Tolling Of Interest In Individual Income Tax Audits

One of the frustrations expressed in hearings before Congress last year was the inordinate time it often took IRS examiners to state the amount of the asserted tax deficiency. In response to this complaint, Act §3305 amends Code §6404(g) to suspend interest on tax, interest, and certain penalties where the IRS delays in sending an examination report (30-day letter) or notice of deficiency (90-day letter) to an individual undergoing an income tax audit.

The suspension applies only if the individual filed a timely return and only if the IRS has not issued a 30- or 90-day letter within 18 months of the later of the due date of the return or the date the return was filed. In that case, interest stops accruing on the tax, penalties, and interest accrued up to that date, and only begins accruing again 21 days after the 30- or 90-day letter is issued.

This provision applies to audits of income tax returns for the taxable years 1998 through 2003. For later taxable years, Congress expects the IRS to work even faster and has set the interest suspension period to commence after 12 months, rather than after 18 months.

Interest is not suspended on unpaid taxes reported on the return (or to penalties thereon) or to fraudulently underreported tax. Nor is interest suspended on fraud, late-filing, late-payment, or criminal penalties. As a practical matter, therefore, the only penalty on which interest will typically be suspended will be the accuracy-related penalty of Code §6662 -- a penalty which applies in the case of negligence, substantial understatement of tax, or valuation misstatement. The §6662 penalty of 20% of the tax normally accrues interest from the due date of the return until it is paid.

Ironically, the new changes that shift the burden of proof will put pressure on IRS examiners to do more thorough and time-consuming audits (just in case the IRS is held to have the burden). Also, other changes dealing with reimbursement of attorneys fees in Code §7430 brought about by the Act will put further pressure on examiners not to take hasty, unreasonable positions, and also will cause them to want to slow down their examinations. The interest suspension provision pushes examiners in the exact opposite direction -- speed up the examination or lose interest. It will be interesting to see whether IRS managers urge their examiners to accelerate or slow down individual income tax examinations as a result of the Act..

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