Interest Netting: How to Claim a Refund From the IRS

A taxpayer may find they have both underpaid taxes for one period and overpaid in another. This creates a situation of mutual indebtedness, where the taxpayer owes the Internal Revenue Service (IRS) and the IRS owes the taxpayer. For corporate taxpayers, this can be particularly costly because the interest rate charged on underpayments is higher than the rate paid on overpayments.

Interest netting is a provision designed to remedy this imbalance. Codified in the Internal Revenue Code, this process allows for the equalization of interest rates for any period a taxpayer has both an outstanding tax underpayment and an overpayment. The principle is to create a “net interest rate of zero” on the overlapping amounts, effectively treating the two debts as if they cancel each other out for interest calculation purposes during the time they coexist.

Eligibility for Interest Netting

To qualify for interest netting, a taxpayer must have both paid underpayment interest to the IRS for one tax period and been credited with overpayment interest for another. This mutual indebtedness is the primary requirement for the process.

An overlapping time period is also required, meaning there must be at least one day where the underpayment and overpayment existed simultaneously. Interest netting applies only to these specific days of overlap and does not cover periods where only one of the two existed.

The underpayment and overpayment must belong to the same taxpayer. For married couples filing a joint return, they are treated as a single taxpayer, allowing netting between years even if their filing status changed, as long as they filed jointly in one of the years. The provision also applies across different types of taxes, so an income tax overpayment can be netted against a self-employment tax underpayment.

Calculating the Net Interest Benefit

Calculating the benefit of interest netting involves applying a “net interest rate of zero.” This does not mean no interest is charged or paid; rather, for the period of overlap, the interest rates on equivalent amounts of the underpayment and overpayment are equalized. The result is a refund for the difference between the higher interest paid on the tax debt and the lower interest the IRS credited on the tax refund for that overlapping amount and time.

For example, suppose a corporate taxpayer had a $20,000 tax underpayment for Year 1, on which they paid interest at the higher underpayment rate. Later, it is determined they had a $15,000 tax overpayment for Year 3, on which the IRS credited interest at the lower overpayment rate. Assume the period where the $20,000 debt was outstanding and the $15,000 credit was available overlapped for 24 months.

Under interest netting rules, for those 24 months, the interest on $15,000 of the underpayment is recalculated. The higher interest rate originally charged on that portion is adjusted downward to match the lower rate paid on the overpayment. The taxpayer remains responsible for the original, higher interest rate only on the $5,000 portion of the debt that did not overlap. The outcome is a refund for the excess interest paid on the $15,000 during the overlap.

Information Required to Claim a Refund

To formally request a refund through interest netting, you must file Form 843, Claim for Refund and Request for Abatement. Before filling out the form, gathering all necessary documentation is important to ensure the claim is processed efficiently.

You will need to provide the following information:

• Your name, address, and Social Security Number or Employer Identification Number.
• The exact tax period of the underpayment, including the date the underpayment interest was paid.
• The tax period for the overpayment and the date the overpayment interest was credited or received from the IRS.
• A detailed schedule that shows the precise dates of the overlapping period of mutual indebtedness.
• A clear calculation of the interest to be refunded, demonstrating how the net interest rate of zero was applied to the overlapping amounts.

On Line 7 of Form 843, you should state, “Request for interest netting” and attach the detailed schedules and calculations as supporting evidence. An interest netting claim can be filed as long as the statute of limitations to claim a refund is still open for at least one of the tax periods involved.

The Submission Process

Once Form 843 is fully completed and all supporting calculations and schedules are attached, the final step is submission. The mailing address for Form 843 varies, so you must consult the official form instructions to find the correct service center address. For an interest netting claim, the form is sent to the IRS service center where you filed your most recent tax return. Sending the form to the wrong location can cause significant processing delays.

After the claim is mailed, the IRS will begin its review process, which can take several months. You may receive a notice from the IRS acknowledging receipt of the claim. If the agency approves the request, a refund check for the netted interest amount will be issued. The IRS will contact you by letter if it requires additional information.