When the IRS assesses the tax there is an immediate tax liability for the taxpayer. Assessment begins when the taxpayer files a return or the IRS files one in his behalf. When that tax liability is not paid on time, the IRS imposes interest.
Computing the interest is difficult. First, it is set by formula and based on the federal short-term interest rate. Secondly, the rate fluctuates every three months and compounds daily. Lastly, additional interest is charged on the outstanding tax and penalties. Eventually, the interest penalties exceed the original tax liability.
However, the penalties imposed on outstanding tax liabilities can be lessened in a procedure of abatement. Although interest charges are generally not abated, there are instances tax relief can be granted. These are:
1. When the IRS was wrong in computing the interest
2. An undue IRS delay caused the interest to accumulate
3. The IRS erroneously sent a refund but later wants it back plus interest
4. The taxpayer was not notified within 18 months from date of filing of return or date the return was due, that he has outstanding tax liabilities
5. The interest was imposed on a late filing of return by a taxpayer whose address is in a declared disaster area.
On the other hand, interest is also granted by the IRS on a tax overpayment from date of filing. The rate is also formula-based and varies depending whether the taxpayer is an individual or a corporation, which gets a lower rate. The interest is likewise compounded daily, but is not charged during the intervening time between the date it was filed late and its due date.
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