the IRS has denied interest suspension pursuant to Section 6404(g). It must be noted, however, that review under Section 6404(h) is limited to taxpayers who do not exceed certain net worth thresholds.
Taxpayers and practitioners should also be aware of the opportunity for interest abatement under IRC Section 6404(e). IRC Section 6404(e) provides that the IRS may abate interest attributable to “unreasonable errors and delays” by the IRS. Unlike IRC Section 6404(g) discussed above, IRC Section 6404(e) is not limited to individual taxpayers.
Abatement of interest under IRC Section 6404(e) may apply where the error or delay affected the determination of a deficiency or affected the payment of tax. This applies to both “ministerial” and “managerial” acts of the IRS.
According to IRS regulations, a “managerial act” means an administrative act that occurs during the processing of a taxpayer’s case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel. A “ministerial act” means a procedural act that does not involve the exercise of judgment or discretion, and that occurs during the processing of a taxpayer’s case after all prerequisites of the act, such as conferences and review by supervisors, have taken place.
Common situations where IRC Section 6404(e) applies include unreasonable delays in issuing notices, failure to work cases for an unreasonable period of time, unreasonable delays in transferring or reassigning a taxpayer’s case and losing a taxpayer’s file. Suspension does not, however, apply, for example, in situations involving delays due to an IRS decision to request internal advice on a substantive issue of law. IRC Section 6404(e) interest abatement also does not apply where a significant aspect of the error or delay is attributable to the taxpayer.
As with IRC Section 6404(g), the amounts of interest at issue can be substantial in unreasonable error or delay situations. Not surprisingly, the IRS does not typically acknowledge that there was an unreasonable delay and voluntarily abate interest. Thus, taxpayers and their representatives must be aware of this provision and the circumstances in which interest abatement may apply.
Similar to IRC Section 6404(g) claims, requests for abatement under IRC Section 6404(e) typically require that the taxpayer or their representative submit IRS Form 843 setting forth the IRS’ error or delay and showing the computation of the amount of the requested refund or abatement. While many claims are resolved with the IRS either at the initial review stage or with the IRS appeals office, many cases require litigation. Prior to Corbalis, Tax Court jurisdiction to review denials of abatement requests under IRC Section 6404(e) was already established, subject again to net worth limitations.
As noted at the outset, interest charges are a significant component of tax liabilities. Internal Revenue Code Sections 6404(e) and (g) provide opportunities to challenge and substantially reduce IRS interest charges.
Posted on Law360 on April 28, 2014 (subscription site)
This publication is for informational purposes only and is not intended to provide legal or tax advice, or to create an attorney-client relationship.
Pursuant to IRS Circular 230, unless expressly stated to the contrary, any tax advice is not intended and cannot be used to (i) avoid penalties under the Internal Revenue Code or (ii) promote, market or recommend any transaction or matter to another party.
