Author: Matthew Schiller

What You Need to Know About Penalties & Interest

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.

Seizure and Sale Procedures Can Be Improved

For those with any experience dealing with the Internal Revenue Service, it may come as no surprise that the entity has some room for improvement.  According to a report recently released by the Treasury Inspector General for Tax Administration (TIGTA), the IRS needs to improve its compliance with procedures for conducting sales of property seized for unpaid taxes.

To break it down, TIGTA recommended that the IRS do the following to improve its seizure and sale procedures:

  • Mandate that Property Appraisal and Liquidation Specialists (PALS) consistently prepare a detailed sale plan once they accept custody of the seized property
  • Document the return of all personal items from seized vehicles; and
  • Require the PALS to follow Internal Revenue Manual (IRM) requirements for conducting a sale adjournment and recalculating the minimum bid, and ensure that any adjustments are supported by the facts of the situation and properly documented.

In response to the report, IRS officials did agree with most of the recommendations; however, disagreed with two recommendations to add IRM guidance for:

  • Indirect expenses of seizure sales that can be charged to the taxpayer and
  • Return of license plates from seized vehicles that are sold. TIGTA maintains that the appropriate IRM sections should be updated to provide clear guidance for IRS employees and managers to follow.

It is safe to say that the IRS, in performing its duties, does not always seem to place a high priority on protecting taxpayer rights or advising taxpayers of the different rights and remedies available to them under the law. There are provisions in place to help ensure that taxpayers are properly advised and taxpayer rights are honored. Yet, given the opposing interests of the parties and the overarching function of the IRS to collect revenue, these taxpayer protections sometimes seem to be treated as a mere formality in practice.  This illustrates why it is important and valuable to have an experienced representative working on your behalf to advocate for and protect your best interests at all times while resolving your outstanding tax liabilities.

We understand that the world of tax resolution can be confusing, click here if you’d like to connect with a tax expert today to discuss your situation in more detail.  If you are a tax professional, take a look at some of these useful resources, we hope you find them to be helpful.

How Do Tax Penalties Work?

 

Cowardly or not, the Internal Revenue Service and state Taxing Authorities assess penalties against taxpayers who do not meet their tax obligations. Penalties are very costly, and are meant to be that way to discourage citizens from failing to timely file and/or pay the balances due on tax returns. If at all possible, it is always wise to avoid incurring tax penalties by filing and paying all returns when due, making timely and sufficient quarterly estimated tax payments where required, and making proper federal tax deposits if you have a business with employees.

However, if you are reading this, it may be too late to avoid penalties. You may be more concerned with how and why these penalties were assessed against you, and what you can do about it.

The major types of penalties assessed by the Internal Revenue Service against taxpayers are as follows:

  • Failure to File: The Internal Revenue Code imposes a penalty for failure to file a tax return by the due date of 5% of the amount due on the return, for each month or part of a month that the return is late, up to a maximum of 25% of the amount due.
  • Failure to Pay: The penalty for failure to pay is .5% of the unpaid amount, for each month or part of a month that the tax remains unpaid, up to a maximum of 25%. Ten days after notice and demand for payment, this amount is increased to 1%, and if an individual taxpayer enters into an Installment Agreement, this amount is reduced to .25% during the Installment Agreement.
  • Federal Tax Deposit Penalty: The penalty for failure to make a timely federal tax deposit of employer withholding tax begins at 2% of the tax due, and increases up to 15% depending on how late the deposit is made. To ensure compliance, employers should make a deposit in full for each payroll period no later than three business days after each payroll date.
  • Estimated Tax Penalty: Self employed individuals must make quarterly estimated tax payments. The penalty for failure to make these quarterly payments is the federal short-term rate plus 3%.
  • Trust Fund Recovery Penalty: This penalty may be assessed against any person who is responsible for collecting or paying withheld income and employment taxes, or for paying collected excise taxes, and willfully fails to collect or pay them. A responsible person for this purpose can be an officer of a corporation, a partner, a sole proprietor, or an employee of any form of business. A trustee or agent with authority over the funds of the business can also be held responsible for the penalty.

Taxpayers have the right to request removal of penalties, known as penalty abatement. Generally, a taxpayer should have the tax fully paid or be on a formal resolution such as an Installment Agreement before it is wise to request penalty abatement. The standard used by the Internal Revenue Service in deciding whether to abate penalties is “reasonable cause.” If a taxpayer can show that the failure to file and/or pay was due to reasonable cause and not willful neglect, the Internal Revenue Service will abate the penalties and the interest on those penalties. Penalty relief is also available for one period based on a clean compliance history for prior periods. If you were assessed the Trust Fund Recovery Penalty or have a proposed assessment pending, you may be able to remove or prevent this assessment if you were not willful and responsible.

Most states have similar penalty and abatement structures to the Internal Revenue Service rules listed above. Penalties are difficult to stomach. However, if penalties have been assessed against you, you can minimize the damage by remaining current on all tax obligations moving forward, establishing a formal resolution to the back tax liabilities, and requesting abatement of all assessed penalties. At 20/20 Tax Resolution, we specialize in guiding and representing you through this often-complicated process, while working to keep you protected from enforced collection by the Taxing Authorities.

“A penalty is a cowardly way to score.” –Pele