All kinds of penalties are being assessed by the Internal Revenue Service (IRS) against taxpayers, and more can be expected in the future. In 1954 there were 13 penalties in the Internal Revenue Code, and now there are more than 150. Taxpayers should not overlook the opportunity to request the IRS to abate penalties. The IRS abates many penalties for reasonable cause.
Requesting an Abatement
Sometimes the IRS imposes penalties improperly; therefore, the taxpayer should not accept them as correctly applied. Penalties should certainly be protested if there is a belief that they have been asserted unfairly. Abatement is simple and is done by the taxpayer formally requesting an abatement of any penalty that is believed to have been wrongfully asserted by the IRS. Such request should be signed by the taxpayer and notarized and sent to the IRS with a copy of the notice showing the penalty.
Denial of Request
If abatement of the penalty is denied, then the taxpayer has the right to appeal such denial. Upon denial of the taxpayer’s request for abatement, the IRS is required to give the taxpayer notice of his right to appeal the denial of the abatement. The notice received by the taxpayer is like the 30-day letter sent by the IRS at the conclusion of an audit. If the taxpayer cannot convince Appeals that the penalties are improper, the taxpayer’s only choice is to pay the penalty and underlying tax deficiency and file a claim for refund.
A penalty can be abated when the taxpayer can show reasonable cause for failing to comply with a particular requirement. Although there is no specific definition of reasonable cause, Regulations Section 301.6651-1(c)(1) contains the following basic language relating thereto:
* * * If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause. A failure to pay will be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship * * * if he paid on the due date.
The Internal Revenue Manual gives several examples of what the IRS accepts as reasonable cause. However, keep in mind that what the IRS has listed as examples of reasonable cause does not contain all the reasons that penalties are abated. Some examples of reasonable cause accepted by the IRS are:
- Death or serious illness of the taxpayer or a death or serious illness in his/her immediate family.
- Unavoidable absence of the taxpayer.
- Destruction by fire or other casualty of the taxpayer’s place of business or business records.
- Taxpayer was unable to determine amount of deposit or tax due for reasons beyond the taxpayer’s control.
- The facts indicate that the taxpayer’s ability to make deposits or payments has been materially impaired by civil disturbances.
- Lack of funds is an acceptable reasonable cause for failure to pay any tax or make a deposit under the Federal Tax Deposit System only when a taxpayer can demonstrate the lack of funds occurred despite the exercise of ordinary business care and prudence.
The Internal Revenue Manual sets forth additional examples of reasonable cause. In cases where ignorance of the law is claimed, reasonable cause should not be presumed. Each taxpayer’s case is determined individually. However, lack of knowledge of the internal revenue laws may also be considered reasonable cause in cases of first-time filers or those having to meet sudden first-time Federal Tax Deposit requirements. The taxpayer will have to show evidence of ordinary business care and prudence and the case will be judged on its own merits.
Heasley v. Commissioner
Although an older case, Heasley v. Commissioner, 902 F.2d 380, 90-1 USTC ¶50,314, 66 AFTR 2d 90-5065 (5th Cir. 1990), high school graduates holding blue collar jobs with no investment experience relied upon an economic and financial consultant to assist them with their investments. The Heasleys invested $14,000 in an energy tax shelter. They received a $10,000 deduction and a $20,000 investment tax credit. As a result of their investment, they obtained more than $23,000 in refunds. Upon audit the IRS imposed the negligence penalty, valuation overstatement penalty, and substantial understatement penalty. The Tax Court found in favor of the IRS; however, on appeal the Fifth Circuit reversed the Tax Court and held for the Heasleys.
The Heasleys, who had previously prepared their own tax returns, retained a CPA to prepare their return for the year in which they took the deduction in question. The Fifth Circuit Court of Appeals found that moderate income investors (such as the Heasleys) do not have to independently investigate their investments, and that the Heasleys exercised reasonable care in reading the prospectus and having their advisors explain the rest. The Court further found that the Heasleys had an honest misunderstanding of the law, relied on their financial advisors, and monitored their investment. The Heasleys attempted to assess their proper tax liability by taking their taxes to a CPA for the first time. The Court found that the Heasleys showed reasonable cause and good faith and that no substantial understatement penalty should be imposed.