Many clients contact our office when they receive a notice informing them that the IRS has assessed additional tax, penalties, and interest to their tax return from one, two, or even three years ago. Sometimes there is a dispute as to whether the additional tax is correct, but other times the clients discover that the IRS is right, and they do owe the additional tax.
The additional tax liability is bad enough, but the added penalties and interest are frequently additional sources of aggravation, and they ask if there are any ways to avoid paying them.
Unfortunately, the tax code requires the IRS to charge interest on unpaid balances. Interest can only be waived if the IRS made an administrative error, or if the IRS caused an unnecessary delay in assessing the tax obligation.
On the other hand, the IRS can waive penalties if there is “reasonable cause”. It is important to understand that the term “reasonable cause” has a precise and detailed definition as it relates to penalty forgiveness.
Why Does the IRS Impose Penalties?
To foster public confidence that the tax system is fair, the IRS imposes penalties when taxpayers fail to meet their obligations. Penalties serve to encourage voluntary compliance by defining standards of compliant behavior, consequences for noncompliance, and imposing monetary sanctions against taxpayers who do not meet the standards.
Penalties are designed to 1) be severe enough to deter noncompliance; 2) encourage noncompliant taxpayers to comply; 3) be objectively proportioned to the offense; and 4) be used as an opportunity to educate taxpayers and encourage their future compliance.
What Does the IRS Consider to be Reasonable Cause?
Taxpayers have reasonable cause for penalty forgiveness when their conduct justifies the non-assertion or forgiveness of a penalty. Each case is judged individually based on the facts and circumstances for that case.
The IRS provides several examples of reasonable cause in their documentation, such as:
- Your unavoidable absence
- Death or serious illness of yourself or an immediate family member
- The inability to obtain necessary records to comply with your tax obligation
- Destruction or disruption caused by fire, casualty, natural disaster, or other disturbance
- Reliance on erroneous advice of a tax advisor can be used to demonstrate reasonable cause to forgive accuracy-related penalties. In these situations, the following three aspects must be met in order to qualify for penalty abatement:
- The advisor was a competent professional with sufficient expertise to justify reliance;
- You provided all necessary and accurate information to the advisor; and
- You actually relied in good faith on the advisor’s judgment
Ignorance is not reasonable cause for failing to comply with the tax law, but in some cases, you can establish reasonable cause for penalty relief if you can show ignorance of the law in conjunction with other facts and circumstances. The IRS may consider the following factors in conjunction with ignorance of the law to establish reasonable cause:
- Your education;
- Whether you have previously been subject to the tax in question;
- Whether you have been penalized before;
- Whether there were recent changes in the tax forms or law which you could not reasonably be expected to know; and
- The level of complexity of the tax or compliance issue.
Some excuses are not accepted as reasonable cause. You should not base your request solely on any of the following reasons:
- You made a mistake
- You relied on another party to comply on your behalf. While it might seem reasonable to rely on a tax professional, the U.S. Supreme Court, in the infamous Boyle decision, held that the executor of a decedent’s estate lacked reasonable cause for not filing the estate tax return on time, even though he had hired and relied on an experienced probate lawyer to meet his legal and tax obligations.
A lack of funds, in and of itself, is not reasonable cause for failure to file or pay on time. But the reasons for the lack of funds may meet reasonable cause criteria for the failure-to-pay penalty.
To be successful in asserting a reasonable cause exception for penalty assignment, the taxpayer should provide all relevant details, with dates and explanations that clearly correspond to the events on which the penalties are based.
How Does the IRS Evaluate Reasonable Cause Penalty Forgiveness Requests?
The IRS is considers the following criteria in evaluating requests for reasonable case penalty forgiveness:
- What happened and when did it happen?
- During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax, and/or otherwise complying with the law?
- How did the facts and circumstances result in the taxpayer not complying?
- How did the taxpayer handle the remainder of his or her affairs during this time?
- Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
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. In other words, once the unusual circumstances have ended, the taxpayer MUST take action to address the tax within a reasonable amount of time – the tax obligation cannot be ignored or be left unaddressed until the IRS comes calling.
The IRS expects taxpayers to take ordinary business care and prudence in addressing their tax obligations. This includes making provisions for tax obligations to be met when reasonably foreseeable events occur. Taxpayer may establish reasonable cause by providing facts and circumstances showing that they exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless were unable to comply with the law.
The IRS also reviews the taxpayer’s three preceding tax years (at a minimum), looking especially at payment patterns and overall compliance history. If they discover that the same penalty has been previously assessed or forgiven, they will likely determine that the taxpayer is not exercising ordinary business care. On the other hand, a determination that this is the taxpayer’s first incident of noncompliant behavior does not by itself establish reasonable cause, but it is a factor to be weighed with other factors in the final determination.
Reasonable cause is generally established when the taxpayer exercises ordinary business care and prudence, but, due to circumstances beyond the taxpayer’s control, the taxpayer was unable to timely meet the tax obligation. The taxpayer’s obligation to meet the tax law requirements is ongoing. Ordinary business care and prudence requires that the taxpayer continue to attempt to meet the requirements, even though late.
Thorough documentation of all relevant details and particulars is required for a successful reasonable cause penalty forgiveness request. If the facts and circumstances in your case are is complex, we strongly recommend working with an experienced tax professional. The tax professional can help you frame your reasonable cause penalty forgiveness argument and create a formal written presentation of your relevant arguments with supporting precedents and evidence.
Willi Law Office, LLC has been providing personalized legal services to individuals and businesses in Westerville and Central Ohio for over 20 years.