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.
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.