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 a tax assessment. Penalties are imposed primarily for the purpose of promoting timely tax compliance.
This website cannot cover nor explain the entire range of tax penalties imposed under the Internal Revenue Code. Penalties are imposed on taxpayers, return preparers, and various non-taxpayer third parties. Here are the most common penalties:
- The failure to file a timely return under IRC §6651, 6653, 6654 and 6658 – 5% per month; up to a maximum penalty of 25%.
- The failure to timely pay tax penalty under IRC 6651 and 6654 – from ½ of 1% to 1% per month.
- IRC Section 6662 (the Accuracy Related Penalty) combines under its umbrella the former penalty provisions covering various degrees of taxpayer negligence (IRC Section 6653(a)) currently 20% of tax assessed. Appeals Officers commonly reduce this penalty to 10%.
- The fraud penalty (IRC Section 6663(a)) is 75% of the understated tax 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. Rarely utilized except in parallel criminal investigations.
- Internal Revenue Code Section 6695 allows penalties to be assessed against taxpreparers who prepare a return which understates liability due to a position which is not supported by documentation. There must be an understatement of a client’s tax for this penalty to be imposed. This office has never been assessed a penalty under IRC §6695.
- There are a variety of penalties imposed on the promoters of tax shelters under IRC Sections 6700(a) and (b).
- There are 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.
Most penalties are subject to a defense (and abatement of the penalty) of taxpayer behavior based upon reasonable cause. Proposed pre-assessment penalties may be abated (removed from their report) during the filing/audit process with either the Service Center, an Office Auditor, or a Revenue Agent. The IRS Appeals Office is also available during the pre-assessment process.
This practitioner has found that most clients simply open their mail one day and find that they have been assessed penalties. Whether a penalty is one which is proposed pre-assessment or assessed after tax assessment (post-assessment), the abatement for “reasonable cause” is available to taxpayers.
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 a favorable result, the taxpayer may appeal the initial IRS position to the Service Center Appeals Office in an attempt to overturn the earlier IRS determination that reasonable cause did not exist.
In this same vein, if a return was filed with no understated tax due and the return was later audited resulting in a proposed tax deficiency and penalty, this penalty would be contested with both the IRS Examination Division and the regular Appeals office.
There are at least three different divisions or functions within the Internal Revenue Service which ordinarily consider abatement of penalties for “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 and Collection Divisions. Within the Internal Revenue Manual are provisions which deal with reasonable cause for all three divisions. The appeals Division has the most latitude in abating penalties. Tax Court review of reasonable cause for pre-assessment penalty proposals by the IRS is also available.
Reasonable cause throughout the Internal Revenue Service utilizes the same standards. General comments can be made about the reasonable cause standard. Reasonable cause is based upon the facts and circumstances in each case. If a taxpayer exercised “ordinary business care and prudence” in addressing his tax obligations then reasonable cause may be a defense. A question for a taxpayer: how did the facts and circumstances of the taxpayer prevent the taxpayer from complying with the law/regulations?
Following is a list of reasons which can justify the finding of reasonable cause and the abatement of penalties. These fact situations are taken directly from case law, the Internal Revenue Manual and/or this practitioner’s actual experience:
- Death or serious illness of a taxpayer or member of his or her immediate family (almost an automatic penalty abatement during the period of illness).
- Illness of various types have been found to be reasonable cause, e.g., post-traumatic stress syndrome, a series of tragic and stressful life incidents or dementia.
- Unavoidable absence of the taxpayer.
- Destruction of records 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 relevant taxpayer’s records. This office has had this happen with a successful abatement of penalty result.
- Oversight on the part of the taxpayer’s employee in filing a required business return or paying the tax.
- Ignorance or misunderstanding of the law; usually on the more complex issues.
- Over-work, stress or health problems of a tax advisor or tax return preparer.
- If it is the taxpayer’s first incidence of non-compliant behavior the IRS will be more lenient than the taxpayer having had the same penalty assessed and abated in a prior year.
BURDEN OF PROOF/LITIGATION:
The taxpayer may contest a penalty assessment. Pre-assessment penalty proposals can be challenged in Tax Court. Alternatively, a taxpayer may pay all the penalties (post-assessment penalties), file a claim for refund and then pursue litigation in U.S. District Court or 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 on penalties, when favorable to the IRS, are for the most part immediately incorporated into the Internal Revenue Manual; no so for penalty decisions unfavorable to the IRS. Therefore, federal tax law research is indicated in large dollar penalty cases.
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 proposed tax assessment itself. Post-assessment penalties, on the other hand, generally do not have judicial review without difficult and expensive posturing in CDP hearings or for tax refund litigation in a U.S. District Court or the Court of Claims. The latter requires paying the penalty and suing the government for a refund.
It was thought that the 1998 Restructuring and Reform Act and the “friendlier IRS” literature would help in the penalty abatement area. In retrospect, however, it has been of little help. Code Section 6751(a) had added, however, and required that the IRS now include on each notice of penalty, the name of the penalty, the Code Section underlying the penalty and the computation that results in the penalties shown on the notice. Furthermore, penalties may not now be assessed unless the penalty assessment is personally approved, in writing, by the immediate supervisor of the individual IRS employee making that recommendation. 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.
Post assessment penalties are also subject to mediation procedures (Revenue Procedures 2002-44 and 2009-44, 2002-2 C.B. 10). Since mediation procedures are not public record little is known of a taxpayer success in penalty matters. Post assessment mediation is generally entered into when a taxpayer has appealed an initial unfavorable decision. Mediation is best used when the Appellate Officer is simply parroting the position of the earlier IRS representative.