Tax Pros, Leave Your Bad Habits In 2020 What Every Tax Controversy Professional Should Know Part 2: 6603
Albert Einstein is said to have said: “Compound interest is the eighth wonder of the world. Whoever understands it deserves it. The one who doesn’t pay it. Whether Albert Einstein really said that’s not the point. Instead, consider that the point is well taken, and has never been taken so well as when it came to the Tax service.
I started this week by explaining that while I’m not one to make resolutions, this year I am working to help tax professionals across the country solve their bad habits. You can read the first part of the series here.
The Next Bad Habit I Wish Tax Professionals “Give” Is Not Something They’re Doing Wrong, It’s Something I See My Colleagues do not do, and that’s advising customers on how to avoid paying IRS interest, who composes Daily. Interest is set by law, IRC § 6621, and the rate is 3% above the prime rate, unless the taxpayer is a large corporation, in which case it is even higher. In this case, “hot” interest applies. Tax professionals like me receive emails from the IRS that include rates on a quarterly basis, like this:
Audited taxpayers have the following choices as to how to proceed:
- Accept the changes proposed by the IRS, pay the tax, and end the dispute.
- Pay the disputed tax under protest, file a request for reimbursement and file a trial if the IRS does not grant the refund request or if six months have passed.
- Do not pay the disputed tax and file a petition for United States Tax Court contest the proposed adjustment. The IRS can only assess and attempt to collect the disputed amount after the Tax Court has made a decision and if the decision is in favor of the IRS. In other words, taxpayers do not to have pay tax unless and until the Tax Court says so, because the IRS can’t even assess it until the court determines whether the IRS or the taxpayer is right .
Many clients that I have had over the years have no interest in paying the IRS a dime before a final court decision if the tax is challenged. They think that in terms of negotiation, they would be crazy to give money to the IRS before they have to. They think he will look like them do owe tax. They may not want to part with the money because it is difficult to part with the money. Or, they may not have the money to pay. (By the way, that’s wrong. The IRS doesn’t take into account whether taxpayers make a deposit or want to pay, and in fact, I’ve found IRS agents to be much more willing to negotiate when ‘a taxpayer paid or made a deposit that refused to pay.) There are a lot of reasons people don’t want to pay the IRS unless they have to, but there is a good reason why tax professionals should advise their clients on the option of making a down payment even if they want to fight: interest.
The IRS has established a procedure by which taxpayers can make a “deposit”To suspend interest from running. Taxpayers who take advantage of this procedure will not “pay” the IRS. Think of a Section 6603 deposit as a bond or security deposit for an apartment. The funds belong to the taxpayer and not to the IRS. If a taxpayer requests that the funds be returned, unless the IRS believes the taxpayer can flee the country and never pay, they must be returned to the taxpayer on demand.
Imagine that a taxpayer and their CPA receive a review notice from the IRS. The element in dispute is whether the taxpayer qualifies as a real estate professional. If the taxpayer wins, no additional tax will be due. If the taxpayer loses, then $ 1.5 million in taxes will be due. The CPA should advise the taxpayer that they can file $ 1.5 million with the IRS using the procedures set out in 6603 and Proclamation of income 2005-18. The taxpayer can fight and win and he owes nothing and will get his deposit back, plus the prime interest rate. On the other hand, if the taxpayer fights and leads his battle to the tax tribunal and 5 years later a decision is rendered against the taxpayer, he will not owe $ 1.5 plus interest.
How does it work in practice?
At the current federal rate, suppose a taxpayer has a contentious item of $ 1.5 million for the 2019 tax year. The tax is due in 2020. It is likely that the IRS will only conduct an audit. ‘in 2022 at the earliest. If the IRS audits in 2022 and the audit lasts one year, the taxpayer goes to tax court and the lawsuit lasts two years, then a decision is made against the taxpayer in early 2026. Assuming no penalties applies (which is a big assumption), and the interest rate stays the same (another important assumption), the amount of interest owed is now $ 384,055.45. Instead of owing the IRS $ 1.5 million, the taxpayer now owes the IRS nearly $ 1.9 million.
Maybe the client won’t want to part with so much money, or will want to make a deposit. There is no reason why the client cannot make a deposit of $ 150,000 instead of $ 1.5 million. At least interest won’t accrue on that part of a balance.
Either way, taxpayers who have disputes with the IRS should be made aware of their options for making a filing. Whether they take it or not is up to them to decide.