Penalties and their Defenses

The Code imposes a variety of deadlines upon taxpayers for filing tax returns and paying tax.  The deadlines are straightforward and uncomplicated; yet, many taxpayers fail to meet them and, as a result, face a daunting array of potential monetary sanctions

In addition to interest, monetary sanctions include penalties for:

(1) Late filing penalty

(2) Late payment penalty

(3) Estimated tax penalty

(4) Accuracy-related penalty for substantial understatements of tax liabilities when filing a return

These penalties pose additional burdens on taxpayers who may already have financial difficulties.

When penalties have been assessed, there are several approaches that can be taken to mitigate them, referred to as penalty abatement.  Abatement is the reduction of or exemption from taxes granted by the IRS for a specific period and is done by filing an IRS Form 843, although these penalties can also be accomplished over the phone.  The IRS can grant an abatement of interest, penalty or additional tax.  Abatement may be granted where taxpayer can show:

  • Interest, penalties, or additions to tax were caused by certain IRS errors or delays, or certain erroneous written advice from the IRS
  • The taxpayer is eligible for the First Time Penalty Abatement policy, which requires:
    • The taxpayer did not previously have to file a return or did not have any penalties for the three years prior to the year the penalty is being assessed
    • The taxpayer has filed all required returns or filed an extension
    • The taxpayer has paid all taxes due or has made arrangements to pay these taxes.
  • Penalty or addition of tax is due to reasonable cause or other reason (other than erroneous written advice provided by the IRS) allowed under the law
    • Establishing reasonable cause avoids both the failure to file and failure to pay penalties under section 6651
    • Reasonable cause determinations are based on the facts and circumstances of each case
    • Taxpayer bears the burden of proving reasonable cause
      • CAVEAT: Although the taxpayer has the burden of proving reasonable cause, the Service has the burden, in a court proceeding, of producing evidence that it is appropriate to apply the penalty to the taxpayer
      • NOTE: There is no reasonable cause exception to the estimated tax penalty imposed under section 6654
      • By requiring the penalty to be imposed “unless” the failure is due to reasonable cause, the statute precludes any partial waiver of the penalty. The Service must either waive or impose the penalty in full.
      • CAVEAT: Appeals Office can (and often does) settle a penalty for an amount other than “all or nothing” if there are hazards to litigating the issue
      • The request for non-assertion or abatement should be accompanied by supporting documentary evidence and legal authority whenever possible. This might include affidavits of tax advisors or return preparers, death certificates, doctor’s statements, insurance statements, police or fire reports, etc.
      • The Internal Revenue Manual includes a list of the most common reasons given by taxpayers that are considered reasonable cause.
      • Some reasons are more appropriate to late filing, others to late payment, and others to both.
      • Examples:
        • Reliance on a Tax Advisor or Other Third Person
          • Ex: Reasonable reliance on a tax professional’s advice regarding the requirement to file or the return’s due date; Reliance on a tax advisor with respect to a question of substantive law may constitute reasonable cause when such advice turns out to be mistaken
        • Death, Serious Illness, or Unavoidable Absence
        • Fire, Casualty, Natural Disaster, or Other Disturbance

Any time you see that penalties have been assessed, you should make a determination as to whether an abatement request is warranted.  This is particularly important in cases where the taxpayer’s only resolution mechanism is to pay the tax liability either in full or in an installment agreement.  Note, however, that if the taxpayer is eligible for first-time penalty abatement, it may make sense, depending on statute of limitations issues, to wait until the payment plan has been completed to request it because the failure to pay penalty continues to accrue until the liability is paid.