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Installment tax payments are not deductible


Dear Tax Talk,
I am making monthly payments to the Internal Revenue Service on income taxes owed for 2002. Is any amount of these payments deductible on my 2003 income tax return? -- Adam

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Dear Adam,
You're in for a double whammy.

Although you're paying the IRS tax, interest and penalty for not having paid on time, you can't deduct any of it. Interest paid to the IRS on late taxes is only deductible by a corporation that owes back taxes. Individuals are not allowed to claim interest paid to the IRS even if the taxes relate to business income reported on their personal tax return.

A lot of taxpayers deem this difference in treatment to be unfair and have litigated over the years in an attempt to claim interest paid to the IRS at least as a business deduction. Although some of the earlier cases favored the taxpayers, lately the consensus is that the interest is not deductible.

Since the payments to the IRS are not deductible, this means that you have to earn enough to pay tax on the amount that you earned so that you can turn the remainder over to the IRS for the back taxes. For example, assume you're a self-employed sole proprietor in the 25 percent tax bracket and also pay self-employment tax of 15.3 percent. Your combined tax rate is 40.3 percent. Assume also that you owe the IRS $10,000 for back taxes. If you earn $16,750, your current tax is $6,750. That leaves you $10,000 to pay the IRS on the old debt.

As you can see, the $10,000 debt has transformed itself into an unmanageable 67.5 percent more. This what we in the tax profession call a double whammy.

-- Posted: Sept. 24, 2003




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