The IRS assesses over 150 different types of penalties. Each year, 27 million taxpayers are assessed an IRS penalty. However, only 11% of all penalties are abated. There are four reasons the IRS abates penalties:
- Correct an error made by the IRS
- Apply a statutory or regulatory exception (like disaster relief)
- Promote fairness in penalty determinations by applying an administrative waiver (for example, first-time penalty abatement)
- The taxpayer has a “reasonable cause” why they could not comply with the law
There is a fifth way for penalty relief. The IRS will also consider penalty abatement or non-assertion to settle cases (mainly audit cases) where there are “hazards of litigation.” Generally, this relief is obtained when you take your audit case to IRS appeals.
The IRS rarely provides written evidence that allows a taxpayer to argue penalty abatement based on an error made by the IRS. Regulatory exceptions are rare also and mostly applied automatically when a return is filed. The two main reasons taxpayers ask for relief is for first-time abatement (an administrative waiver) and reasonable cause.
Penalty facts:
- Three penalties make up 98% of all penalties assessed: the failure to pay penalty is by far the most assessed penalties (59% of all penalties). The estimated tax penalty makes up 26% of all penalties. 13% of all penalties are for late filing (the failure to file penalty).
- Estimated tax penalties: the estimated tax penalty applies when a taxpayer does not pay their tax bill throughout the year through estimated payments and/or withholding. Taxpayers self-assert the estimated tax penalty and provide any exceptions when the file their tax return using Form 2210. It is rare to abate the estimated tax penalty. Less than 1% of all estimated tax penalties are abated after they are assessed.
- You must request abatement for the failure to file and pay penalties: the IRS automatically applies these two penalties. That is, there is not a penalty determination that considers all the facts and circumstances before the penalty is assessed. After the penalty is assessed, a taxpayer must request relief for these two common penalties to be abated.
- Argue accuracy penalties (audits and CP2000s) before the IRS assesses them: if you make an error on your return, the IRS can charge you a 20% accuracy penalty. The IRS will propose this penalty during an audit or during a CP2000 notice and provide you the opportunity to argue why it should not be assessed. After it is assessed, the taxpayer has few options if they have been given the opportunity to contest the penalty during an audit or CP2000 and failed to do so.
- Besides criminal prosecution, the IRS also has a civil fraud penalty: if you fraudulently file a return or intentionally fail to file a required return, the IRS can criminally prosecute you for tax evasion. In addition, the IRS can also assess a 75% civil fraud penalty. The IRS does not have to criminally prosecute a taxpayer to apply the civil fraud penalty. In fact, each year there are many more civil fraud penalty assessments v. criminal prosecutions.
- The key to abatement: the general rule that the IRS applies to abating penalties is that the taxpayer made a reasonable attempt to comply, but for reason outside of their control, were unable to comply. The reasons are called “reasonable cause” arguments.
- Reasonable cause exceptions apply to the failure to file, failure to pay, and accuracy penalties: reasonable cause relief does not apply to the estimated tax penalty. However, reasonable cause is often used to argue FTF, FTP, and the accuracy penalty. However, what the IRS accepts as reasonable cause for these penalties differ. FTF and FTP penalties are generally related to hardships. Accuracy penalty reasonable cause arguments relate to the effort and care by the taxpayer in accurately filing a tax return.
- Reliance on a tax professional is not a good reasonable cause argument for failure to file or pay: if you just argue that the taxpayer relied on a tax pro to comply with filing and paying timely, the IRS will shoot down your abatement request every time. The courts have supported the IRS on the basic principle that taxpayers cannot outsource their filing and payment duties to a third-party. However, reliance on a third-party in addition to other reasonable cause factors can be effective in abating penalties.
- Clean compliance history always helps with abatement: taxpayers with a clean history of filing and paying on time, self-correcting errors, and having isolated incidents of non-compliance always make good penalty relief candidates. The IRS’ purpose in assessing penalties is to deter noncompliance (IRS Policy Statement 20-1). A good history of compliance is consistent with this IRS’ policy.
- The IRS likes a chronology of events and other aspects of your life that were affected by your circumstances: in penalty relief requests, the IRS will want you to outline dates of your reasonable cause circumstances. They will also want to know other aspects of your life that were affected by the hardship or other reasonable cause circumstances. For example, if the taxpayer is claiming reasonable cause due to a long-term illness, the request should outline the dates of the illness and how it directly impacted the tax year compliance in question. To support the dates, the taxpayer should illustrate how other areas were affected, such as not being able to work during the long-term illness. Chronologies with examples of related affected areas make great arguments for abatement.
- You must appeal adverse abatement determinations: the IRS uses an automated tool to help its employees make penalty abatement determinations. This tool is called the “Reasonable Cause Assistant” or “RCA.” The RCA is flawed: it does not consider the totality of the taxpayer’s situation – but summarily rejects penalty relief when one, of possibly many factors, does not meet their standard for abatement. Often, taxpayers must request an appeal so that an appeals officer at the IRS can consider all of the facts and make a correct determination.
Solutions:
There are several solutions that you can employ to get relief from penalties. Which solution(s) you use usually depend on the type of penalty(ies) assessed. IRS collection enforcement (audit, collection, nonfiling) will also determine which avenues are available.
Penalty abatement requests:
This is the standard first request for abatement, especially for the failure to file and failure to pay penalties. The format and procedure to file this request will depend on whether the penalty has been paid or the taxpayer still owes the penalty. This request outlines the specific taxpayer’s circumstances and reasons that were outside of their control that caused them to not comply. Responses usually come within 4-8 weeks from the IRS. Adverse requests should consider appeals so that a person at the IRS considers all of the taxpayer’s circumstances.
IRS Service Center Penalty appeals:
If a taxpayer gets a relief denial determination for the failure to file penalty and the failure to pay penalty, the first course of action is to appeal to the IRS. Taxpayers have 60-days to appeal the adverse determination with the IRS Service Center Appeals Coordinator. 3-4 months after the appeals request has been sent, taxpayers receive an informal phone to argue their case with an IRS appeals officer.
Collection Due Process (“CDP”) appeals:
If a taxpayer does not pay their penalty, they can request a more formal CDP hearing after the IRS sends a notice of intent to levy or files a tax lien. A timely CDP hearing request (uses IRS Form 12153) will result in a hearing with an appeals officer in about 8 weeks. CDP hearings are good venues to argue penalties because the IRS must provide any adverse determination reasons in writing. This formal process affords the taxpayer the right to contest these findings in court.
Audits/CP2000s and the accuracy penalty:
If the taxpayer is assessed an accuracy penalty (negligence, substantial understatement, and/or civil fraud), the avenue to first contest the penalty is with the IRS auditor or IRS unit that is proposing the penalty. The taxpayer must show how they made a reasonable attempt to file an accurate return. If the auditor disagrees with the taxpayer and still proposes the penalty, the taxpayer has the option to contest the penalty determination with the IRS office of appeals before the penalty is assessed. If the taxpayer does not contest this penalty, the IRS will assess the penalty and the taxpayer will have two alternatives to “undo” the accuracy penalty assessment: request reconsideration (audit or CP2000) or pay the penalty and file a claim for refund with the IRS. Many claims for refund are not successful in abating the accuracy penalty unless the taxpayer is willing to take the IRS to court to contest the penalty.
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