Taxing Lessons Case Summaries

Case — Abatement of Interest on Tax Underpayment

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TL Case Summ

THE QUESTION

Should the IRS assess interest on the net or gross amount of a tax underpayment?

THE DISPUTE

Taxpayer Says: Interest should only be charged on the net amount still due after two corrections to a tax return.

Internal Revenue Service Says: Interest is due on the entire amount of the underpayment assessed after the final correction.

THE LAW

From Internal Revenue Code Section 6404(e)(1): The IRS may abate part or all of an assessment of interest on any deficiency or payment of tax if (a) either (1) the deficiency was attributable to an unreasonable error or delay by an IRS official in performing a ministerial or managerial act, or (2) an error or delay by the taxpayer in paying his or her tax is attributable to an IRS official’s being erroneous or dilatory in performing a ministerial or managerial act; and (b) the taxpayer caused no significant aspect of the delay.

From Internal Revenue Code Section 6404(h)(1): If the IRS denies the abatement request, the taxpayer may petition the Tax Court for a review of that determination.

From Federal Tax Regulation 301.6404-2(a)(1): Since the IRS’s authority to abate interest is discretionary and not mandatory, the Tax Court may order the abatement of interest only if it finds the IRS abused its discretion by failing to abate the interest.

From Woodral v. Commissioner, 112 T.C. 19, 23 (1999): In order to prevail, a taxpayer must prove the IRS exercised its discretion arbitrarily, capriciously, or without sound basis in fact or law.

THE CAUSE OF THE DISPUTE

When you underpay your taxes, the IRS assesses interest on the amount you owe for the period running from the date your payment was due until the date you make the payment (code section 6601(a)). In 1986, Congress gave the IRS authority to abate the interest if the IRS was at fault for the assessment.

In this case, the taxpayer timely filed his 2001 federal income tax return, showing a refund of $3,303. The IRS found a mathematical error on the return, made a correction and issued a refund check of $5,962. Two years later, in 2004, the IRS determined the taxpayer had not reported income from a pension, and adjusted the return again, this time showing an underpayment of $2,604 (based on a corrected tax liability of $3,716). The IRS charged interest on $2,604.

While agreeing he underreported income, the taxpayer says he did not ask for his return to be corrected the first time, resulting in a larger refund. Because his final underpayment would have been less without that unrequested correction, he believes interest should be charged only on $413, the balance of the original overpayment shown on his return ($3,303) and what the IRS finally determined he owed ($3,716).

The IRS says there were no errors on the part of the government and interest is assessable and due on the entire underpayment.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 24KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. The IRS properly assessed interest on the income tax deficiency of $2,640 according to law. The IRS made no error in processing the refund that gave rise to the deficiency. Rather, the errors were the taxpayer’s.
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