When to Request IRS Reasonable Cause Penalty Abatement
What is reasonable cause penalty abatement? One of the first questions clients ask me is whether penalties and interest can be removed from their IRS tax debt. The answer, as you may have guessed is “maybe.” First, there is good news; late filing and late payment penalties can be abated under the right circumstances. However, “interest” cannot be removed as a general rule. There are a few exceptions but for the most part the interest will remain on your balance. Nevertheless, there are a few ways to remove penalties from your IRS tax debt. In this blog, I will go over “reasonable cause” penalty abatement and what circumstances might qualify you for the relief.
Why Penalty Abatement is Important to Consider (penalties can easily increase debt by 50%)
Before we get into the specifics of reasonable cause penalty abatement I want to provide some context as to why this is important. There are two common types penalties that can easily increase your tax debt by 50%. First, there is a penalty for filing your return late. This penalty is the harsher of the two because it imposes a 5% penalty each month for five months. Therefore, after five months your tax debt will increase by 25%. The second penalty commonly assessed is the failure to file penalty. This penalty will also cap out at 25%. However, it usually 50 months (timing changes based on several factors).
If you are late on filing a tax return and paying the balance the consequences can be quite punitive. Nevertheless, life is complicated and sometimes events occur that prevent us from meeting out tax obligations. Accordingly, Congress required the IRS to abate penalties where reasonable cause exists. If you are facing steep IRS penalties then continue reading to determine if reasonable cause may be an option for you. If you are still unsure after reading this blog please give us a call to determine what options you have.
Death, Serious Illness, or Unavoidable Absence – Reasonable Cause Penalty Abatement
There are countless scenarios that can qualify someone for Reasonable Cause Penalty Abatement (RCPA). The first and probably most obvious circumstances warranting penalty abatement are death, serious illness, or unavoidable absence of a taxpayer or a taxpayer’s immediate family member. Immediate family member refers to a taxpayer’s spouse, child, parent, brother, sister, grandparent, grandchild, step-parent, step-child, step-brother, or step-sister.
Corporations can qualify for RCPA under the same circumstances. An individual who has sole authority of the corporation to make tax payments, file returns, or issue payroll may allow the corporation to qualify for RCPA if the individual or their immediate family suffered a death, serious illness, or unavoidable absence. If the business has additional people with the authority to complete these tasks, the IRS may still consider RCPA for the corporation. However, they will heavily scrutinize why one of the additional individuals with authority did not step up and complete the task(s) (filing or paying taxes).
The items that need to be included in the RCPA request when it concerns death, serious illness, or unavoidable absence are:
The date of death, dates, duration, and severity of the illness, or dates and reason for absence.
How the event prevented the filing of the return, the estimated tax deposit(s) from being made, or the paying of the balance due.
Did the taxpayer return to promptly filing returns, making estimated tax deposits, or paying the balance due once the serious illness passed, they returned from the absence, or their immediate family member passed.
The relationship the taxpayer has to their immediate family member.
If other business obligations were impaired, for example, the corporation also fell behind on rent or credit card obligations.
Here is a quick look at a case that illustrates the importance of providing documentation:
In the case of Walter Kowsh v. Commission
er of Internal Revenue, an RCPA request (based on disability) was analyzed by the Court. The petitioner (Mr. Kowsh) sited his depression, which arose from his wife’s untimely death and the loss of friends during the Sept. 11, 2001 attacks, caused him to not file or pay the tax due for tax year 2003. It was ultimately found that the petitioner did not qualify for reasonable cause penalty abatement because the petitioner failed to provide any corroborating evidence (documentary or otherwise).
Specifically, Mr. Kowsh was unable to specify when he took medication prescribed for his depression. Additionally, he did not provide any reports or letters from doctors. And finally, the petitioner’s own doctor was unwilling to provide certification that the petitioner was disabled.
This example illustrates why it is vital to have supporting documentation when submitting your request for RCPA.
Fire, Casualty, or Natural Disaster
Another event that could qualify a taxpayer for RCPA is if they were affected by a natural disaster. According to Internal Revenue Code (IRC) § 165(i)(5)(A) a federally declared disaster area is any disaster area subsequently determined by the President of The United States to warrant assistance by the Federal Government. In order to be considered an “affected person” by the IRS the following requirement must be met:
Residence or business entity is located in the covered disaster area.
Personal, business, estate or trust tax documents are maintained in a covered disaster area.
A spouse is located within the covered disaster area (when filing a joint return).
The taxpayer is a relief worker assisting in a covered disaster area.
If the taxpayer is not deemed an “affected person” but due to a fire, casualty, or other disturbance they were unable to file their return on time, make their estimated tax payments, or pay their balance, they may still qualify for RCPA. Here is a list of items that will need to be provided to the IRS:
The timing in which the incident took place (the event occurred in close proximity to the filing deadline, etc.).
How the event affected the taxpayer or business.
What steps were taken to comply with filing the return, making estimated tax deposits, or paying the balance (searching for records, etc.)
After the incident was over, the taxpayer began complying once they were able to do so (taxpayer did not wait ten years after the event to try an comply)
Note: Though the circumstance may not fall under the qualifications for RCPA due to fire, casualty, or natural disaster, they may inevitably allow for qualification under other RCPA relief.
Unable to obtain records
RCPA requests may also be accepted by the IRS if the taxpayer can show they were unable to obtain the records necessary to file their return, make estimated tax payments, or pay their balance. As with any RCPA request the circumstances are judged on a case by case basis and depend on the facts and circumstance. According to Internal Revenue Manual (IRM) § 22.214.171.124.2.2.3 reasonable cause may be established if the taxpayer exercised ordinary business care and prudence, but due to circumstances beyond the taxpayer’s control, he or she was unable to comply.
Information needing to be submitted to the IRS with the RCPA request are:
Why were the records necessary for compliance?
Why were the records unavailable and what steps did the taxpayer take to try and secure the records?
When did the taxpayer become aware that they did not have the necessary records?
Why the taxpayer did not try an estimate the information.
Did the taxpayer contact the IRS to ask about what to do regarding the missing information?
Did the taxpayer comply once the missing information was received?
Supporting documentation (correspondence) received during the course of trying to obtain the records.
Were other avenues explored for trying to obtain the records?
RCPA can end up saving you thousands of dollars. If you believe you qualify for penalty abatement under the “reasonable cause” standard please remember supporting documentation is crucial to getting your request accepted. Moreover, when writing your request only include relevant information. For example, stick to the reasons the event was unforeseeable. Additionally, discuss the reasonable steps you took to comply. It may be beneficial to seek legal representation to make sure that your request is structured properly, which will give you the best chance of acceptance.