Restricted interest and common errors made by the IRS.

• Author: Chambers, Valrie

The Internal Revenue Code allows the IRS to charge interest when a taxpayer does not pay all required taxes by the due date of the return. The Code also requires the IRS to pay interest on refunds in certain circumstances. While these broad general principles are not new, there are many nuances relating to the computation of interest that tax professionals should be familiar with.

In order to understand these complex issues, a review of the basic interest rules is necessary. The rate of interest is set by Sec. 6621. The rate is determined quarterly and can be found in a revenue ruling issued every quarter. Secs. 6601 (which deals with underpayment interest) and 6611 (which deals with overpayment interest) provide that, if applicable, interest starts on the return due date and ends on the date the taxes are paid or refunded. Within the Code and the Treasury regulations, there are many exceptions to the general rule. These exceptions are commonly referred to as the restricted interest rules.

One exception is when the tax adjustment is related to carrybacks. Tax adjustments involving net operating loss (NOL), capital loss, and credit carrybacks are deemed effective on the due date of the loss year (Secs. 6601(d) and 6611(f)). If a carryback reduces the amount of tax due, interest will stop accruing on the due date of the carryback year.

Example 1: Individual Q did not fully pay her 2008 income taxes. She files a Form 1045, Application for Tentative Refund, to carry back a 2009 NOL that fully pays the unpaid 2008 tax. Interest on the 2008 balance due is computed from April 15, 2009, to April 15,2010. Additional deficiency interest is computed on the accrued interest from April 15, 2010, until the interest is paid. Sec. 6611(e) provides that a refund relating to a carryback that is issued within 45 days of the date the carryback claim is filed will accrue no interest. If the IRS does not issue the refund within 45 days, interest will begin to accrue on the due date of the loss year.

Example 2: Z Corp. files a Form 1139, Corporation Application for Tentative Refund, to carry back a 2009 NOL to 2007. If the IRS does not issue a refund within 45 days, interest will accrue from March 15, 2010, until the refund is issued. If the carryback adjustment is part of an IRS audit that has adjustments to the return and carrybacks from subsequent years' returns, the IRS is required to coplete a Form 2285, Computation of Increase (Decrease) in Tax, Concurrent...