Abatement or suspensions of penalties and interest on a tax deficiency.

Over the years, taxpayers have experienced mounting increases of interest due on tax deficiencies. These ever-increasing tax bills are generally attributable to long, extended tax examinations, tax shelter suspended cases or collection activities involving installment arrangements. The IRS has also recognized that numerous delays in processing a case may not be a taxpayer's fault, but may be due to an IRS employee's mistake or error. Unfortunately, even in these situations, the mounting interest, or some part of it, could not be abated; the Service simply did not have the statutory authority. The Tax Reform Act of 1986 (TRA '86) changed this. The Taxpayer Bill of Rights 1 (which was incorporated into the TRA '86) gave the IRS the authority to abate interest if an IRS official either failed to perform a ministerial act in a timely fashion or erred in performing a ministerial act, provided the taxpayer was not significantly responsible for the delay. In 1987, the Service issued temporary and proposed regulations defining a ministerial act as "a procedural or mechanical act that does not involve the exercise of judgment or discretion, and that occurs during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and review by supervisors, have taken place." The problem, however, did not end there; more relief was needed.

Under the Taxpayer Bill of Rights 2 (TBOR2), the Service had the authority to abate interest when a managerial act caused the error or delay. The IRS recently proposed regulations defining the term "managerial act" as it applies to situations in which the Service has the authority to abate interest because of delays and errors caused by IRS personnel. The new rules define a "managerial act" as a loss of records or a personnel management decision, such as a decision to approve a personnel transfer, extended leave or extended training. The expansion of the Service's authority is effective for interest accruing on deficiencies or payments for tax years beginning after July 30, 1996.

The TBOR2 also gave the Tax Court the jurisdiction to consider the issue of the IRS's failure to use its discretionary authority to abate interest, effective for requests for abatement after July 30, 1996.

Congress has recently gone through a series of extensive hearings on restructuring the IRS. In the IRS Restructuring and Reform legislation, Congress has once again looked at the problem of interest.

One of the continuous problems haunting taxpayers is the accumulation of interest during a long, extended tax examination. The new legislation proposes to suspend the accrual of interest and penalties after one year if the IRS has not issued a notice of deficiency within one year from the later of (1) the return's original due date or (2) the date on which the taxpayer timely filed the return. The proposal applies only to individuals and would not apply to failure to pay, fraud or criminal penalties.

There is no doubt that the proposal will accelerate and make IRS audit examinations more timely. But at what price? Interest will be decreased, but what will be the effect on tax compliance?