Report: IRS inconsistent on interest penalties

WASHINGTON -- The IRS inconsistently charges interest on penalties imposed on delinquent taxpayers, resulting in unequal treatment for some of them, the Treasury Department's inspector general for taxes said Thursday.

The Internal Revenue Service acknowledged some delinquent taxpayers end up paying more interest on penalties than others, but said the Treasury IG report overstates the problem.

Taxpayers who file their returns on time but cannot pay all they owe are charged a penalty of 0.5 percent a month on the unpaid balance, with a maximum cumulative penalty of 25 percent. The IRS also charges interest on both the unpaid taxes and unpaid penalties.

An audit by the Treasury Inspector General for Tax Administration said interest on penalties is not being assessed throughout the year on most delinquent accounts.

Most delinquent taxpayers get an automated statement once a year, updating the accumulated back taxes, interest and penalties owed. The penalties rise as the total amount owed goes unpaid.

But the IRS doesn't start charging interest on the updated penalty amount until it notifies the taxpayer of the amount owed.

However, some delinquent taxpayers get hand-produced statements more often than once a year, the report said. Among those taxpayers were people who were granted filing extensions for special circumstances, such as victims of natural disasters and soldiers who served in combat. For them, interest on the higher penalty starts accruing immediately, once they receive their new statements, the report said.

"Selective enforcement of the tax law based on convenience should not be an option," the report said. "The IRS should ensure that it charges interest on the penalty fairly to all taxpayers."

The inspector general's office analyzed a sample of 278 delinquent taxpayer accounts -- 139 individuals and 139 businesses. Of those, 257, or 92 percent, did not have penalties assessed, and no interest on those penalties had started to accumulate.

The IRS, in its response to the audit, said penalties eventually were assessed on most of the sample accounts, leaving only 25 that should have been penalized but weren't. The IRS said it was researching why those accounts weren't penalized.

In 2007, delinquent taxpayers owed more than $10 billion in penalties, the audit found. Interest on those penalties would have amounted to about $800 million, if it had been assessed quarterly.

The report said it is unlikely the IRS could collect the entire $800 million because many accounts are inactive. Based on its analysis, the report estimated the IRS could have collected an additional $171 million in interest by assessing penalties quarterly rather than yearly.

The inspector general's report did not address the cost of sending quarterly statements to all delinquent taxpayers.

The IRS said in response that the IG audit overstates the amount of additional interest that could be assessed.

"We acknowledge that the current system results in some inequity between taxpayers because interest is assessed for different taxpayers at different times of the year," wrote Christopher Wagner, head of the IRS division for small businesses and the self-employed. "It should be noted that this inequity does not disproportionately affect taxpayers in combat zones or disaster areas."