IRS describes suspension of interest under 2007 Small Business Tax Act

Earlier this year, Congress made some important changes to the suspension of interest rules in the Tax Code. Those rules determine when and how much interest the IRS can charge you on a tax deficiency that it might drag its heals on before bringing it to your attention. The IRS recently issued guidance describing how it will apply transition rules. 

Suspension of interest

The Tax Code suspends the accrual of interest for individuals on taxes due if the IRS does not notify a taxpayer of the potential liability within 18 months after the filing of the return. The suspension applies only to individuals who timely file their returns (returns filed by the original due date or by the extended due date) and only for income taxes.

The Small Business and Work Opportunity Act of 2007 (2007 Small Business Tax Act) extended the period before suspension of interest starts to 36 months. The accrual of certain penalties and interest is suspended starting 36 months after an individual timely files an income tax return, unless the IRS sends the taxpayer a notice specifically stating the taxpayer's liability and the basis for the liability within the 36-month period. The extension in the 2007 Small Business Tax Act is effective for notices provided by the IRS after November 25, 2007.

New rules

In the latest guidance, the IRS describes how it will apply the new rules to notices issued on or after November 26, 2007 relating to a return that was timely filed before November 26, 2007.

Interest and penalties will be suspended if, as of November 25, 2007, the 18-month period has closed and the IRS has not provided notice to the taxpayer. The suspension period begins on the day after the close of the 18-month period. The suspension period ends on the day that is 21 days after notice is provided.

In all other cases, interest and penalties will be suspended beginning on the day after the close of the 36-minth period and ending on the day that is 21 days after notice is provided.

Examples

Let’s look at some examples:

Toby files his federal income tax return for 2005 by April 17, 2006 (the last day to timely file). On December 26, 2007, the IRS issues a notice of deficiency.  Because the 18 month-period has closed as of November 25, 2007, interest and penalties are suspended with respect to Toby’s return beginning on October 17, 2007, the day after the close of 18-month period and ending on January 16, 2008, which is 21 days after notice is provided.

Abby files her federal income tax return for 2006 by April 17, 2007 (the last day to timely file). On January 2, 2009, which is less than 36 months after the due date of the return, the IRS issues a notice of deficiency. Because the 18-month period has not closed as of November 25, 2007, interest and penalties are not suspended with respect to Abby’s return.

What’s Ahead?

The House has approved legislation, the Temporary Tax Relief Bill of 2007, H.R. 3396, which would repeal the suspension of interest and penalties on certain tax deficiencies where the IRS has notified a taxpayer after 36 months. The bill would effectively eliminate interest suspension for penalties which may be assessed more than three years after the filing of a tax return, according to the Joint Committee on Taxation.

If you have any questions about how these complex rules work, please don’t hesitate to contact our office. There’s been a lot of change in this area and there could be more. We’ll keep you up to date on all the developments.

(Notice 2007-93)