Corporate Underpayment of Taxes

Current law holds that individuals are not permitted to deduct interest on federal taxes that have been assessed after 1990. Corporations are entitled to that deduction; however the interest charged against major corporate underpayments is higher than that charged individuals. Major underpayments are any amount in excess of $100,000, excluding penalties and other assessments and they are charged interest at the rate of five percentage points over the short-term federal rate, two percentage points more than the rate for non-major underpayments. The general rule has been that the interest rate begins to run at the increased level thirty days after the date of a letter of notice of deficiency.

Taxpayer Relief Act of 1997

The Taxpayer Relief Act of 1997 created the assessment differentiation for major underpayments. Beginning January 1, 1998, any notice of increased interest rates or "proposed deficiency:" or "proposed assessment" (So-called "hot rates") for amounts under $100,000 is discarded, and any notice for hot rates for larger amounts goes into effect thirty days after its date of issuance. The notice of deficiency is also no longer the only document of import in the process.

Negotiation and Appeal

The statutory reference that invites discussion of the issue is unprecedented. The Tax Code is silent on the issue of appeals, and the IRS has argued that its procedural rules do not give taxpayers any right to an appeals conference. The amended language states specifically however, that the hot rates take effect thirty days after "the date on which the 1st letter of proposed deficiency which allows the taxpayer an opportunity for administrative review…" In this fashion, the degree of corporate penalty for underpayment of taxes is tied to a document inviting review, in direct conflict with the longstanding IRS position that no appeal is available to the taxpayer.

The Secretary of the Treasury has the power to credit the amount of any overpayment against an assessed underpayment: no interest shall be charged against that portion of the tax retired by the overpayment. While the Secretary is charged with implementing the most comprehensive crediting available "under sound administrative practice," there is a high level of conflict among corporations and IRS Service Centers on the validity, dates and amounts of credits.

The Threshold Underpayment

One of the most interesting regulations interpreting the sections applicable to corporate underpayment is the concept of the threshold underpayment of tax. The threshold underpayment is defined as the excess tax imposed over the amount already paid by the due date, excluding any interest, penalties, additional amounts and additions to the predetermined tax due. In other words, the threshold payment is simply the payment of the remaining principal due. The reasoning behind this regulation is to provide clarity to the corporate taxpayer as to when, whether and to what degree penalties and interest rates began to accrue.

Numerous rules affect the calculation of the threshold underpayment. Amended returns do not reduce the threshold amount. Different types of taxes are not aggregated: underpaid income taxes and FICA taxes are not combined in this calculation. Finally, it is the process of assessment that determines whether a threshold tax is an available option and whether there is a large corporate underpayment at issue. The notice of deficiency or proposed deficiency is not the determinant document in this process.