Is a Taxpayer Liable for Interest if the IRS Delays an Audit?

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Can the IRS fail to audit a taxpayer for several years and then, once it actually opens the audit, drag its feet for years and then charge the taxpayer interest retroactively back to the date the tax return was filed? What if that period of time happens to be, say, fourteen years? The court considers this in Adams v. Commissioner, T.C. Memo. 2019-99.

Facts & Procedural History

This case involves the 1999 tax year. The taxpayer sold a business he owned in 1999 and did not report the income from the sale on his 1999 income tax return.

The taxpayer filed an amended return for the 1999 tax year in 2001, which also omitted the income from the business sale.

The IRS started a criminal investigation in 2002. The taxpayer was convicted in 2007. The IRS started a civil audit in 2011. The civil audit was closed in 2012. IRS Appeals closed their review of the case in 2014.

The taxpayer filed a refund claim to request the IRS abate the interest assessed on the ensuing tax debt. The IRS denied the claim and, on appeal, the IRS Office of Appeals denied the claim in 2018.

This court case is for the denial of the interest refund claim.

The Interest Abatement Rules

The IRS is authorized to abate interest. The reference to “authorized” notes that it is at the IRS’s discretion to abate interest.

Unlike penalties, interest is not abated based on a showing of reasonable cause.

The Code says that the IRS can abate interest if the interest is:

  • excessive in amount,
  • is assessed after the expiration of the period of limitations or
  • is erroneously or illegally assessed

The IRS cannot abate or remove interest on certain taxes, such as interest on employment taxes.

While discretionary, the IRS’s policies require IRS employees to abate interest if they discover an error in the amount of interest. They are obligated to do so even if they discover the error on their own. This usually comes up with mathematical or posting errors. However, it does not arise if the IRS calculates the tax to fix one error and then recalculates the tax again to fix another error.

The IRS is also authorized to abate interest if there is an unreasonable delay by the IRS in assessing the tax. The delay has to be due to a “ministerial or managerial act.” Taxpayers have to submit a refund claim to request the IRS abate the interest on this basis.

IRS’s Practices in Abating Interest

The IRS typically does abate interest if the taxpayer submits a refund claim and there is no evidence the IRS was actively working to assess the tax. The IRS will typically do this on a month-by-month basis. It usually entails reviewing the IRS’s auditor’s case activity record to note any gaps where time entries are not made.

It can help if the tax attorney who submits the refund claim gets a copy of the IRS’s records in advance and identifies the delays and provides this to the IRS as part of the refund claim.

Even then, it is common for taxpayers to have to file an administrative appeal to have their interest refund claim considered by the IRS Office of Appeals. This is true even if the IRS Office of Appeals was the function that delayed working on the case. Appeals will typically assign these appeals to a second appeals officer who did not work the first appeal.

Applying the Interest Abatement Rules

This brings us back to the issue in the Adams case. The IRS didn’t start the civil audit for the 1999 tax year until 2011. The courts have held that the IRS cannot abate interest until the IRS’s civil audit starts. It does not include criminal investigations that come before the IRS audit, as in this case. The court noted this rule in the Adams case.

The court then considered whether interest should be abated from 2011 until 2014. The court noted that the IRS had various time entries in the IRS’s records. These entries were primarily for “research.” It is not clear from the court case whether these entries were legitimate or merely an IRS employee plugging time on a case without doing any work on the case. The IRS does not scrutinize employee time records, which casts some doubt on the legitimacy of IRS timesheet records in cases like this.

But the court accepted the records. It cited them in support of its conclusion that interest should not be abated in this case. Thus, this case stands for the proposition that the IRS can in fact refuse to abate interest charged to a taxpayer when it held an IRS audit open for fourteen years.

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