Each year, the Internal Revenue Service assesses millions of tax penalties against individuals and businesses. If you have received an IRS penalty notice, you are not alone. In 2019, the IRS sent over 40 million penalty notices and assessed over 40 billion dollars in penalties. More than 60 percent of these penalty notices involved just two offenses: delinquency (failure-to-file) and failure-to-pay.
These two penalties can be quite costly. Although they are legally capped at a combined rate of 5 percent per month on the unpaid tax amount, together these two penalties can rise to as much as 47.5 percent of the unpaid tax. For example, a $100,000 unpaid tax liability on a return filed late could, in some scenarios, ultimately result in $47,500 of penalties.
The IRS, as explained below, can reduce these penalty assessments. In 2019, the IRS reduced almost 4.3 million penalties, resulting in total penalty decreases of 11.4 billion dollars. More than 60 percent of these penalty reductions, or abatements, as the IRS calls them, involved delinquency and failure-to-pay penalties.
The IRS abates these two penalties under two basic provisions that are contained in its Internal Revenue Manual (IRM), a procedural guidebook for IRS employees that is also available to the public.
- First Time Abatement: This is simple to request if a taxpayer meets the criteria. This administrative waiver, implemented in 2001, is available for penalty relief the first time an individual taxpayer is subject to the delinquency or failure-to-pay penalty. In short, taxpayers qualify for this one-time abatement when they have met their return filing and payment responsibilities and have not had either of these Form 1040 penalty assessments in the prior three years.
- Reasonable Cause: These penalties will be abated in cases where the taxpayer can establish reasonable cause. Reasonable cause determinations by the IRS are based on the facts and circumstances in each situation. It is generally present when the taxpayer exercised ordinary business care and prudence but was still unable to comply due to circumstances beyond the taxpayer’s control.
The IRM is an excellent guide for tax professionals when requesting penalty abatements for clients. Part 20 of the IRM explains the factors that IRS uses to determine if reasonable cause exists for filing or paying late.
The abatement request for reasonable cause should answer the following general questions:
- What happened and when?
- What facts and circumstances prevented filing a return or paying a tax?
- How did these facts and circumstances result in noncompliance?
- Once the facts and circumstances changed, what attempt did the taxpayer make to comply, and was this attempt made within a reasonable time frame?
Some key IRM reasonable cause factors and considerations are:
- Death, Serious Illness or Unavoidable Absence: With these factors, documentation as well as detailed explanations are important. Information about the taxpayer or immediate family member who died, was seriously ill or unavoidably absent and why this prevented compliance must be fully addressed.
- Fire, Casualty, Natural Disaster or Other Disturbance: What was destroyed or made unavailable, and how did this prevent compliance? Another key consideration is whether the taxpayer complied as soon as it became possible to do so.
- Unable to Obtain Records: Address why the missing records were needed, when they became unavailable, what steps were taken to obtain them and what other means were taken to comply, such as making estimates or obtaining the missing information from other sources. Supporting documentation of the measures taken to obtain the records or information is also important.
- Erroneous Advice or Reliance: If the taxpayer relied upon someone else, considerations to address are who was relied upon, the nature of this reliance and if there is any supporting documentation. The IRS cautions that relying on someone else for filing or paying obligations may not meet the reasonable cause standard since these responsibilities cannot be delegated.
- Ignorance of the Law: Ignorance of the law in conjunction with other facts and circumstances may establish reasonable cause. Facts such as the taxpayer’s education; whether the taxpayer has previously been subject to the tax; recent changes in tax forms or law; and the complexity of the tax or compliance issue should be considered. A taxpayer may have reasonable cause if he or she made a good faith effort to comply and could not reasonably be expected to know of the compliance requirement.
- Other Factors: An acceptable explanation to establish reasonable cause is not limited to just the factors provided in the IRM but can include other factors that establish that ordinary business care and prudence was exercised.
Calling the IRS Practitioner Priority Service (PPS) can sometimes result in the abatement of penalty assessments under the IRM’s First Time Abate (FTA) procedures. IRS Customer Service Representatives at the PPS call center use a software tool that can readily determine whether the taxpayer meets the criteria for a first-time abatement.
Reasonable cause abatement requests must be submitted in writing to the IRS Service Center that assessed the penalty as shown on the penalty notice. If a reasonable cause abatement request is denied, the taxpayer will have 60 days to file an appeal with the Service Center Appeals Coordinator as explained in the denial letter. In many cases, particularly those with rather unique or unusual facts and circumstances, it will take a telephone hearing with the IRS Appeals Division to get the fullest possible consideration of the reasonable cause factors.
Bennett Thrasher has a Tax Controversy Practice that helps clients resolve IRS matters prior to the litigation stage. This includes helping clients manage IRS tax disputes involving both field and correspondence audits; post-audit issue resolution, including representation in IRS appeals; penalty and collection notices; and other tax compliance-related matters. For more information contact James Pickett by calling 770.396.2200.