Stopping Interest During an Audit: Section 6603 Deposits

Here is a fact that surprises most people in an audit: the interest on any additional tax does not start when the audit ends. It started when the return was due. Under IRC 6601(a), interest runs from the last date prescribed for payment until the tax is paid. A two-year audit on a three-year-old return can add years of interest to every dollar of deficiency.

You have two ways to stop it before the case is over. You can pay the tax, or you can make a deposit under section 6603. They are not the same thing, and the difference can matter a lot.

What section 6603 says

IRC 6603(a) lets a taxpayer make a cash deposit with the IRS that can be used to pay income tax (and certain other taxes) that has not yet been assessed. Three provisions make it useful:

• No interest on the tax it pays. To the extent the deposit is used to pay tax, the tax is treated as paid when the deposit was made (IRC 6603(b)).
• You can get it back. Except where the IRS determines collection is in jeopardy, it must return any part of the deposit not used to pay tax when you ask in writing (IRC 6603(c)).
• It can earn interest when returned. A returned deposit earns interest to the extent it is attributable to a "disputable tax," at the Federal short-term rate, compounded daily (IRC 6603(d)).

The IRM sums up the practical point: a taxpayer may stop the further accrual of interest while the case is being resolved by making either a payment or an IRC 6603 deposit (IRM 4.19.3.23.1.15). It also warns that the rate paid on returned deposits is lower than the rate for overpayments.

Deposit versus payment

	Payment	6603 deposit
Stops interest on the amount sent	Yes	Yes
Can you get it back on request?	Only by winning a refund claim or the case	Yes, on written request, unless collection is in jeopardy
Interest if returned	Overpayment rate if refunded as an overpayment	Federal short-term rate, only on the disputable tax portion
Effect on the case	An undesignated full payment can resolve the deficiency	Does not concede the issue

The designation is everything

Money you send the IRS during an audit is a payment unless you say otherwise. Rev. Proc. 2005-18, which sets the procedures, says a remittance not designated as a deposit is treated as a payment (section 4.01(2)). The IRM is equally specific: the taxpayer must use the specific designation for the payment to be considered an IRC 6603 deposit.

Under Rev. Proc. 2005-18 section 4.01, you make a deposit by sending a check or money order with a written statement designating it as a deposit under section 6603. The statement should identify:

1. The type of tax.
2. The tax year or years.
3. The amount and basis of the disputable tax (section 7.02), or a copy of the 30-day letter if you are relying on it (section 7.03).

There is a narrow exception. Section 4.04(1) of the revenue procedure treats an undesignated remittance made during an exam, before any liability is proposed, as a deposit if you have no outstanding liabilities. Do not rely on exceptions. Designate.

What "disputable tax" means and why it matters

Interest on a returned deposit is paid only on the part attributable to a disputable tax. The statute defines disputable tax as the amount you specify, at the time of the deposit, as your reasonable estimate of the maximum tax attributable to disputable items (IRC 6603(d)(2)(A)). A disputable item is one where you have a reasonable basis for your treatment and reasonably believe the IRS also has a reasonable basis for disallowing it.

The 30-day letter creates a safe harbor. If you have received a 30-day letter, the maximum tax used for this purpose is not less than the proposed deficiency in that letter (IRC 6603(d)(2)(B)). The statute defines a 30-day letter as the first letter of proposed deficiency that gives you an opportunity for Appeals review.

Here is the trap. Rev. Proc. 2005-18 section 7.04 says that if the disputable tax is not identified when you make the deposit and you later withdraw it, no interest is paid unless you later provide the written statement, and then interest runs only from the date you identify it. Identify it up front.

What happens to the deposit when the case ends

Rev. Proc. 2005-18 section 4.02 lays out the endings:

• You agree. If you sign a waiver or agree to the full deficiency, the deposit is applied as a payment as of the assessment date. Interest on the deposited amount already stopped when the IRS received it.
• You do not agree. The IRS mails a notice of deficiency. The deposit, up to the deficiency plus interest, is posted as a payment when the 90-day (or 150-day) period expires, unless you petition the Tax Court and ask in writing that it continue to be treated as a deposit.
• The deposit is more than the final liability. You can ask in writing to have the excess applied to another liability, or request its return.

Also note section 4.05(1): a remittance that is not designated, sent after a notice of deficiency, is treated as a payment. It does not take away the Tax Court's jurisdiction, but it is a payment, not a deposit.

Getting your money back

You can request the return of all or part of a deposit before it is used to pay tax. Under Rev. Proc. 2005-18 section 6.02, and as repeated in the IRM, the written request must include the dates and amounts of the deposits, the type of tax, and the tax years. Deposits are returned on a last-in, first-out basis (IRC 6603(e)(2)).

A deposit is not subject to a claim for refund while it remains a deposit, because it has not been applied as a payment of assessed tax (section 6.01). That is the point. It is your money, parked, not paid.

When a deposit makes sense

• The audit will take a while, and the amount at stake is significant.
• You expect to lose some issues but not others, and you want to stop interest on the likely loss without conceding anything.
• You have a 30-day letter and want the safe harbor for disputable tax.
• You want the option to fight in Tax Court before paying, which a designated deposit preserves if handled correctly.

When it makes less sense: when the amount is small, or when you are certain to agree. Then a plain payment is simpler.

Practical steps

1. Get the proposed adjustments, ideally a Form 4549 or 30-day letter.
2. Decide how much of the exposure you want to cover.
3. Write a one-page designation letter stating it is a deposit under IRC 6603 and Rev. Proc. 2005-18, with the tax type, years and disputable tax amount, and attach the 30-day letter if you rely on it.
4. Send it to the office handling the exam, keep proof of delivery, and check your transcript to confirm how it posted.

In CP2000 cases, the AUR manual recognizes the same tool (IRM 4.19.3.23.1.15). See how to respond to a CP2000.

Interest is the one part of an audit that gets worse every single day, whether anyone is working on your case or not. A properly designated deposit is how you stop paying for the IRS's calendar.