Underpayment Catch-22

Spent a while on the phone today with the IRS. It was an eye opener.

Broad overview of the issue (confidentiality issues), client filed their 2011 return in Feburary. Since there was a balance due, they decided to hold off payment until closer to April. Before then, the return was amended and mailed in with a new lower balance due which was paid at that time. All this was done before April. Case closed, right? No! Both the original and amended returns had underpayment of estimated tax penalties. The client received a bill for the difference between the penalty shown on the orginal return and what was paid with the amended return - plus interest.

According to the IRS, the Underpayment of Estimated Tax Penalty is a self-imposed penalty and is not easily abated. Here is the deal, if I don't include the penalty on the return, the taxpayer will get a notice for the underpayment penalty plus interest and penalties. But if the return changes and the underpayment penalty decreases, the taxpayer is still on the hook for the difference. Why? Because they put the penalty on the return themself. The IRS didn't assess the penalty so they can't easily take it off. Can you say Catch -22?

The fight's not over. I had a very good IRS representative who double checked the issue and gave me a possible solution; sending in the notice with a Form 2210 and a copy of the amended return to see if we can get rid of the penalty. No guarantees.

So what's a poor tax pro to do? Not add the penalty onto the return and deal with a mad client when they get the bill or deal with a mad client when they get penalized for not paying a penalty they really don't owe. Gotta love our tax system.

Comments

[Robert D Flach]

TM-

I will never calculate an underpayment penalty when preparing a return, even if I believe one is appropriate. Why would a taxpayer want to charge himself/herself a penalty?

If the IRS wishes to charge a client a penalty let them do the determination and calculation.

When such a penalty notice is received I look into the issue to see if the penalty can be done away with via annualization on Form 2210, if there is a "safe harbor" issue, or if there are other circumstances that would warrant abatement.

To repeat - why would I charge my client an IRS penalty. I am not the IRS. If the IRS wants additional monies let them ask for it.

Neither I, nor a client, ever been further penalized for not self-calculating an underpayment penalty on a tax return.

TWTP

[Trish]

I have found that clients don't like getting surprise bills and would rather pay the penalty with their returns. In fact, some have gotten very mad about the penalty not being on the return when I knew it was due. As I'm preparing the return I check annualization and other exceptions. This is the first time in over 20 years that I've seen this happen.