Offsetting by the IRS can save money.

• Author: Blattner, Dave

In its congressionally mandated study of interest netting, the Treasury has concluded that new legislation should be enacted to deal with interest on tax overpayments and underpayments during a time of mutual indebtedness. Therefore, it will be some time before procedures are issued that will adequately address this problem. Until such procedures are in place, CPAs need to take steps to minimize the interest the Service charges clients. One way to do this is through offsetting.

When closing multiyear IRS audits, clients may save interest charges if a tax deficiency or portion thereof is paid by credits or overpayments transferred (offset) from one or more tax years to the deficiency tax years. Sec. 6402 provides that the Service may credit overpayments to satisfy an outstanding tax deficiency. Until the IRS changes its procedures, the key words are "may" and "outstanding."

If a client agrees to close the audit of a tax year with an overpayment before a deficiency tax year is closed, the IRS will issue a refund check, paid to the date of the refund, with allow able interest (currency 8% for the first $10,000 and 6.5% on the remaining overpayment for corporations). When the deficiency tax year is later closed, the Service will charge deficiency interest from the due date of the return until the date the deficiency is paid (currency 9% for "regular" interest and 11% for "hot interest" on large corporate underpayments). This can cause an overlap of time when the interest rate differential can be as much as 4.5% between the interest rate the client pays and the interest rate it receives from the IRS (6.5% versus 11%).

If the tax deficiency is outstanding at the time of the tax overpayment, the Service will generally apply the overpayment to the deficiency using the availability date of the credit. The IRS calls this type of transfer "offsetting." It is to the client's benefit to have the Service offset in this way, as it can eliminate interest during the overlapping period, thereby reducing excessive deficiency interest charges.

Example 1: X has a tax deficiency of $50,000 on his 1987 Form 1040 and an overpayment of $50,000 on his 1988 Form 1040 after an audit. If the overpayment is credited/offset against the underpayment on dune 1, 1995, using April 15, 1989 (the date the 1988 overpayment became available), X will only pay interest on the $50,000 underpayment from April 15, 1988 to April 15, 1989. On the other hand, if X pays the deficiency on...