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Abatement of Penalties

The Internal Revenue Service imposes a variety of penalties for failure to file returns and for failure to pay taxes. These penalties are most often computed as a percentage of tax paid or to be paid. A penalty is not deductible against income because it is not a tax - penalties are imposed primarily for the purpose of regulating taxpayers and promoting compliance.

This website cannot cover nor explain the wide range of tax penalties imposed under the Internal Revenue Code. Penalties are imposed on taxpayers, return preparers, and various non-taxpayer third parties for a variety of reasons. The reader wishing to thoroughly investigate penalties is directed to the Internal Revenue Manual - "Consolidated Penalty Handbook" at IRM (20) 100 which provides information on the assessment as well as the abatement of penalties. Here are a few of the more common penalties:

1. The failure to file a timely return under IRC Sections 6651, 6653, 6654, and 6658.
2. The failure to pay on time penalty under IRC 6651 and 6654.
3. IRC Section 6662 (the Accuracy Related Penalty) combines under its umbrella the former penalty provisions covering negligence (IRC Section 6653(a)), valuation penalties (IRC Section 6659), and substantial understatements of income tax (IRC Section 6661). The negligence penalty is a 5% of the understated tax. The accuracy related penalty is 20% of the understatement.
4. The fraud penalty (IRC Section 6663(a)) is 75% of the underpayment amount providing the IRS can show an intent to evade taxation or defeat the tax. The IRS has the burden of proof on the imposition of this penalty.
5. Internal Revenue Code Section 6695 allows penalties to be assessed against tax preparers who prepare a return which understates liability due to a position which is not supported by documentation. There must be an understatement of tax for this penalty to be imposed.
6. There are a variety of penalties imposed on the promoters of tax shelters under IRC Sections 6700(a) and (b). There are a variety of penalties imposed for the failure to file information type returns (IRC Section 6721(a)(2)). The information return penalty is $50.00 for each return. Typically this penalty is imposed for failure to file the various Forms 1099, Form 1098, and Forms W-2 and W-2G.

IRS RESTRUCTURING AND REFORM ACT AND INNOCENT SPOUSE RELIEF:

There was not much help in the penalty area under the newly legislated IRS Restructuring Act. The penalty rate for failure to pay taxes is now limited to one-half the usual rate (0.25% rather than 0.5%) for any month in which an installment payment agreement with the IRS is in effect. This is new Code Section 6651(h). This reduced penalty is only in the limited situation where a taxpayer has a valid installment agreement which has not been defaulted.

It is worth noting, however, that the IRS Restructuring and Reform Act drastically impacted the area of tax law known as "innocent spouse" relief. The IRS must now notify taxpayers (innocent spouses) of their right to elect innocent spouse relief and/or separate liability treatment under new Code Section 6015.

If a client is interested in exploring whether they qualify for innocent spouse relief, please e-mail us and we will furnish you a copy of Notice N(35)00-170, dated January 11, 2000. Additionally, in October of 1999, the Internal Revenue Service issued new Form 8857 (Request for Innocent Spouse Relief) which initiates a process of requesting innocent spouse relief from the Internal Revenue Service. The Tax Reform Act also gives innocent spouses the right to petition the Tax Court to review a client's request for innocent spouse relief if the IRS denies that request. This is an extremely important development with regard to those spouses who have little or no knowledge of the business activities of their spouses when such activity resulted in assessments on jointly filed returns.

REASONABLE CAUSE:

Most penalties are subject to the defense of reasonable cause. Pre-assessment penalties may be abated during the filing/audit process with either the Service Center, an Office Auditor, or a Revenue Agent. Appeals are available during the pre-assessment process. This practitioner has found, however, that most clients simply open their mail one day and find that they have already been assessed penalties. These are called "post assessment" penalties and this discussion will address this type of penalty. Whether a penalty is one which is proposed pre-assessment or a post-assessment, the defense is the same: "reasonable cause".

Penalties are subject to abatement at different IRS managerial levels and by different divisions within the IRS. For example, if a return is filed late, the taxpayer may request an abatement of penalty at the Service Center where the return was filed. Failing that, the taxpayer may take the matter to the Service Center Appeals Office in an attempt to overturn the determination that reasonable cause did not exist.

In this same vein, if a return was filed with no tax due and the return was later audited resulting in a proposed tax deficiency and penalty, this would be contested with the IRS Examination Division. There are therefore at least 3 different divisions or functions within the Internal Revenue Service which ordinarily consider pleas of "reasonable cause", that is, the Examination Division, the Collection Division, and the Appeals Division. The Appeals Division will hear appeals on penalties assessed through the Examination Division and Collection Division. Within the Internal Revenue Manual are provisions which deal with reasonable cause in all three functions. These provisions are nearly identical. A good starting point is to examine the Internal Revenue Manual provisions at IRM 8:1113.

Following are reasons which may justify the finding of reasonable cause and the abatement of penalties. These fact situations are taken directly from the Internal Revenue Manual and/or this practitioner's actual experiences:

• Death or serious illness of a taxpayer or member of his or her immediate family (almost an automatic penalty abatement).

• Unavoidable absence of the taxpayer.

• Destruction by fire, casualty or civil disturbance.

• The taxpayer is unable to obtain necessary records for reasons beyond his or her control.

• The taxpayer did not file his return or pay his tax after receiving erroneous information from an employee of the Internal Revenue Service.

• The taxpayer received incorrect information from a competent tax advisor.

• The Internal Revenue Service has the taxpayer's records (I have actually had this happen).

• Oversight by the taxpayer's employee in filing a required business returns on paying tax.

• Ignorance or misunderstanding of the law by a non-expert.

• Over-work, stress or health problems of a tax advisor or tax return preparer.

BURDEN OF PROOF/LITIGATION:

The taxpayer may contest a penalty assessment if the underlying tax assessment is petitioned to the United States Tax Court. Pre-assessment petitioning of the Tax Court allows penalties to be challenged. Alternatively, a taxpayer may pay all the penalties (post-assessment), file a claim for refund and then pursue litigation in U S District Court of the Court of Claims in a refund suit.

The information in this website cannot be considered an in-depth examination of the procedures and criterias on penalty abatement issues. The reader is encouraged to review the Internal Revenue Manual which is the main source of information in this area. Case law, when unfavorable to the IRS, is for the most part immediately incorporated into the Internal Revenue Manual. Therefore, case law is generally of minimal help.

Remember that pre-assessment penalty proposals can be appealed and in fact can be litigated in U S Tax Court along with the issue of the correctness of the tax assessment itself. Post-assessment penalties, on the other hand, generally do not have judicial review without posturing for tax refund litigation jurisdiction in a in U S District Court or the Court of Claims. This requires paying the penalty and suing the government.

The IRS Restructuring and Reform Act was of little help in the penalty abatement area. Code Section 6751(a) was added, however, and requires that the IRS now include on each notice of penalty, the name of the penalty, the Code Section that authorizes the penalty and the computation that results in the penalties shown on the notice. Furthermore, penalties may not be assessed unless the assessment is personally approved, in writing, by the immediate supervisor of the individual IRS employee making that determination. Presumably, the latter requirement was added so that lower level IRS employees could not use a proposed penalty assessment as a bargaining chip in dealing with taxpayers; furthermore, it removes the appearance of any type of IRS collection based performance goals.