Out of the IRS Penalty Box

If your company was one of the 3.8 million to receive a payroll tax penalty notice from the Internal Revenue Service last year, there's a 90 percent chance that the penalty was too high.

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If your company was one of the 3.8 million to receive a payroll tax penalty notice from the Internal Revenue Service last year, there’s a 90 percent chance that the penalty was too high. And, as high as the error rate is, the IRS isn’t disputing the statistic. The sorry news comes from a California firm that recently launched a Web site designed to recalculate and lower tax penalties for its clients.

The problem, according to Ken Hubenak, an IRS spokesman, is a recent change to tax law that allows taxpayers to designate the period to which a specific payroll tax deposit applies. Prior to this ruling, the IRS could allocate the payments to the oldest balance, often resulting in “cascading” penalty fees, since one underpayment would affect all subsequent payments until the difference was paid. In June 1998, as part of the IRS Restructuring and Reform Act of 1998, Congress ordered the IRS to begin, in 2002, applying payments to the most recent balance when calculating penalties, which will eliminate cascading fees.

But in the meantime, the IRS continues to allocate payments the way it always has, although now it notifies taxpayers that there may be alternative ways to calculate the figure.

“We can’t reallocate those deposits on behalf of the taxpayer,” says Hubenak. “Taxpayers who want to reallocate have to wait until the penalty has been issued.”

One company, TimeValue Software, in Irvine, Calif., is taking advantage of the situation. According to president Mike Applegate, the company’s new Web site, taxpenalty.com, calculates more than 250 allocation scenarios for its penalized clients, and picks the one that yields the lowest penalty. In the past six months, the company claims it has processed more than 600 cases, and found lower penalty allocation scenarios in 90 percent of them, with an average penalty reduction of $1,000.

One taxpenalty.com customer, Gary Johnson, president of GLJ Enterprises Inc., in Kant, Wash., has already used the service for four of his clients, yielding penalty reductions of up to $400. Getting those abatements, however, was another story.

“I sent in the initial abatement request letter,” says Johnson, “and I got a call from the local IRS representative. She said she wouldn’t grant the abatement, and was shipping the request off to [IRS headquarters]. A couple of weeks later, I got a letter granting the abatement for slightly less than the amount that taxpenalty.com calculated.”

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