Reduce interest due IRS: favorable new rules for interest-reducing deposits.

• Author: Josephs, Stuart R.
• Position: Federal tax

Interest continues to accrue while a tax liability is disputed, but the taxpayer has only a few choices to limit underpayment interest. The taxpayer can continue the dispute, but if the taxpayer ultimately loses, interest will accrue from the return's original due date until the payment date.

To avoid this accrual, the taxpayer can pay the disputed tax and file a refund claim, preventing interest from accruing if the taxpayer loses. The taxpayer earns interest on the overpayment if successful. However, this denies Tax Court access.

Rev. Proc. 84-58 allowed a deposit in the nature of a cash bond. Such a deposit permitted Tax Court access and stopped interest accruing on the underpayment, equal to the deposit, if the taxpayer lost. But no interest was earned on the deposit if the taxpayer prevailed.

Recent Tax Law Change

Under new IRC Sec. 6603, a taxpayer can deposit cash with the IRS that may be used to pay an underpayment of income, gift, estate, generation-skipping, or certain excise taxes. No interest will accrue on the portion of the underpayment for the period that it was on deposit.

Generally, deposited amounts that have not been used to pay a tax may be withdrawn upon the taxpayer's written request. Withdrawn amounts will earn interest at the Federal short-term rate, compounded daily, to the extent attributable to a "disputable tax." Under Rev. Rul. 2005-15, this rate is 3 percent for the quarter beginning April 2005.

Note: The interest rate on tax overpayments is the above rate plus 3 percentage points for noncorporate taxpayers or 2 percentage points for corporations (0.5 percentage point if the overpayment exceeds $10,000).

For tax underpayments, the interest rate is the above rate, plus 3 percentage points or 5 percentage points for C corporation underpayments exceeding $100,000.

Disputable Tax: This is the amount of tax specified at the time of the deposit as the taxpayer's reasonable estimate of the maximum amount of any tax attributable to "disputable items."

A disputable item is any item of income, gain, loss, deduction or credit if the taxpayer:

1. Has a reasonable basis for the item's treatment on the return; and

2. Believes the IRS has a reasonable basis for disallowing that treatment.

However, under a safe harbor, all items included in a 30-day letter are deemed disputable. Thus, the disputable tax cannot be less than the proposed deficiency. A 30-day letter is the first letter of proposed deficiency allowing review in...