Anyone who has been faced with unfiled tax returns or an overdue balance owed to the IRS knows that the penalties assessed for failing to pre-pay, deposit, pay, or file with the IRS can be quite substantial. A common question we get here at Bryson Law Firm, LLC is “I know I owe the tax and intend to pay it, but is there anything I can do about these penalties?” Here’s a crash course on the how to handle the most common types of penalties you can expect to see from the IRS if you run into tax troubles, how to avoid them, and the options available to you for getting those penalties removed.
The most common penalties taxpayers will run into are for Failure to File and Failure to Pay as provided for under Internal Revenue Code 6651. As everyone knows, the deadline to file a Form 1040 Individual Income Tax Return is April 15th. The best way to ensure penalties are avoided is by filing and paying all income tax obligations by that date. (This means that the return must be postmarked by that date.)
Side Note: Keep in mind that if you are self-employed or owed in the year prior, even if you file and write a check for the full balance on April 15th, you will still incur a Penalty for Underpayment of Tax if you did not pay enough taxes via Estimated Tax Payments throughout the year unless you owe less than $1000 or paid at least 90% of the tax on the current year/100% of the tax due on the prior year return (whichever is smaller). Remember, the United States income tax is a “pay-as-you-go-tax” and you are supposed to pay taxes on income as you earn it.
You can also avoid any late filing penalties on income tax returns temporarily by filing for an Extension of Time to File. It is important to keep in mind that this extension will give you extra time to file, but will NOT give you any additional time to pay the amount owed. You CANNOT request an Extension of Time to File on any employment tax returns.
You can request an Extension of Time for Payment of Tax Due to Undue Hardship with Form 1127 if you can show that an undue hardship would be suffered if payment is made with the return. The IRS can generally give taxpayers up to a six month extension, and the Failure to Pay accrual will not begin until after this extension expires.
Reasonable Cause Penalty Abatement Request:
If you were unable to timely file and/or pay your tax obligations, with or without an extension, there may still be relief available to you if you have reasonable cause.
Treasury Regulation 301.6651-1(c)(3) explains that reasonable cause will be presumed in the case of failure to pay income tax by April 15th IF at least 90% of the amount shown on the tax return was paid on or before the due date and the remainder was paid with the return filed (or if this pertains to corporate income tax- the remainder was paid by the extended return due date).
IRM 18.104.22.168.4.1 discusses additional options available to have Failure to File or Failure to Pay penalties abated based on reasonable cause. The IRS looks at the facts and circumstances of each case to determine whether the taxpayer’s reasons for not filing/not paying on time were based on reasonable cause, not willful neglect (conscious, intentional failure or reckless indifference). Ultimately, the taxpayer must show that though ordinary business care and prudence was exercised, the taxpayer fell nevertheless unable to file/pay timely. The IRS looks to what happened, when it happened, what facts and circumstances prevented a taxpayer from filing/paying, how these facts and circumstances resulted in non-compliance, how the taxpayer handled all other financial affairs at the time, and what happened once the facts and circumstances changed. (IRM 22.214.171.124.2(5)). The IRS also checks the previous years of compliance history, the length of time between the cited reason and subsequent compliance, and whether the taxpayer could have anticipated the event that caused non-compliance (IRM 126.96.36.199.2.2(2)).
Reasonable Cause Penalty Abatement Request Examples:
Here are some examples as to what is and what is not considered reasonable cause. Keep in mind that IRM 20.1 lays out specific examples of acceptable explanations, but reasonable cause is NOT limited to these; any acceptable explanation provided by the taxpayer that proves he or she exercised ordinary business care and prudence will suffice:
- The reason “I just didn’t have the money” is not considered reasonable cause to the IRS unless you can prove that the funds necessary to pay the taxes were used for unusual or unforeseen circumstances. (EX: extravagant living expenses caused you to have to forego paying taxes in order to pay the mortgage)
- Reasonable cause does exist if paying the tax would have resulted in a significant hardship for the taxpayer. (EX: suddenly had to pay necessary medical expenses). There is generally no “undue hardship” excuse for not filing timely.
- Continued failure to file generally suggests willful neglect, not reasonable cause (EX: it is much more persuasive that you had reasonable cause for paying late in 2014 when you’ve filed and paid on time from the time you began working than if you haven’t filed in 10 years)
- Generally, the IRS is more willing to abate Failure to Pay penalties if the tax portion of the debt owed has been paid, BUT the IRS still can abate penalties with the tax portion still owed if there is sufficient reasonable cause; this is not the case for Failure to File
More specific examples include:
- IRM 188.8.131.52.2.1 lists “Death, Serious Illness, or Unavoidable Absence” as grounds for reasonable cause. The death/illness/absence must be of the taxpayer or death/illness in the taxpayer’s immediate family. The IRS looks at the relationship, date of death, dates/duration/severity of illness, dates/reasons for absence, how all of this prevented compliance, if other obligations were impaired, and if tax duties were addressed within a reasonable time after the death/illness/unavoidable absence.
- IRM 184.108.40.206.2.2.2 lists “Fire, Casualty, Natural Disaster, or Other Disturbance-Reasonable Cause” as reasonable cause if the taxpayer could not comply with their tax obligations because they were an “affected person” eligible for disaster relief (see IRM 220.127.116.11). Even if not an “affected person”, if there was a fire, casualty, natural disaster, or other disturbance a taxpayer may request a waiver of penalties (though this alone is not enough).
- IRM 18.104.22.168.2.2.3 discusses when a taxpayer is “Unable to Obtain Records”. This is very fact specific, and the IRS looks to why the records were needed, why they were unavailable, when the taxpayer discovered they were unavailable, means explored to secure the records, etc.
- IRM 22.214.171.124.2.2.4 explains that “Mistake was Made” generally does NOT provide a basis for reasonable cause, but may be a supporting factor to explain all facts and circumstances re: reasonable cause.
- IRM 126.96.36.199.2.2.5 discusses “Erroneous Advice and Reliance”. Generally, relying on another party to comply for you is NOT reasonable cause, as “the taxpayer is responsible for meeting his or her tax obligations and that responsibility cannot be delegated.”
- IRM 188.8.131.52.2.2.6 covers “Ignorance of the Law” and explains that if the taxpayer makes reasonable efforts to determine their tax obligations, they may be able to use Ignorance of the Law as grounds for reasonable cause. The IRS looks to the taxpayer’s education, whether they were previously subject to the tax, if the taxpayer has been penalized before, recent changes to tax forms, level of complexity of issue, etc. There must be a good faith effort to comply OR the taxpayer must be unaware of the requirement and was not reasonably expected to know the requirement
- IRM 184.108.40.206.2.2.7 explains that “Forgetfulness” is generally NOT reasonable cause.
First Time Penalty Abatement Request:
IRC 6651(a)(1) and IRM 220.127.116.11.1.6 lays out the requirements for a First Time Abate (FTA). No reasonable cause explanation is required to receive relief under this type of penalty abatement. If you did not have to file a return for the previous 3 years OR had no prior penalties assessed against you for the prior 3 years AND has filed all currently required returns and paid any tax due, the IRS can grant you a First Time Abatement.
This type of relief can only apply to a single tax period. If a taxpayer owes for multiple tax periods, you can request a First Time Abatement on the first year, assuming all qualifications discussed above are met.
Though all tax amounts due should be paid, the IRS can also grant a First Time Abatement if the balance is in an Installment Agreement and the taxpayer is current with installment agreement payments.
Penalty Abatement Requests are a great avenue to pursue with the IRS if you are ready to get the tax debt paid but feel you have just cause for not being able to file your tax return on time or pay the taxes you owed in a timely manner. Taxpayers can request a Penalty Abatement on an IRS Form 843. When you submit a request for penalty abatement, you are certifying under penalties of perjury that the reasons you set forth are true, correct, and complete. Keep in mind that if you’ve paid off your tax debt, you still have some time to request a waiver of penalties and obtain a refund for the amount of penalties and the corresponding interest abated- 2 years from the date you made the “overpayment” and paid the tax.
Hoping you found this blog post helpful, and for those of you with tax balances, overdue returns, or IRS penalties assessed against you and good reasons to explain why, give us a call to see how Bryson Law Firm, L.L.C. can assist you with making an IRS Penalty Abatement Request.