This is part one of a two-part article on the IRS’ first time tax penalty abatement. While this policy can provide a lot of relief for taxpayers, particularly those with six figures of tax debt, there are a lot of details involved. Instead of writing one long article, we decided to break this up into two. The first article will detail the IRS’ first time tax penalty policy, while the second article will outline the procedures involved. That way, after reading the eligibility requirements outlined in the first article, you can decide if you need to go through the trouble.
What does the IRS’ First Time Tax Penalty Abatement Policy cover?
For taxpayers meeting the eligibility criteria (see below), the IRS’ First Time Penalty Abatement Policy (FTA), covers the following types of penalties:
Failure to file (FTF) penalty
Failure to pay (FTP) penalty
Failure to deposit (FTD) penalty
Technically, the FTA is available only for one of the above penalties for a single return. If you owe penalties for more than one tax year, you might still be able to seek penalty relief, but the FTA will probably be applied to the first applicable tax period.
Subsequent tax periods could be granted under other relief provisions, the most likely of which would be reasonable cause.
What is reasonable cause?
The IRS’ website describes reasonable cause as:
Based on all the facts and circumstances in your situation. Any reason which establishes that you used all ordinary business care and prudence to meet your federal tax obligations, but were unable to do so, will be considered.”
The website also includes examples, such as fire or natural disaster, death or disability in the immediate family, or inability to obtain records, among other reasons.
In its guidance to employees, the IRS indicates:
Taxpayers generally bear the burden of proof to establish reasonable cause
Each reasonable cause request must be evaluated on its own merit
IRS must determine if the reason addresses the imposed penalty
Review previous periods for payment patterns and penalty history—in other words, someone who is eligible for FTA might get the benefit of the doubt over someone who has had to go through this before
Consider the length of time between events
Consider whether the taxpayer could have anticipated the event that caused noncompliance
It’s also worth noting that the type of penalty matters. For example, the IRS specifically states:
A lack of funds, in and of itself, is not reasonable cause for failure to file or pay on time. However, the reasons for the lack of funds may meet reasonable cause criteria for the failure-to-pay penalty.
In other words, not having money won’t stop you from having to pay the failure-to-file penalty. After all, you can file your tax returns for free. But if you happen to not have money due to circumstances beyond your control, the IRS would consider the circumstances that caused your money shortfall in its determination.
How do I know if I’m eligible for penalty relief?
The criteria for FTA and for reasonable cause are different, yet somewhat related. Let’s understand that it is difficult to anticipate what the IRS examiner will say in any particular case, so this is not blanket guidance.
For FTA, the eligibility criteria is pretty clear, from the website. The taxpayer must have:
Not had penalties for the 3 tax years prior to the tax year in which you received a penalty.
Filed all currently required returns or legitimate extensions.
You have paid, or arranged to pay, any tax due.
In other words, if it is April 20, and you did not file the most recent tax return, the IRS will not consider granting the FTA. You have to file the return (or have filed an extension). If your tax returns for other years are on file and properly filed, then you will have met this criteria.
If you owe taxes, you must either be brought current by paying the balance (including penalty), or have entered into a payment plan that the IRS has approved. In other words, before abating any penalties, the IRS wants to make sure you’re paid up, or have a legitimate payment plan in place that will pay off your debt.
For reasonable cause, it’s a little less clear. Since reasonable cause is based upon all of the relevant facts, each case will be a little different.
Does this policy cover interest?
Technically, no and yes.
No, with respect to back taxes owed. The IRS will only reduce interest owed is due to an unreasonable error or delay by an IRS officer or employee in performing a ministerial or managerial act. In IRS Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund, the IRS specifically defines these as follows:
Ministerial act: A procedural or mechanical act, not involving the exercise of judgment or discretion, during the processing of a case after all prerequisites (for example, conferences and review by supervisors) have taken place.
Managerial act: An administrative act during the processing of a case that involves the loss of records or the exercise of judgment or discretion concerning the management of personnel. For example, you’re in the middle of an audit. Your auditor is sent to an extended training course, and their supervisor does not reassign your case. Instead, your case waits until the agent returns. The interest that accrued during that unreasonable delay could be reduced in this circumstance.
In other words, the scenarios in which the IRS would remove interest on taxes owed are very few.
However, if you are successful in waiving penalties, any interest that has accrued on those penalties will automatically be reduced. That means not only is the penalty abated, but the interest goes away. This is automatically calculated for you by the IRS.
If you believe that you could qualify for the IRS’ first time tax penalty abatement, or penalty abatement under reasonable cause, stay tuned. In next week’s article, we’ll outline the procedures involved.
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