IRS Tax Penalties

The Internal Revenue Service asserts penalties for filing returns late, for paying taxes late, for filing returns that are inaccurate, for fraud, and for a variety of other issues.

Penalties are almost all based upon deficiencies, that is, on amounts being owed to the IRS. If nothing is owed, there is no basis for the assertion of a penalty.  Penalties can be abated if there is “reasonable cause” for what the taxpayer has done or not done.  Reasonable cause is a very subjective standard.

Background facts need to be carefully examined to determine if there is a good excuse for what the taxpayer did or did not do. With proper facts we can explain and document the circumstance to the IRS in a way that will encourage IRS to not assert or to abate the penalties.  I have been successful in getting penalties (and the interest on the penalties) abated for clients with post traumatic stress syndrome, dementia, alcoholism, and drug addiction. A third party representative can usually tell the story more persuasively than the embarrassed taxpayer.

The sophistication of a taxpayer is to be considered by the IRS in evaluating whether a penalty should be asserted or abated after assessment.  The IRS Manual tells us that the following factors should be considered by the IRS:

  • Efforts to report the proper tax liability
  • Experience of the taxpayer
  • Knowledge of the taxpayer
  • Educational background
  • Reliance on the advice of a tax advisor
  • Nature and complexity of the investment generating a tax consequence
  • Complexity of the tax issues
  • Competence of the tax advisor and quality of the opinion relied upon

These factors need to be explored in detail and explained to the IRS in efforts to get penalties abated.  In the area of reliance on tax advisor it is important to show what facts were disclosed to the tax advisor. Where the taxpayer raises reliance on a tax advisor, the IRS manual requires revenue agents to contact the preparer to confirm that the advice was provided and it will consider return preparer penalties against the advisor.  This invariably leads to conflicts.  Taxpayers who have a penalty problem related to advice by a preparer, generally should seek outside counsel as to how the matter should be managed.

The IRS manual says that penalties are not to be a bargaining point in resolving taxpayers’ other tax adjustments.  That is an interesting theory, but difficult to apply in practice.  I handled an audit several years ago in which the agent asked me in considerable detail why they should not be asserting a fraud penalty in an examination.  I sent a letter back to the agent and to the agent’s manager saying I took offense at IRS using the fraud penalty as a negotiating item.  The manager killed the issue and backed away from several other unrelated issues.