Tax Law Center Blog

By Parag P. Patel, Esq. | Updated October 12, 2012

When the IRS receives payment with amended tax returns for taxes, interest and penalties, the IRS may misapply the payment.

This results in IRS notices. Reminiscent of the mistakes of the 2009 OVDP, the IRS now appears to be applying all of the separate annual payments to the 2007 tax year alone.  This means that interest continues to accrue for all other years, even though the tax liability, accuracy penalty and interest for each year had been paid with the initial OVDI submission, many months ago.

Suppose your amended returns call for $100 due for 2007 and $500 for 2008, so you send $600 to cover both. The IRS may apply the entire $600 to 2007. That leaves an overpayment of $500 for 2007 and underpayment of $500 for 2008. Despite participation in the OVDP, an IRS computer automatically demands payment despite the $500 overpayment for 2007. Notices may even say “Second Notice” although no first notice was ever issued. Letter writing and phone calls ensue, but you could even receive a Notice of Intent to Levy.

Taxpayers have gotten “refunds” for 2007, because of the application of multi-year payments to that single year, and the IRS is issuing demands for payment for all other years of the voluntary disclosure.  The demands include interest, notwithstanding that interest has already been paid.  Moreover, in some cases, the IRS is assessing failure to pay penalties, notwithstanding that full payment has in fact been made months ago.  In one case, the “refund” for 2007, which should never have been issued in the first place, resulted in a new demand for the amount “refunded”.

When we raise these issues with the IRS agent assigned to the voluntary disclosure, the agent advises that the application of payments is made at the IRS campus, and the OVDI agent is powerless to alter them.  The agent then advises us (orally) that “it will all reconcile at the end”. We are not persuaded by the agent’s assurances.

The IRS’ failure to apply taxpayer’s payment to taxpayer’s entire tax liability, including penalties and interest, on a year-by-year basis, will result in more delays, additional interest and penalty assessments, additional back-and-forth between the IRS and the taxpayer, and additional professional fees to resolve what should otherwise be a straightforward application of payment.

In addition, disregarding the taxpayer’s instructions as to application of payments is in violation of taxpayer’s rights, because “[w]here a taxpayer makes voluntary payments to the IRS, he does have the right to direct the application of payments to whatever type of liability he chooses.” Salazar v. CIR, T.C. Memo 2008-28, *34 (February 25, 2008); Estate of Wilson v. CIR, T.C. Memo 199-221, *14 (July 6, 1999); Muntwyler v. U.S., 703 F.2d 1030, 1032 (7th Cir. 1983).

The IRS must recalculate taxpayer payments in a manner consistent with the taxpayer’s instructions as made in the OVDI submission.  We are also advocating that any interest or penalties which may have accrued as a result of the misapplication of taxpayer payments be fully abated.

Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign accounts.

About the Author

Parag P. Patel, Esq. brings over three decades of experience to individuals and businesses facing complex tax problems. Holding advanced degrees from Georgetown University Law Center (J.D.) and New York University School of Law (LL.M. in Tax Law), the nation’s top tax programs, Mr. Patel delivers sophisticated and creative strategies in complicated federal and state audits, penalty abatements, and foreign asset/income reporting. His practice emphasizes international tax matters, specifically foreign financial account reporting (FBAR), voluntary disclosures, and penalty defense.

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