Each year the IRS assesses over 40 million penalties against taxpayers. Of the total number of assessed penalties over 5 million of them are eventually abated by the Service. Generally the IRS only abates penalties when the taxpayer contests the penalty. Since most taxpayers don’t contest IRS penalties the number of abated penalties is artificially low. Most taxpayers and their representatives are unaware that if the taxpayer establishes a reasonable cause for failure to comply with tax laws, the applicable penalties may be abated. Therefore sophisticated taxpayers and their representatives have a much greater chance of reducing tax penalties than the approximately 12% abatement rate for all penalties. It is in a taxpayer’s best interest to contest IRS penalties if she has a reasonable cause for her noncompliance.
[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]
Chapter 20 of the Internal Revenue Manual provides guidance to IRS employees on the standards for reasonable cause. Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations. Reasonable causes is defined by the Internal Revenue Manual in the following manner:
“Any reason that establishes a taxpayer exercised ordinary business care and prudence but nevertheless failed to comply with the tax law may be considered for penalty relief.” The most important part of that definition is the term ordinary business care and prudence. Ordinary business care and prudence is defined as follows in the Internal Revenue Manual:
“Ordinary business care and prudence includes making provisions for business obligations to be met when reasonably foreseeable events occur. A taxpayer may establish reasonable cause by providing facts and circumstances showing that they exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless were unable to comply with the law.”
The Internal Revenue Manual sets forth a series of circumstances that would allow a taxpayer to establish reasonable cause and secure abatement of tax penalties. The following is a partial list of excuses that might establish reasonable cause:
• Death, Serious Illness, or Unavoidable Absence
• Fire, Casualty, Natural Disaster, or Other Disturbance
• Unable to Obtain Records
• Mistake was Made
• Erroneous Advice or Reliance
• Ignorance of the Law
• Statutory Exceptions or Waivers
• Undue Hardship
• Written Advice From IRS
• Oral Advice From IRS
• Advice from A Tax Advisor
• Official Disaster Area
• Service Error
Practitioners may be surprised to learn that the IRS uses a computer program to review abatement request. The program is known as Reasonable Cause Assistant (RCA). Therefore it is in the best interest of the taxpayer for his representative to submit a letter specifically requesting abatement of penalties which quotes the Internal Revenue Manual with respect to reasonable cause and cites to specific reasons set forth in the manual. The greater the specificity of the reasonable cause letter, the greater the chance that the IRS may abate that penalty.
The RCA provides that taxpayers who have not been penalized by the IRS in the past may have their penalties reduced. The IRS Manual sets forth a First Time Abatement Rule. That rule generally allows IRS employees to abate penalties asserted against formerly compliant taxpayers. The manual provides as follows:
“RCA provides an option for penalty relief for the Failure To File, Fade To Pay, and/or Failure To Deposit Penalties if the taxpayer has not previously been required to file a return or if no prior penalties (except the Estimated Tax Penalty, on the same taxpayer…in the prior 3 years.”
Robert E. McKenzie of the law firm of Arnstein & Lehr LLP of Chicago, Illinois, concentrates his practice in representation before the Internal Revenue Service and state tax agencies. He previously served as a member of the IRS Advisory Council (IRSAC) which is a group appointed by the IRS Commissioner from 2009 to 2011.