IRS tax penalties – how to abate them

— This is a technical and educational piece —

The IRS consistently assesses different type of penalties. In 2017 the IRS assessed nearly 39 million civil penalties totaling roughly $26.5 billion, the IRS abated 4 million civil penalties totaling $12.6 billion. More than 80% of civil penalties were assessed against individuals, estates, and trusts for income taxes.

Taxpayers asking why me, why more penalties, and can I get rid of them or abate them?

Purpose of tax penalties: Penalties exist to encourage voluntary compliance by supporting the standards of behavior required by the tax code. I.R.M., pt. 20.1.1.2 (Nov. 21, 2017)

Growth of penalties: more than 150 civil penalties, additions to tax, and additional taxes authorized, more than 10 fold increase from the 13 penalties in the 1954 version of the Code, anecdotal evidence suggests the IRS asserts penalties more frequently than in the past.

Civil tax penalties and additions to tax:

Additions to tax

– Failure to file

– Failure to pay

– Failure to make estimated deposits

Penalties

– Accuracy-related penalties

– Fraud penalty

– Certain information returns and payee statement penalties

– Tax return preparer penalties

– Promoter and protestor penalties

– Compensation statements, pension plans, exempt organization, education programs and other reporting

Options to abate

I.R.C. § 6662 generally imposes a penalty on underpayments of tax attributable to one or more of the following:

– Negligence or disregard of rules or regulations (I.R.C. § 6662(b)(1))

– Substantial understatement of income tax (I.R.C. § 6662(b)(2))

– Substantial valuation misstatement (I.R.C. § 6662(b)(3))

– Substantial overstatement of pension liabilities (I.R.C. § 6662(b)(4))

– Substantial estate or gift tax valuation understatement (I.R.C. § 6662(b)(5))

– Disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law (I.R.C. § 6662(b)(6))

– Undisclosed foreign financial asset understatement (I.R.C. § 6662(b)(7))

– Inconsistent estate basis (I.R.C. § 6662(b)(8))

I.R.C. § 6662A authorizes a penalty for reportable transactions

Other penalties authorized above 20% for various misdeeds, abatement options

Title 26 and Title 31 penalties relevant to tax

  • Only one accuracy-related penalty applies to a given portion of an underpayment even though that portion resulted from more than one of the types of misconduct specified in I.R.C. § 6662(b) Treas. Reg. § 1.6662-2(c)
  • To the extent the fraud penalty is imposed under I.R.C. § 6663, an accuracy-related penalty may not also be imposed – I.R.C. § 6662(b)

Requesting Penalty Abatement Defenses – Reasonable Cause

  • No underpayment of tax
  • Non-applicability of penalty for reasonable cause and good faith

– An accuracy-related penalty generally does not apply to any portion of an underpayment of tax where it is shown that the taxpayer acted with reasonable cause and in good faith

  • I.R.C. § 6664(c)(1)

– Certain accuracy-related penalties, such as the gross valuation misstatement penalty, may not be eligible for the reasonable cause defense depending upon the year at issue

Reasonable cause and in good faith abatement

– Honest misunderstanding of fact or law

– Isolated computational or transcription errors

– Reliance on information returns

– Reliance on a tax professional

Reasonable cause and in good faith abatement – Reliance on a tax professional

The taxpayer reasonably believed the tax professional upon whom the reliance is placed is a competent tax advisor with sufficient expertise to justify reliance;

The taxpayer provided necessary and accurate information to the advisor; and

The taxpayer actually relied in good faith on the advisor’s judgment.

– Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002) – Treas. Reg. § 1.6664-4(c)(1)

Abatement is no easy task, but if you have good reasons, you should request it right away.

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