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Allocating Advance Payments between Tax and
Interest
Rev. Proc. 2005-18
supersedes Rev. Proc. 84-58, which for more than 20 years had specified the
procedures for making remittances to suspend interest running on tax
underpayments. The issuance of Rev. Proc. 2005-18 was welcome, as it provides
guidance on making deposits under new Sec. 6603, withdrawing them and
converting deposits made under Rev. Proc. 84-58 to Sec. 6603 deposits. In
one important respect, however, the lack of congruity between the scope of the
new and old procedures has left a void. Specifically, while section 6 of Rev.
Proc. 84-58 addressed in some detail the allocation of advance payments between
tax and interest, Rev. Proc. 2005-18 does not address that issue. As a result,
while it is tempting (and arguably, even reasonable) for taxpayers and tax
advisers to continue to look to Rev. Proc. 84-58 for guidance on payment
allocation questions, the fact that Rev. Proc. 84-58 has been superseded by
Rev. Proc. 2005-18 would appear to compel taxpayers to identify—and evaluate
the continuing applicability of—the statutory and regulatory provisions and
case law that underpin section 6 of Rev. Proc. 84-58.
Full and Partial Payments In
the case of an advance payment in an amount greater than the tax due, Rev.
Proc. 84-58 provided that the IRS would respect the taxpayer’s allocation of
the excess amount to interest or penalties. This position is not controversial;
support for it is found in Rev. Proc. 2002-26. For
partial payments, Rev. Proc. 84-58 stated that the Service would honor the
taxpayer’s request to allocate all or part of the payment to interest if the
taxpayer either (1) agrees to the assessment and collection of the liability by
executing a waiver of restrictions (i.e., Form 870, Waiver of Restrictions on
Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment; 870-AD, Offer to Waive Restrictions on
Assessment and Collection of Tax Deficiency and to Accept
Overassessment;
or 4549, Income Tax Examination Changes); or (2) pays the portion of the
underlying tax that corresponds to the amount of the payment designated as
interest. Otherwise, any purported partial payment of tax would be treated in
its entirety as a deposit in the nature of a cash bond, unless (and until) the
taxpayer cured the defect by redesignating the amount
to be allocated to interest. By
honoring the taxpayer’s allocation of all or some of a payment to interest, the
IRS was implicitly allowing the taxpayer to deduct that interest in the year of
payment under Sec. 163(a). Although not explicitly mentioned in Rev. Proc.
84-58, the Regs. Sec. 1.461-1(a)(2)
“all events” test appears to underlie the Service’s position. Taxpayers and
advisers should look to that test for guidance on payment allocation issues. In
the first situation described above, if a taxpayer agrees to the liability and
signs a waiver of the assessment restrictions, for accrual-method taxpayers the
all-events test appears met; both the fact and the amount of the liability can
be determined with reasonable accuracy, and economic performance has occurred
according to Regs. Sec. 1.461-4(e). For cash-method
taxpayers, the interest has been paid; thus, it is deductible. Resolution
of the second situation—in which the taxpayer pays a portion of the tax and a
corresponding amount of interest—depends on a number of factors, the existence
of which cannot be determined from Rev. Proc. 84-58. For example, if the
additional tax and interest have been assessed, or mutually agreed to but not
yet assessed, Rev. Proc. 2002-26 may apply. It provides that if the Service
accepts a partial payment, it will honor the taxpayer’s specific instructions
regarding payment application; any part of the payment applied to interest will
be deductible under Sec. 163(a) in the year of
payment. However,
as noted above, under section 6.02 of Rev. Proc. 84-58, the IRS would honor a
taxpayer’s allocation to interest only if a proportional amount of underlying
tax has also been paid (but see Perkins,
92 TC 749 (1989); Preble, TC Memo
1989-208; and AODs 1990-022 and -015). If
the additional tax and interest have not been assessed or agreed to, Rev. Proc.
2002-26 would seem inapplicable. Instead, if the taxpayer is regarded as
contesting the liability in spite of the partial payment, Sec. 461(f) seems to apply.
An accrual-basis taxpayer can deduct a contested liability if the following
conditions are met: (1) the taxpayer contests an asserted liability; (2) the
taxpayer transfers money or other property to provide for the satisfaction of
the asserted liability; (3) the contest continues after the time of the
transfer; and (4) a deduction would be proper but for the contest of the
liability. The deduction may be taken in the year in which the money (or other
property) was transferred. In
a Rev. Proc. 84-58 partial-payment situation, the Sec. 461(f) “asserted
liability” requirement is met. Section 6.02 of Rev. Proc.
84-58 states that the partial payment of tax is being made under section 4.03
of the procedure, which in turn provides that a remittance can constitute a tax
payment only if made in response to a proposed liability. The taxpayer’s
payment to the Service satisfies the “transfer of money (or other property)”
requirement. Finally, as was noted, the existence of a contest has been
assumed. In
Rev. Rul. 89-6, an accrual-method corporate taxpayer
remitted the total amount of unassessed tax proposed
by the IRS (plus appropriate interest) in a 30-day letter, did not designate
the remittance as a deposit and contested the proposed tax and interest both
before and after making the remittance. The ruling held that the interest
portion of the remittance was deductible under Sec. 461(f). Importantly, it
specifically stated that it also applied to partial remittances that constitute
payments of tax and interest under section 4.03 of Rev. Proc. 84-58.
Conclusion While
the issuance of Rev. Proc. 2005-18 is a complicating factor when dealing with
payment allocation questions, Rev. Proc. 2002-26, Rev. Rul.
89-6 and the numerous other authorities that interpret and apply the all-events
test should provide the guidance needed to resolve many such issues.
From Michael A. Urban, J.D., |
