Stopping Interest on Proposed Liabilities

You may not know this unless you’ve been through it, but when the IRS makes proposed adjustments to your taxes, interest begins to accrue beginning on the tax return due date.  And it is an even lesser known fact that one can completely stop interest from accruing on proposed tax balances by making what is called a “remittance.”  There’s a special term for it because we’re talking about proposed liabilities (before anything has officially been assessed).  After taxes are assessed, it is simply called a payment.

Why would anyone want to make a remittance?  The primary reason for making a remittance is that the taxpayer plans on disputing the adjustment, which could take a long time (especially if taken through the appeals process), and the taxpayer could potentially be on the hook for quite a bit of interest.  Paying a remittance sufficient to cover the total tax, penalties, and accrued interest will stop interest from running on the date it is received.  And if the taxpayer is successful in getting the liability reduced, the IRS will either return the excess or apply it to other tax liabilities.

There are two types of remittances: a deposit and an advance payment.  If you clearly designate your payment as a deposit, the IRS must return it to you, upon request, unless the IRS has already applied it against an assessed liability.  You may even qualify for interest being paid to you for the time that the IRS held your funds.  To qualify, you must provide a written statement that includes the tax type, tax year, and a copy of the 30-day letter.  An advance payment, on the other hand, is treated just like a regular tax payment and will only be refunded to you if you make a valid claim for a refund.

This is all fully explained in IRS Notice 1016 (Feb. 2006) which is often included as an insert in various IRS correspondence.  Be careful not to confuse this process with the cessation of interest on assessed tax liabilities.  The procedures above apply to proposed liabilities only.  Who knows how many of my clients have received this insert and read the title only (“How to Stop Interest on Your Account”) and assumed there is a way to stop interest on their assessed liabilities without paying in full.  The IRS should probably modify the title of this insert so that it is absolutely clear.