If you file an IRS return late or pay the debt owed late in Arizona, the IRS is going to hit you with a penalty. There are other IRS penalties of course… but these two are the most common, and the most frustrating for the average person with IRS income tax debt or employment tax debt.
This is especially true when these penalties can reach almost 50% of the underlying principal debt...plus interest at the current Federal Short Term Rate plus 3%(Failure to Pay Penalty is .5% per month up to 25% of the debt and Failure to File Penalty is 4.5% per month up to 22.5% of the debt)
It doesn't help to know that the government allows the IRS to issue penalties to try and prevent you from filing late and paying late in the first place…or again.
In its own words, it assesses penalties in order to encourage voluntary compliance by “supporting the standards of behavior required by the Internal Revenue Code”. (See IRM 22.214.171.124)
Whether this form of punishment is actually preventative…is debatable.
In our opinion, there are lots of reasons people file various returns late or are unable to pay the tax timely that don't change because of this penalty system.
The IRS understands this at least in theory and has decided that because its goal in assessing penalties is to encourage “compliance” and not to punish…it will allow certain people in certain situations to remove penalties that have been assessed.
Partial Removal of the IRS Penalty
The partial removal isn't “penalty abatement”. It's just the side-effect of reducing large penalties by filing the correct return with the IRS that is used to replace the IRS' incorrect substitute return.
Because the underlying debt that is created by the incorrect IRS substitute return is inflated, the correction of the underlying debt will reduce the penalties (and interest) for filing late and paying late…sometimes dramatically.
But…it isn't always a good idea to file the corrected return to reduce the penalty and interest, let alone the underlying debt. This is because the amount of the incorrect debt that exists as a result of the substitute return(s) may help you obtain a better overall result in the end than just reducing the debt on one return.
Before going through the process of challenging IRS Substitute Returns to remove IRS penalty…it's a good idea to have an experienced attorney look at your unique situation.
First Time Penalty Abatement
If you are typically good with getting returns filed and paid but had a bad year…you can use this type of abatement request to eliminate the penalties and the interest attached to the penalty.
In order to qualify…
You have to have a penalty that is based on filing late, paying late, or failing to deposit on time
You must have 3 years of clean history just prior to the year in question – no penalties or non-compliance at all
You must currently be in compliance, all returns filed or properly extended and/or an arrangement to pay any back taxes
If the three requirements above are true...you may want to try to reduce your debt by asking for this type of abatement. Visit the IRS' page on First Time Penalty Abatement for more:
Reasonable Cause Penalty Abatement
If you can convince the IRS that you had a really good reason for failing to file a return on time, or paying the tax debt from the return on time, you may be able to get rid of the penalty and interest on the penalty.
This process is more complex than the First Time Penalty Abatement process, and it requires a recitation of the facts and application of the law/rules to those facts at a minimum.
Because of it's increased complexity, it's smart to make sure it's worth doing beforehand.
The most common reasons not to request penalty abatement are:
If you are settling the overall debt in an Offer in Compromise
If you are in a Partial Payment Agreement that will pay less than the principal before the 10-year Statute of Limitations runs out
If you are in Non-Collectible Status that will pay less than principal before the 10-year Statute of Limitations runs out
If you are going to file a chapter 7 bankruptcy that will discharge the underlying tax debt to which the penalty is attached
If you are going to file a chapter 13 bankruptcy which will treat the penalty as a dischargeable debt and pay little of it or none at all during the case
The most common reasons you should think about trying to obtain Penalty Abatement for Reasonable Cause are:
If you are going to full pay the debt now or overtime
If you are going to file a chapter 7 bankruptcy, the underlying tax debt will survive, and you know you'll end up in a full pay payment arrangement
If you are going to file a chapter 13 bankruptcy and your plan payment is large enough to fully pay all or most of your dischargeable debt
There are lots of situations that might qualify you to obtain a Penalty Abatement based on a Reasonable Cause. They often overlap and you can use that to your advantage by pointing out all of them to IRS and how they joined forces to make it difficult even given “ordinary business care and prudence” to file or pay on time.
The IRS must believe that you made a reasonable effort to comply and circumstances prevented compliance nonetheless. If the IRS doesn't believe this, you won't win.
The IRS will most often consider the following as reasons to abate:
Death, Serious Illness, or unavoidable absence
Fire, Casualty, Natural Disaster, or other serious disturbance
Inability to obtain records
The IRS' own error
Financial Hardship – caused by true hardship not by decisions to spend money elsewhere
Most cases fall under one of the above, but this doesn't mean that there aren't other reasons for failing to file or pay that aren't worth arguing.
The obligation to pay IRS Penalties for Failure to File and Failure to Pay is dischargeable (can be wiped out) in bankruptcy in certain circumstances. In Chapter 7 Bankruptcy, the obligation is removed if the underlying tax debt is discharged and in Chapter 13 Bankruptcy these penalties are always treated as dischargeable no matter the dischargeability of the underlying debt.
Of course, bankruptcy shouldn't be used just to deal with IRS penalties…but if bankruptcy makes sense for other reasons, the analysis should consider how penalties will be affected.