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IRS penalties are like being kicked in the stomach as you are trying to get off the ground after stepping in a hole and breaking your ankle. You really didn't mean to break your ankle and you didn't see the hole, but it happened, and now the IRS is going to come along and give you a swift kick because you fell down and broke your ankle.
Penalties are painful and come in many sizes and flavors. There's a failure-to-file penalty, failure-to-pay penalty, failure-to-deposit penalty, accuracy-related penalty, fraud penalty and others. Penalties can range from 100% of an asset value to 0.5% of tax due and can be applied concurrently, as a one-time assessment, or repeatedly, on a monthly basis.
But what if you are a conscientious taxpayer — you try to comply with all the tax rules and regulations, filing requirements and deposit requirements, but fall short. Should you have to pay a hefty fine for your oversight?
Believe it or not, penalties are not to generate revenue. The IRS policy is to use penalties as a deterrent to taxpayer noncompliance. In some situations, you can get relief from penalties.
The IRS will abate a penalty if it falls into one of the following categories:
Reasonable cause;
Statutory exception;
Administrative waiver; or
Correction of IRS error.
Generally, if you have a good reason for not paying, depositing or filing, you should ask for relief using the reasonable cause exception.
What if you just don't have a good reason, but you're otherwise compliant? There's an administrative waiver called the first-time abatement waiver, or FTA.
Established in 2001 by the IRS, FTA's are designed to help with the fair and consistent administration of penalties, reward compliant taxpayers and promote future compliance with the tax law. This administrative penalty waiver allows first-time noncompliant taxpayers to request a penalty abatement for a single tax period.
Notice the word request in the prior sentence. The IRS does not publicize nor offer the penalty abatement and, as a result, many qualifying penalties are not abated. According to a report by the Treasury Inspector General for Tax Administration, “in 2010 approximately 250,000 taxpayers with failure to file penalties and 1.2 million taxpayers with failure to pay penalties did not receive penalty relief even though they qualified under FTA waiver criteria.” The study found that more than 90% of the taxpayers who received failure-to-pay penalties qualified for the abatement but failed to receive it because it was not requested.
The FTA only applies to certain penalties in specific circumstances. The penalty waiver can be applied to:
Failure to file;
Failure to pay; or
Failure to deposit.
The FTA does not apply to estate and gift tax returns, the estimated tax penalty, or accuracy-related penalties.
If the assessed penalty is eligible for the FTA, the taxpayer must have a clean compliance history for the past three years on the same tax return that the abatement is being requested.
For example, Sunshine Inc. always makes payroll deposits on time and has a clean history. The accounting manager is distracted with personal issues and forgets to make a payroll tax deposit. The company gets hit with a failure-to-deposit penalty of $5,000. The company does not have a valid excuse for the reasonable cause exception.
This type of penalty is eligible for FTA treatment, and the accounting manager requests a FTA. The $5,000 penalty is abated.
The following situations do not affect the “clean status” of a taxpayer:
Penalty assessment older than three years;
Estimated tax penalty assessment;
Penalty abatement due to reasonable cause;
FTA older than three years; and
Subsequent penalties.
A FTA can be requested by telephone or in writing. The IRS has a ceiling on the amount of penalty that can be abated through a telephone request. Large penalty abatement requests should be made in writing.
If there are reasons for the tax underpayment that clearly meet the reasonable cause exception for relief, then reasonable cause should be used instead of the FTA. The reason is that if a penalty is abated due to reasonable cause, the taxpayer still has a clean history and can receive a FTA in subsequent years, if needed.
And what if you just wrote a large check for a penalty and you qualified for the FTA? You can file a Form 843, Claim for Refund and Request for Abatement, and request a refund.
So when you're lying on the ground after your stumble and the IRS is headed your way to hit you with a penalty, go ahead and avoid that additional pain. Ask for a first-time penalty abatement and get some relief.
Pamela Schuneman, C.P.A., is a practicing tax accountant in Sarasota. She has 33 years of experience helping her clients navigate the vast federal tax system and has worked with businesses as varied as Fortune 500 companies to small sole-proprietors. Contact her at [email protected]
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