More often than not, clients come through the door and want to know one thing: how much can be removed from their total tax bill. While penalty abatements are available, I always caution my clients to focus on the more important matter first, which is obtaining a formal resolution to the tax debt. Although penalty abatement can grant some penalty relief if reasonable cause can be established, it is not always wise to request it until the client has paid the tax in full or established a resolution such as in Installment Agreement. In fact, if neither has been done, the taxing authorities will rarely grant penalty abatement.
A lesser known fact when it comes to interest is that Congress, not the IRS, sets the rates (currently 3%). And under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. Interest is probably not going to be waived, but there is an exception if penalties are abated. In such cases, interest on the penalty will be adjusted so that the interest on the penalty amount is removed. However, the interest on the tax itself is a necessary evil and typically cannot be removed.
When it comes to penalties assessed by the IRS, the most common are failure to file, failure to pay, federal tax deposit penalty, estimated tax penalty, and the Trust Fund Recovery Penalty (TFRP). To call the TFRP a penalty is a bit of a misnomer, since it is actually the principal tax amount that a business withheld from employees’ paychecks, and then failed to pay over to the IRS. It is a portion of the related business liability, so if a business is paying its liability through an Installment Agreement, those payments are applied to the TFRP as well. But, remember that establishing a resolution for the business collection case does not automatically resolve the TFRP case against the individual(s). The individual cases must be addressed and resolved separately.
The IRS will abate or remove penalties if you establish reasonable cause. This is generally granted when the taxpayer proves that he or she exercised ordinary business care and prudence in determining his or her tax obligations but nevertheless failed to comply with those obligations. A showing of reasonable cause typically requires evidence that the taxpayer acted in good faith, and that the failure to comply was not due to willful neglect. Absent first-hand knowledge of what led to the tax accrual, a good starting point for a penalty abatement, is asking the taxpayer to describe in his or her own words what happened. This should provide enough insight for the tax professional to further investigate and eventually expound upon key relevant points. It’s always best to focus on the facts and timelines that overlap with the time of the accrual, thereby providing the best chance of success.
Some of the specific reasons listed in the IRS penalty handbook that may establish reasonable cause are as follows:
- Death, serious illness, or unavoidable absence of the taxpayer or in the taxpayer’s immediate family
- Fire, casualty, disaster or other disturbance
- Unable to obtain records
- Erroneous advice or reliance
*The above list is not exhaustive, and other reasons may qualify for penalty relief. It is important to provide as much detail as possible, and any written documentation available, to have the best chance to obtain relief.
If penalties have been assessed against you or your business, you can minimize the damage by remaining current on all tax obligations moving forward, establishing a formal resolution to the back tax liabilities, and formally requesting abatement of all assessed penalties. In the meantime, if you are unsure about your liability, we encourage you to utilize our online calculator tool (click here) that will allow you to calculate the penalty and interest on your tax liability, today.