Jim Buttonow
Know these penalty abatement realities to better help your clients

Recent updates streamline procedures for requesting first-time penalty abatement.

November 10, 2014
by Jim Buttonow, CPA/CITP

The IRS uses penalties to encourage taxpayers to follow the rules and remain in compliance—and it uses them a lot. In 2013, for instance, the IRS assessed almost 38 million penalties to taxpayers. However, the IRS also provides several options for taxpayers to get penalties removed, or abated, if taxpayers qualify.

The reality is that the IRS doesn’t abate the majority of penalties. In 2013, the IRS abated only 13% of penalties assessed. In many cases, taxpayers may not know to ask for penalty relief—or the process may seem as if it’s not worth the time or effort.

The general lack of understanding about penalty abatement among taxpayers presents a client service opportunity for CPAs. Practitioners who focus on the most common types of penalties, and the two most commonly successful abatement options, will have a process ready for clients who need penalty relief.

The most common IRS penalties
There are almost 150 penalties in the Internal Revenue Code. But most tax practitioners need to address only a few common penalties that make up 74% of all penalties. The most common penalties are:

  • Failure-to-pay penalty—56% of all penalties, imposed when a taxpayer doesn’t pay taxes on time;
  • Failure-to-file penalty—14% of all penalties, imposed when a taxpayer doesn’t file a return on time; and
  • Failure-to-deposit penalty—4% of all penalties, imposed when a business doesn’t pay employment taxes on time, or pays them incorrectly.

A frequently encountered nuisance penalty for tax practitioners is the late-filing penalty for partnerships and S corporations (Secs. 6698(a)(1) and 6699(a)(1)). The estimated tax penalty is another common penalty that’s often disputed by providing an exception when filing the tax return, using Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, or Form 2220, Underpayment of Estimated Tax by Corporations.

Reasons for abating penalties

Tax professionals generally request penalty abatement for the most common penalties using four reasons:

1. Statutory exception: proving a specific authoritative exclusion to the penalty

Statutory exceptions are uncommon and are easily explained to the IRS, mostly at tax filing. Examples include disaster relief or combat zone relief.

2. IRS error: documenting that the error was the result of reliance on IRS advice (Sec. 6404(f))

This penalty relief argument is typically unsuccessful and isn’t used much. The taxpayer must have documented erroneous advice from the IRS that he or she reasonably relied on, and the IRS doesn’t routinely put tax advice in writing. The Internal Revenue Manual (§ states that the IRS also allows penalty relief based on erroneous oral advice, but in practice, this is rarely seen.

3. Reasonable cause: providing a valid reason that the taxpayer couldn’t comply based on the facts and circumstances

More commonly, taxpayers try to argue that they relied on the erroneous guidance of their tax software or tax professional. This type of argument falls under reasonable cause.

To successfully present a reasonable-cause argument for late filing and payment, a taxpayer must demonstrate that he or she exercised ordinary business care and prudence but couldn’t comply. The taxpayer must also demonstrate that the noncompliance was not due to willful neglect.

Taxpayers haven’t traditionally been successful with reasonable-cause arguments before the IRS or in court. For example, in the most litigated issues section of her 2013 Annual Report to Congress, National Taxpayer Advocate Nina Olson reported that reasonable-cause arguments were successful for the taxpayer in only four out of 63 failure-to-file penalty cases litigated from June 2012 to May 2013. For failure-to-file cases, taxpayers most often argued reasonable cause based on medical illness and reliance on a tax professional. In cases of late payment, taxpayers often argued financial hardships. Most of these arguments did not prevail because the taxpayers’ facts weren’t convincing.

In reality, most penalty abatement determinations never get to court. Most are administrative determinations made by the IRS. For a practitioner to be successful in reasonable-cause determinations, he or she will need to make sure that the IRS considers all of the client’s facts and circumstances. This can be difficult, because IRS representatives use an automated tool called the Reasonable Cause Assistant (RCA) to make initial penalty abatement determinations. This tool provides a mechanical, isolated look at reasonable cause factors and ignores the full picture of the taxpayer’s circumstances. Often, RCA determinations result in penalty abatement denial letters that don’t seem to address the facts and argument presented in the taxpayer’s penalty abatement request. If this happens, a practitioner should request an appeal of the determination to present all of the client’s facts and circumstances. 

4. Administrative waiver: taking advantage of a provision that facilitates effective tax administration

The IRS can provide administrative relief from a penalty under certain conditions. The most widely available administrative waiver is first-time penalty abatement (FTA).

FTA can be used to abate the failure-to-file, failure-to-pay, and failure-to-deposit penalties for one tax period when the taxpayer has a clean compliance history for the past three years. FTA can be used for penalties on Form 1040, Form 1120, and payroll and passthrough entities. One-time noncompliance can be addressed simply by requesting abatement for the qualifying taxpayer. For more on FTA rules, see the July 2013 edition of The Tax Adviser

Despite being widely available, FTA is one of the most overlooked penalty abatement options. According to a 2012 study by the Treasury Inspector General for Tax Administration, 92% of penalties that qualified for FTA weren’t abated because taxpayers were unaware of the FTA option.

In reality, FTA is the easiest of all penalty relief options, and it was recently streamlined even more. IRS procedural changes made in August now allow practitioners to call the IRS Practitioner Priority Service line or compliance unit (if applicable) to request FTA for any penalty amount. Before August, the IRS required abatement requests for larger penalty amounts to be made in writing (the specific threshold amount was not published by the IRS). This change will significantly reduce burden and time for requesting FTA for larger penalty amounts.

Knowing the basics of how to request abatement for the most common penalties will help you streamline decision-making and client service delivery. And, if you take advantage of new IRS procedures for FTA, your clients will thank you if you are able to get their penalties removed by simply calling the IRS.

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Jim Buttonow, CPA/CITP, directs tax practice and procedure product development for a newly launched line of business at H&R Block. He has 27 years of experience in IRS practice and procedure.