Interest netting strategies: Northern States Power decision.

The Eighth Circuit recently held that the IRS is not required to net overpayments of tax against underpayments of tax prior to making interest calculations (Northern States Power Co., 1/2/96). In addition, the court held that if a liability was satisfied (i.e., paid off), a subsequent overpayment could not be netted against the extinguished liability for interest computation purposes. As a result of interest rate differentials, the Northern States Power decision affects the strategies that should be considered in closing an exam and applying overpayments against underpayments or making advance payments.

Interest on underpayments and overpayments is calculated in the manner prescribed by Secs. 6601 and 6611, respectively. Since Jan. 1, 1987, the rate of interest on outstanding underpayments is one percentage point higher than that received by the taxpayer on overpayments. Beginning Jan. 1, 1991, large corporate underpayments (generally defined as those in excess of $100,000) have accrued interest at an additional two percentage points, thus resulting in a three percentage point rate differential between the overpayment and the underpayment rates. And, since Jan. 1, 1995, interest on large corporate overpayments (generally defined as those in excess of $10,000) accrues at a rate 1.5 percentage points less than the standard overpayment rate. Thus, the interest rate differential between overpayments and underpayments can be as little as one or as much as 4.5 percentage points. In Northern States Power, the 1% interest differential resulted in a $460,000 difference in the amount of the potential refund.

The court's ruling raises additional strategy considerations for any taxpayer whose examinations could result in either a deficiency or an overpayment. It is very important that practitioners and taxpayers be cognizant of interest netting issues, particularly when considering various settlement options and approaches when closing examinations. With an interest rate differential that can vary from 1% to 4.5%, interest calculations can have a significant impact on the amount of a deficiency or refund. Thus, various options should be considered to protect a client's interest in the event that there exists a mutuality of indebtedness with the Service. For example, it may be advisable to attempt to get the IRS to agree to interest netting in writing, such as in a Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, or a Form 870-AD, Offer of Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, when closing an examination. Furthermore, if a client will be receiving a refund, and if it is anticipated that a deficiency may arise in other years currently under examination or to be examined, one should consider attempting to obtain an agreement from the Service to credit the overpayment against the open tax years as of the date the overpayment arose (as opposed to requesting and receiving a refund). Lastly, the Northern States Power decision could also affect strategies in making advance payments or deposits so as to stop the running of interest.

Editor's note: Mr. Cammarata chairs the AICPA Tax Division Tax Practice and Procedures Committee. Dr. O'Neil, Mr. Ely and Ms. Pflieger are members of the committee.