Don’t Pay an IRS Penalty Without Looking Into Penalty Relief
The IRS doesn’t abate the vast majority of penalties. Why? Probably because people don’t know to ask for penalty relief – or it may seem like it’s not worth the time or effort. Here’s why it is.
The IRS uses penalties to encourage us to follow the rules and remain in compliance – and it uses them a lot. Each year, the IRS assesses tens of millions of penalties totaling billions of dollars. But the IRS also provides several options to get penalties removed, or abated, for people who qualify.
The most common IRS penalties are for not filing and not paying
There are almost 150 penalties in the Internal Revenue Code, but a few common penalties make up 74% of all penalties. The most common penalties are:
- Failure to pay penalty – 56% of all penalties, imposed if you don’t pay taxes on time
- Failure to file penalty – 14% of all penalties, imposed if you don’t file a return on time
- Failure to deposit penalty – 4% of all penalties, imposed if a business doesn’t pay employment taxes on time, or pays them incorrectly
A frequently encountered nuisance penalty is the late-filing penalty for partnerships and S corporations. The estimated tax penalty is another common penalty that taxpayers often dispute by providing an exception when filing the tax return.
Reasons the IRS will remove penalties
You can request penalty abatement for the most common penalties using four reasons:
1. Statutory exception: proving a specific authoritative exclusion to the penalty
Statutory exceptions are uncommon and are easily explained to the IRS, mostly at tax filing. Examples include disaster relief or combat zone relief.
2. IRS error: documenting that the error was the result of reliance on IRS advice
This penalty relief argument is typically unsuccessful and isn’t used much. You must have documented erroneous advice from the IRS that you reasonably relied on, and the IRS doesn’t routinely put tax advice in writing. The Internal Revenue Manual states that the IRS also allows penalty relief based on erroneous oral advice, but in practice, this is rarely seen.
3. Reasonable cause: providing a valid reason that you couldn’t comply based on your facts and circumstances
More commonly, people try to argue that they relied on the erroneous guidance of their tax software or tax professional. This type of argument falls under reasonable cause.
To successfully present a reasonable cause argument for late filing and payment, you must demonstrate that you exercised ordinary business care and prudence but couldn’t comply. You must also demonstrate that your noncompliance was not due to willful neglect.
Most people haven’t traditionally been successful with reasonable cause arguments before the IRS, especially in court. In reality, most penalty abatement determinations never get to court. Most are administrative determinations made by the IRS.
To be successful in reasonable cause determinations, you’ll need to make sure that the IRS considers all your facts and circumstances. If you get a penalty abatement denial letter that doesn’t seem to address all the facts and arguments presented in your penalty abatement request, should request an appeal of the determination.
4. Administrative waiver: taking advantage of a provision that facilitates effective tax administration
The IRS can provide administrative relief from a penalty under certain conditions. The most widely available administrative waiver is first-time penalty abatement (FTA).
FTA can be used to abate the failure to file, failure to pay, and failure to deposit penalties for one tax period when you have a clean compliance history for the past three years. You can use FTA for penalties on Form 1040, Form 1120, and payroll and pass-through entities.
FTA is the easiest of all penalty relief options. You can request it by calling the toll-free number on your IRS notice, or your tax professional can call the dedicated tax pro hotline or compliance unit (if applicable) to request FTA for any penalty amount.
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