Overpayments credited to estimated tax.

Tax practitioners often overlook a review of Rev. Rul. 88-98 when their clients have an overpayment that can be credited to the following year's estimated taxes. This ruling discussed the computation dates for interest due on subsequently determined deficiencies when the taxpayer's original return reflected an overpayment. The overpayment on the original return was either refunded without interest (i.e., processed within 45 days) or was credited to estimated tax installments for the next year. The ruling provided that, if the taxpayer applies the overpayment to the September 15 estimated tax installment on the following tax year and a subsequent deficiency is assessed on the overpayment year, deficiency interest will not scare to accrue until September 15 on the portion of the deficiency equal to or less than the overpayment, The subsequent deficiency could be the result of an examination or an amended return filed with a tax increase.

While the IRS has lose several decisions on this issue (e.g., May Department Stores Company, Ct. Fed. Cls. (11/4/96), and Kimberly-Clark Tissue Company, DC Pa. (3/18/97), and has acquiesced to the May Department Stores decision, the Service has not changed its position requiring that taxpayers attach a statement to their returns to elect that their overpayments be applied to an estimated tax installment other than the first installment. If the taxpayer does not designate the installment to which the overpayment should be applied, the IRS credits the overpayment to the first estimated tax installment.

In May Department Stores and Kimberly-Clark, even though the taxpayers had not attached statements electing that their overpayments be credited to the third installment period on the original returns, the courts held that the Service may only charge interest if there is a tax that is both due and unpaid. The courts said that the IRS (not the taxpayers) had the use of the money until the returns were filed requesting the overpayment be applied to the next tax period. (Note: The Service has issued instructions to its Service Center personnel to process claims for interest and issue refunds if the facts are exactly like the May Department Stores case.)

When a taxpayer elects to credit an overpayment to the subsequent year's estimated tax payments, the taxpayer's situation should be analyzed to determine if the payment can be allocated to the third installment period. Care must be taken to ensure that sufficient estimated tax payments have been made for the first and second installment periods so that the taxpayer will not become liable for an estimated tax penalty.

If a taxpayer has made sufficient estimated tax payments for the first and second installments, a statement should be prepared and attached to the return indicating that the taxpayer elects to have the overpayment credited to the third installment. If an amended return or audit results in a subsequent tax assessment, the interest charged on the additional tax will not start accruing until September 15, as opposed to April 15. This is a five month interest-free period for deficiency interest that can result in significant savings for the taxpayer and will not require the filing of a claim to correct the interest charged.