D. Provisions Relating to Interest and Penalties

1. Elimination of interest differential on overlapping periods of interest on income tax overpayments and underpayments

Present Law

A taxpayer that underpays its taxes is required to pay interest on the underpayment at a rate equal to the Federal short term interest rate plus three percentage points. A special "hot interest" rate equal to the Federal short term interest rate plus five percentage points applies in the case of certain large corporate underpayments.

A taxpayer that overpays its taxes receives interest on the overpayment at a rate equal to the Federal short term interest rate plus two percentage points. In the case of corporate overpayments in excess of $10,000, this is reduced to the Federal short term interest rate plus one-half of a percentage point.

If a taxpayer has an underpayment of tax from one year and an overpayment of tax from a different year that are outstanding at the same time, the IRS will typically offset the overpayment against the underpayment and apply the appropriate interest to the resulting net underpayment or overpayment. However, if either the underpayment or overpayment have been satisfied, the IRS will not typically offset the two amounts, but rather will assess or credit interest on the full underpayment or overpayment at the underpayment or overpayment rate. This has the effect of assessing the underpayment at the higher underpayment rate and crediting the overpayment at the lower overpayment rate. This results in the taxpayer being assessed a net interest charge, even if the amounts of the overpayment and underpayment are the same.

Description of Proposal

The proposal would establish a net interest rate of zero on equivalent amounts of overpayment and underpayment that exist for any period. Each overpayment and underpayment would be considered only once in determining whether equivalent amounts of overpayment and underpayment exist. The special rules that increase the interest rate paid on large corporate underpayments and decrease the interest rate received on corporate underpayments in excess of $10,000 would not prevent the application of the net zero rate. The proposal would apply to income taxes and self-employment taxes.

Effective Date

The proposal would apply to interest for calendar quarters beginning after the date of enactment.

2. Increase in overpayment rate payable to taxpayers other than corporations

Present Law

A taxpayer that underpays its taxes is required to pay interest on the underpayment at a rate equal to the Federal short-term interest rate (AFR) plus three percentage points. A taxpayer that overpays its taxes receives interest on the overpayment at a rate equal to the Federal short-term interest rate (AFR) plus two percentage points.

Description of Proposal

The proposal would provide that the overpayment interest rate will be AFR plus three percentage points, except that for corporations, the rate would remain at AFR plus two percentage points.

Effective Date

The proposal would apply to interest for calendar quarters beginning after the date of enactment.

3. Elimination of penalty on failure to pay during installment agreement

Present Law

Taxpayers who fail to pay their taxes are subject to a penalty of one-half percent per month on the unpaid amount, up to a maximum of 25 percent (Sec. 6651(a)). ) If the liability is shown on the return, the penalty begins to accrue on the date prescribed for payment of the tax (with regard to extensions (Sec. 6651(a)(2)). If the liability should have been shown on the return but was not, the penalty generally begins to accrue after the date that is 21 days from the date of the IRS notice and demand for payment with respect to such liability (Sec. 6651(a)(3)). Taxpayers who make installment payments pursuant to an agreement with the IRS (under Sec. 6159) are also subject to this penalty (Treas. reg. Sec. 301.6159-1(f) and Sec. 6601(b)).

Description of Proposal

The proposal would provide that the penalty for failure to pay taxes is not imposed with respect to the tax liability of an individual for any month in which an installment payment agreement with the IRS (under Sec. 6159) is in effect, provided that the individual filed the tax return in a timely manner (including extensions).

Effective Date

The proposal would be effective for installment agreement payments made after the date of enactment.

4. Mitigation of failure to deposit penalty

Present Law

Deposits of payroll taxes are allocated to the earliest period for which such a deposit is due. If a taxpayer misses or makes an insufficient deposit, later deposits will first be applied to satisfy the shortfall for the earlier period; the remainder is then applied to satisfy the obligation for the current period. If the depositor is not aware this is taking place, cascading penalties may result as payments that would otherwise be sufficient to satisfy current liabilities are applied to satisfy earlier shortfalls.

Code section 6656(c) authorizes the Secretary to waive the failure to make deposit penalty for inadvertent failures by first-time depositors of employment taxes.

Description of Proposal

The proposal would address the cascading penalty issue by allowing the taxpayer to designate the period to which each deposit is applied. The proposal would also extend the authorization to waive the failure to deposit penalty to the first deposit a taxpayer is required to make after the taxpayer is required to change the frequency of the taxpayer's deposits.

Effective Date

The proposal would apply to deposits made more than 180 days after the date of enactment.

5. Suspend accrual of interest and penalties if IRS fails to contact taxpayer within 1 year

Present Law

In general, interest and penalties accrue during periods for which taxes are unpaid without regard to whether the taxpayer is aware that there is tax due.

Description of Proposal

The proposal would suspend the accrual of penalties and interest after 1 year if the IRS has not sent the taxpayer a notice of deficiency within the year following the date which is the later of (1) the original due date of the return or (2) the date on which the individual taxpayer timely filed the return. The suspension only applies to taxpayers who file a timely tax return. The proposal would apply only to individuals and would not apply in the case of fraud or with respect to criminal penalties. Interest and penalties would resume 21 days after the IRS sends a notice and demand for payment to the taxpayer.

Effective Date

The proposal would be effective for taxable years ending after the date of enactment.

6. Notices of penalties must show computation

Present Law

Present law does not require the IRS to show how penalties are computed on the notice of penalty.

Description of Proposal

Each notice imposing a penalty would be required to include the name of the penalty, the code section requiring the penalty, and a computation of the penalty.

Effective Date

The proposal would apply to notices issued more than 180 days after the date of enactment.