There are more than 100 penalty provisions in the Internal Revenue Code, a number which has grown more than 10 times in the last half century. In 1989, the IRS issued a report – more than a year in the making – establishing its philosophy concerning penalties. In turn, it developed a source of administration over 100 pages long to address and administer civil tax penalties.
Approximately 15 years ago the IRS developed its first-time abatement (FTA) penalty waiver. The FTA can only be used to abate the following types of penalties: failure to file, failure to pay, and failure to deposit.
The FTA is an administrative waiver that allows a first-time taxpayer that is not compliant with certain tax rules to request an abatement of those penalties. This is a one time “get out of jail free card.” It is only good for one tax period, which could be one year or perhaps one quarter. In order to qualify for the FTA, the taxpayer must have a history (prior three years) of timely filing and payments, albeit there are some exceptions to this requirement.
If a taxpayer’s penalty does not qualify for the first-time abatement relief, then the taxpayer should consider a request for “reasonable cause.” Per the IRS, reasonable cause is based on all of the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise apply. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining tax obligations but was nevertheless unable to comply with those obligations.
Some Internal Revenue Code penalty provisions require that the taxpayer acted in good faith or that the failure to comply with the laws was not due to willful neglect. The IRS looks at each case individually and considers various factors such as what happened, when it happened, the facts and circumstances that prevented compliance, how the taxpayer handled other tax-related affairs during this time, and what attempt the taxpayer made to comply. The IRS states that reasonable cause does not exist if, after the facts and circumstances that explain the taxpayer’s noncompliant behavior cease to exist, the taxpayer fails to comply with the tax obligation within a reasonable period of time.
The request for reasonable cause abatement of penalties must set forth all of the facts that the taxpayer acted reasonably, in good faith, and without willful neglect. It must demonstrate that the taxpayer exercised ordinary care and prudence, and show that the failure was inadvertent. It must also demonstrate the taxpayer’s otherwise history of excellent compliance. The request will also likely need to be signed under penalties of perjury.
If the penalties are not abated on the first attempt, there are procedures to either take the taxpayer’s argument to appeals or to pay the penalty and ask for a refund via Form 843, Claim of Refund and Request for Abatement.
One area where there seems to be a significant lack of compliance over the past several years is in the area of reporting international information returns. The lack of a timely filing of forms related to the ownership of foreign entities, foreign assets, foreign corporations owning U.S. companies, and certain foreign trusts carries minimum penalties of $10,000 or a percentage of the value of the assets owned. Given the sensitivity and amount of these types of penalties, the IRS is likely to assess penalties for noncompliance. All is not lost, however, as there may be opportunities to abate these penalties.
If the federal income tax return that should have contained the requisite form(s) was filed timely, then the taxpayer can amend that return and include the required international information forms. An amended return should be sufficient so long as the taxpayer has reasonable cause for not filing the information return(s) in a timely manner, is not under civil examination or criminal investigation by the IRS, and has not been contacted by the IRS about the delinquent return(s). The amended return must be accompanied by a statement under penalties and perjury that the taxpayer is not engaged in tax evasion.
If the original return that should have included the foreign information filings was not timely filed, then the taxpayer has two options to request abatement of penalties that are or will be assessed. The taxpayer may request first-time abatement of the penalty if they qualify per the above discussion. The second option is providing a reasonable cause defense. In other words, demonstrating that the taxpayer exercised ordinary business care and acted in a reasonable and prudent manner.
I am reminded of a catch phrase from a state lottery ad that says, “You can’t win if you don’t play.” The IRS may assess penalties, but those penalties may be abated if proper procedures are followed. It may take more than one attempt, so time and patience are required. Before you decide to pay an IRS penalty, please consider the various potential alternatives to have that penalty abated.
Lawrence G. Silver can be reached at Email or 215.441.4600.
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