The IRS's position is that applying a penalty when a taxpayer breaks an IRS rule, results in better compliance with IRS rules overall. Congress has given the IRS authority to do this and to determine the specifics of assessment and abatement. The IRS assesses millions of penalties per year to millions of taxpayers as a result.
The most common penalties the IRS assesses are penalties for filing a return late, penalties for paying an estimated tax late or paying the tax itself late. They assess a large amount of accuracy-related penalties as well.
The amounts charged for penalties vary depending on which penalty is being assessed. For the four primary penalties mentioned above, the following are the penalty rates:
Accuracy Related Penalty - 20% of the understatement of the tax. If fraudulent understatement, 75%
Estimated Tax Penalty - An amount equivalent to the Interest lost to the IRS
Failure to Pay Penalty - 0.5% per month to a maximum of 25%. Increases to 1% per month if enforced collection action is taken
Failure to File Penalty - 5.0% per month up to 25%. If fraud is involved, 15% per month up to 75% total
Failure to file and failure to pay penalties can be removed by phone request if the taxpayer qualifies for “First Time Penalty Abatement”.
Qualification is met when the history shows that the taxpayer didn't have a penalty in the 3 years prior to the year in question, has filed all required returns and is current on any payment plan that is in effect.
It's usually wise to wait to request first-time penalty abatement for a few reasons:
The abatement is granted one time and for the penalties that exist on that date. As failure to pay and failure to file penalties grow until they reach their “maximum”, asking for first-time penalty abatement too soon will remove only the penalty that has been assessed as of the date of the request. The remainder of the penalties will be assessed post abatement.
Sometimes it makes sense for the taxpayer to have a larger amount of IRS debt. If the taxpayer is attempting to qualify for an offer in compromise, a bankruptcy, or is going to be in a small partial pay installment agreement or non-collectible status arrangement, reducing the debt may be a waste of time or even negatively affect the outcome.
The IRS will agree to abate penalties if the taxpayer can show that a reasonable attempt to comply was made and compliance wasn't possible because of unforeseen circumstances that were outside of the taxpayer's control.
Explanations that can work include lost records, true ignorance of the law, and serious illness. Almost any explanation has a chance of working if the standard above can be proven.
The penalty abatement request is also helped if the story makes sense when viewed from a “big picture” standpoint. If the taxpayer's explanation for the failure to file on time is a serious illness, but the taxpayer had late-filed returns before or after the date of the serious illness, the IRS will typically disagree with the abatement request.
An overall good compliance history is also important as is the ability to show the IRS that the circumstance that caused the late file/late pay also affected other areas of the taxpayer's life (like the inability to meet living expenses).
Even well-presented reasonable cause-based penalty abatement requests are denied by the IRS. It's often necessary for the taxpayer to file an appeal of the penalty abatement denial.
During an IRS audit or during the IRS cp2000 process, the taxpayer can request that a reasonable attempt be made to properly report the tax liability in order to avoid the penalty assessment on top of the tax assessment.
Taxpayers argue true ignorance of the law, reliance on professional help, illness, and other factors in making the non-assertion request.
If the accuracy-related debt and related penalty have already been placed in the IRS' books, the taxpayer can request a “reconsideration” of the penalty assessment.
The IRS is required to send a “final notice” coupled with instructions related to filing a “collection due process appeal” before it can levy on tax debt for a particular year.
If the penalty abatement hasn't been previously requested, it's possible to raise the penalty abatement issue at the Collection Due Process Hearing.
IRS records will tell the taxpayer whether the requirements for first-time penalty abatement are met and how much of the IRS penalty has been assessed. These records will also show when all penalties have been assessed so that the taxpayer knows which penalties can be addressed using reasonable cause penalty abatement.
The evaluation should be done with an eye toward the “big picture”. If the taxpayer is going to discharge underlying IRS debt in a bankruptcy, settle it in an offer in compromise, challenge it, or obtain a partial pay agreement or non-collectible status agreement, penalty abatement may not be necessary. Abating the penalty may actually harm the taxpayer's case.
The taxpayer should create a timeline or map of what happened and when it happened that corresponds to each penalty assessment. Understanding when penalties were assessed and what was happening in the taxpayer's life to cause the late filing and late payment, will be essential in creating a good request for penalty abatement.
The taxpayer should gather third-party evidence and other evidence that will help show unforeseen circumstances.
Required, missing tax returns will need to be created and filed. A payment plan will likely need to be arranged. Overall the taxpayer will need to show that all is “in order” to be considered compliant and then to have a shot at penalty abatement.
The taxpayer must make the decision about whether to use a first-time penalty abatement request, a reasonable cause request or whether a penalty abatement request should be used at all.
There are deadlines to file for penalty abatement requests. The reasonable cause penalty abatement request must be filed within 3 years from the date the return was filed or within 2 years of its payment. If First-time penalty abatement is used, the request should be made within two years of a first payment arrangement agreement.
Most taxpayers request IRS penalty relief by using IRS form 843. Some simply write a letter. There isn't a requirement to use IRS form 843, but it's helpful as it provides an outline of requirements.
The request by either method should state the years and forms and the specific penalties that are the subjects of the abatement request.
A specific statement should be made at the outset that the facts the taxpayer is providing will show that there were unforeseen circumstances related to each specific penalty for which penalty abatement is being requested, that these circumstances were outside the control of the taxpayer and that they were the cause the non-compliance.
These facts should be provided with supporting evidence attached.
The taxpayer has to sign under penalty of perjury that the facts presented are accurate.
If requesting first-time penalty abatement, the request can be done by calling the IRS collection unit directly. If the first-time penalty abatement is granted, the IRS should tell the taxpayer over the phone and then provide a follow-up confirmation letter within a few weeks.
Even penalty abatement requests with logical arguments and substantial evidence are rejected routinely by the IRS. The denial can be appealed by filing an appeal with the IRS Service Center Penalty Appeals Coordinator within 60 days.
A denial at the appeal level can be argued again in court in certain circumstances.
The IRS can provide documents called “account transcripts” that show the specific history of each year owed. The taxpayer can ask the IRS to provide those transcripts to ensure the penalties the IRS agreed to abate were actually removed. It is often a good idea to wait a few months to request those documents for this purpose.
While dealing with the penalty abatement process, the taxpayer must pay attention to the underlying debt collection case to ensure no collection activity will take place. The taxpayer should monitor the account history, ask for a hold on collection while penalty abatement is being reviewed, or even set up a payment plan to formally stop collection activity if necessary. If no monitoring/managing of collections is done during the penalty abatement process, the taxpayer may find wages garnished and/or bank accounts levied.