If you are not a tax advisor yourself, the last thing you want to do is to try to give tax advice to a client who might be facing tax penalties. The only thing you want to tell that client is some compliance department-approved version of the statement, “You should ask your tax advsor about that.”

You might, however, find yourself sitting next to a tax advisor at a business luncheon. Or, you could find yourself on a team of advisors helping a client with a situation that involves concerns about possible tax penalties. How do you hold your own in those situations?

Here’s a look, by a team of tax compliance specialists, at a topic that can prepare you for conversations with tax professionals: five reasons someone who seems likely to owe tax penalties might be able to get the penalty bills reduced, or even eliminated.

The assessment of a penalty computed as a percentage of the delinquent tax can be devastating.

The failure to pay penalty is 0.5% for each month, or part of a month, up to a maximum of 25% of the amount of unpaid tax. The failure to file penalty is 5% of the tax owed for each month or part of a month up to a maximum of 25% of the unpaid tax. Although it is possible for both penalties to be imposed concurrently, there is a maximum of 25% of the unpaid tax.

In some instances, however, a taxpayer might be able to get the Internal Revenue Service (IRS) to abate the penalties.

(Related: When Undoing the Deal Is the Best Tax Deal)

For example, with the filing of the appropriate return or form, a taxpayer subject to a failure-to-file, failure-to-pay, or failure-to-deposit penalty may request that the IRS not assess the applicable penalty.

With respect to an assessed penalty, the taxpayer can submit a written request for penalty abatement to the IRS.

Finally, if the taxpayer has paid the penalty, the taxpayer can submit Form 843, Claim for Refund and Request for Abatement, provided it is filed within three years of the return due date of filing date, or within two years of the date that the penalty was paid. The denial of a penalty in whole or in part can be appealed for reconsideration.

Penalty relief can be granted based on reasonable cause, statutory exceptions, administrative relief and the correction of an IRS error. In some cases, a taxpayer may also qualify for a limited abatement based on reliance on faulty advice from a tax advisor.

Here are more details about those grounds for seeking penalty abatements.

1. Reasonable Cause

In a penalty abatement letter to the IRS, a taxpayer seeking penalty abatement for reasonable cause must explain why the failure to timely file or pay the tax liability is excusable under the particular circumstances. Some examples of reasonable cause are:

  • A serious medical condition.

  • Being out of the country.

  • Incarceration.

  • Destruction or theft of documents.

  • Death of a close family member

The taxpayer should demonstrate why it was impossible to comply with the tax filing or liability payment requirements in a timely manner.

Depending on the underlying reason for untimely compliance, the penalty abatement letter should include pictures of a flood, insurance claims, a death certificate, or hospital records as proof. Obviously, the payment of the tax in full (including interest) is indicative of the taxpayer’s good faith.

When considering a request to abate a penalty for reasonable cause, the IRS considers whether the taxpayer exercised ordinary business care and prudence, but due to circumstances or events beyond the taxpayer’s control was unable to comply in a timely manner.

Also taken into account is when the excusing event occurred and how long after the event did the taxpayer comply. For example, if a family member died several months prior to the due date of the return and the return was filed a year after the due date, penalty relief may not be appropriate.

Yet another consideration is whether the taxpayer could have anticipated the event that caused the noncompliance and whether the taxpayer could have reasonably been in compliance.

IRS (Photo: Allison Bell/TA)

(Photo: Allison Bell/TA)

Finally, even if the taxpayer has a plausible reasonable cause excuse, there is no guarantee of abatement. The IRS has a Penalty Appeal Online Self-Help Tool which may be of interest.


2. Statutory Exceptions

Due to a natural disaster or a catastrophic event (a major hurricane, a devastating fire, etc.), Congress may provide specific statutory exceptions of penalty relief to affected taxpayers.


3. Administrative Relief

The First Time Abatement (FTA) is an example of an administrative waiver that provides penalty relief for qualified taxpayers. The applicable penalties are failure to file, failure to pay, and/or failure to deposit taxes. To qualify for this relief, all the following must be true:

  • The taxpayer was not previously required to file a return or was not subject to penalties for the three tax years before the tax year of the penalty.

  • All returns or extensions have been filed.

  • Tax has either been paid or an arrangement to pay has been made.


4. Correction of IRS Error

The IRS is required to abate any portion of any penalty due to erroneous written advice by an officer or employee of the IRS acting in an official capacity.

If appropriate, the IRS will consider abatement with respect to taxpayer reliance on erroneous oral advice.

In making this determination, the IRS will consider whether the taxpayer relying on this advice exercised ordinary business care and prudence, the relationship between the taxpayer’s situation, advice and the penalty; the taxpayer’s prior tax history and experience with tax requirements, and whether correct information was provided in written material given to the taxpayer.


5. Limited Abatement for Relying on the Advice of a Tax Advisor

The only penalty that may be abated due to the erroneous advice of a tax advisor is the accuracy-related penalty based on reasonable cause.

In a situation involving a failure to file, pay, or deposit penalties, the taxpayer is deemed responsible.

However, it is possible (determined on a case by case basis) that a taxpayer who relied on the erroneous advice of a tax advisor on a substantive tax issue may be eligible for relief from other penalties.

In the Internal Revenue Manual, there is an example of a taxpayer who relied on an advisor’s opinion that employees were “contract labor.” Although the IRS disagreed, it abated the penalty because the employer researched all relevant IRS publications and provided clear and complete information of the duties of the workers to the tax advisor, who provided an erroneous opinion. 

—-Read For Late IRA Rollovers, IRS Offers a Get-Out-of-Jail-Free Card on ThinkAdvisor.


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