Thursday, July 17, 2008

Stopping IRS Penalties and Interest by Making a Deposit

As a tax lawyer, I am often asked how a client can stop interest and penalties from growing on an overdue tax debt. To do so, a client can (1) pay the debt or (2) make a “deposit.” In this post, I discuss using a “deposit” to stop the growth of penalties and interest. This post is not about how to remove already existing penalties (although there are procedures for doing that as well).

Let’s say that you are currently going through a tax audit. Based on how the audit is going, you know that you are going to owe additional tax, but you disagree with the IRS as to how much. Because you are going to owe, you want to stop additional and unnecessary interest and penalties.

The Internal Revenue Code (in section 6603) and Revenue Procedure 2005-18, provide that a taxpayer may make a “deposit” in lieu of a payment of tax. Once a deposit is made, and if the deposit is ultimately used to pay tax, the deposit will retroactively be treated as a payment of the tax on the date that the deposit was made. This effectively cuts off any additional interest on the amount of tax ultimately due as of the deposit date.

Should a taxpayer want the deposit returned, all he/she needs to do is make a written request for a return of the monies. The IRS is required to return the money unless it determines that returning the deposit would jeopardize its ability to ultimately collect the tax.

Another benefit of making a deposit is that (provided certain requirements or a safe harbor is satisfied) interest may be earned on the deposit. To earn interest, the deposit must be attributable to a "disputable tax" for the tax period at tissue. Interest will only grow on the amount that relates to the disputable tax. A "disputable tax" must be further attributable to a "disputable item."

The determination of whether something is a disputable tax or disputable item has certain requirements and is subject to some safe harbor rules. Therefore, before making a deposit, it is essential that you make certain that the money you send in qualifies as a deposit. Just as important is clearly designating in writing that the money sent is to be used as a deposit.

If you have questions as to whether you qualify to make a “deposit” be sure to consult a professional. If you don’t follow the proper procedures, you may end up making a “payment” instead of a deposit. This is bad because it can cut off future challenges to the amount that tax the IRS says is due.

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