In speaking with taxpayers facing a large tax bill from the IRS, I’m frequently asked whether the IRS will waive the penalty and interest assessments on the account if the taxpayer agrees to pay the balance of tax owing. Unfortunately, the answer is typically no. While a number avenues exist for reducing the total amount owed to the IRS (such as having an Offer in Compromise accepted on the debt, or by requesting First Time Penalty Abatement), in most instances, interest on an IRS tax debt cannot be abated by the IRS and an abatement of penalties assessed on an account requires an affirmative showing of reasonable cause, which is generally a high bar to clear.
What factors does the IRS consider in evaluating a request for reasonable cause relief?
Per IRM §20.1.1.3.2, “reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise apply. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations.”
Ordinary Business Care and Prudence:
In showing that they acted with “ordinary business care and prudence,” a taxpayer must generally demonstrate to the IRS that they took a degree of care that a reasonably prudent person would exercise with regard to their tax obligations, but were nevertheless unable to comply with the law. In evaluating whether a taxpayer exercised ordinary business care and prudence, the IRS will generally review the taxpayer’s stated reason for the non-compliance, in conjunction with the taxpayer’s overall compliance history and the length of time between the event cited as the cause of the non-compliance and the subsequent compliance. Generally speaking, if a taxpayer can demonstrate that they acted with ordinary business care and prudence but circumstances outside of their control caused the non-compliance at issue, the IRS will agree to reasonable cause abatement, at least through the date that the issue causing the non-compliance subsided; as the IRM points out, “[a] taxpayer’s obligation to meet the tax law requirements is ongoing. Ordinary business care and prudence requires that a taxpayer continue to attempt to meet the requirements, even though late.”
What situations typically give rise to reasonable cause abatement:
Death, Serious Illness, or Unavoidable Absence:
Death, serious illness, or unavoidable absence of the taxpayer, or death or serious illness of an immediate family member may establish reasonable cause for failing to pay or file your taxes on time. It bears mentioning that while death, serious illness, or unavoidable absence may give rise to reasonable cause abatement for an individual taxpayer that was unable to comply with their tax obligations, it generally will not give rise to reasonable cause for failure to file or pay corporate taxes, unless the business representative impacted by the death, serious illness, or unavoidable absence was the sole person at the business with the authority to execute the return, make a deposit, or pay the tax. Even if the person impacted is the primary party at the business with the responsibility for handling tax matters, if another party has the authority to meet the tax obligations in their stead, reasonable cause abatement can be denied. I’ve seen the IRS deny reasonable cause relief to a quadrapalegic who filed a form late (in the end the form was found not even to be required for the taxpayer’s business), because there was another business owner (absentee and living in another country, mind you), that technically could have filed the form while the business owner was in intensive care in the hospital. I guess the IRS figured that the quadrapalegic business owner in the hospital should have had the foresight to notify his business partner that he wouldn’t be filing the company’s tax filing while on a ventilator in the hospital and request his business partner complete the filings instead. All this is to say that the IRS applies different standards when evaluating reasonable cause abatement for business and individual taxpayers, and businesses are often held to a higher standard.
Fire, Casualty, Natural Disaster or Other Disturbance:
In most instances, if you’re impacted by a natural disaster, and the IRS officially recognizes a covered disaster area (as they frequently do in the case of wildfires, floods, hurricanes, etc.), the IRS will grant relief for having missed a payment or filing deadline. Often they will proactively push back deadlines for affected taxpayers in federally declared disaster areas. Even if they don’t, or you aren’t technically within the declared disaster area, if you can tie your non-compliance to the impacts of a federally declared disaster, your chances of obtaining reasonable cause relief are significantly improved. Even if you or your business is not located in a disaster area, if your tax records necessary to meet a tax deadline are located in a disaster area and the disaster prevents you from obtaining records in time to file your tax return, the IRS is generally quick to grant relief.
Things are a bit trickier however, in instances where the fire, casualty, or other event is more localized. The best thing you can do is keep records of how you were impacted. If you’ve filed an insurance claim, make sure you maintain those records. If you filed a police report, keep those records. If you had to pay for computer repairs or water damage cleanup, keep those invoices. When it comes to substantiating a reasonable cause request based on fire, casualty, or natural disaster, the more contemporaneous, third-party supporting documentation you can provide to the IRS, the more likely they are to agree with your claim. You want to be able to clearly demonstrate to the IRS how you were affected, how long you were affected, and what steps you took to meet your tax obligations.
Inability to Obtain Records:
In certain circumstances, an inability to obtain records may be justification for a reasonable cause determination. However, this is generally a very difficult argument to win with the IRS. You’ll generally need to explain to the IRS what records were needed to comply, why the records were unavailable, why you could not estimate the information in the absence of specific records, and demonstrate that affirmative steps were taken to try and obtain the records. In most instances, if you’re missing a piece of information necessary for the completion of your tax return, you’re better off filing the tax return to the best of your ability based on available information, and then amending the return at a later date if the information does become available and it necessitates a correction to the information already reported.
Erroneous Advice or Reliance on Others:
Relying on erroneous advice from the IRS can often lead to penalty relief, though in most instances the relief would be based on a statutory exception or administrative waiver in instances where you relied on written advice from the IRS that was erroneous. In some instances, reliance on erroneous oral advice from the IRS may be grounds for reasonable cause, but you’d need to establish that you exercised ordinary business care and prudence in relying on the IRS’s advice. In most instances, IRS representatives are hesitant to give tax filing advice over the phone, but if they do, and you plan on relying on it, make sure you document the date and time that you called the IRS, the representative’s name, and their ID number.
Reliance on others to meet your tax filing or payment obligations who fail to meet those obligations is typically not grounds for reasonable cause relief. You cannot delegate your responsibility to file a timely return and/or make timely tax deposits or payments. The same goes for claiming forgetfulness or a general oversight. The ordinary business care and prudence standard dictates that a taxpayer prone to forgetfulness should put the necessary safeguards in place to ensure their tax obligations are met in a timely fashion. If you rely on a tax professional to file or deposit your taxes, and the tax professional fails to do so, in most instances the IRS would direct you to seek recompense directly from the tax professional, rather than seeking abatement from the IRS.
Ignorance of the Law & International Informational Penalties:
In most instances, ignorance of the law regarding one’s obligation to file tax forms or make tax payments does not not constitute reasonable cause in and of itself. The IRS generally takes the position that ordinary business care and prudence dictates that taxpayers will avail themselves of available resources or professional tax assistance in determining their tax reporting and payment obligations. Specifically with regard to international filing and payment obligations, the IRS has said, “taxpayers who conduct business or transactions offshore or in foreign countries have a responsibility to exercise ordinary business care and prudence in determining their filing obligations and other requirements. It is not reasonable or prudent for taxpayers to have no knowledge of, or to solely rely on others for, the tax treatment of international transactions.” From this language, it would appear that the IRS applies the same standards, if not more stringent standards, on taxpayer’s establishing reasonable cause for failure to file international informational reporting forms.
However, courts have taken a more lenient approach to taxpayers who fail to meet their international reporting obligations. The most frequently cited case where the courts have shown a bit more leniency to taxpayers assessed penalties for failure to file international informational returns is that of Congdon v. U.S. [108 AFTR 2d 2011-6343 (E.D. Texas 2011)]. In Congdon, the taxpayer filed a Form 5471 to report his ownership in a controlled foreign corporation (CFC), however the form was not completed correctly, and the IRS assessed a $10,000 failure to file penalty on the grounds that the 5471 that was filed was substantially incomplete.
The court ruled that although ignorance of the law alone is not sufficient to constitute reasonable cause, inexperience in tax matters, the complexity of the area of law, and a track record of compliance can show reasonable cause. In doing so, the court recognized that much of the foreign informational reporting requirements are complex and little understood in the general community. So long as you can demonstrate that you acted with ordinary business care and prudence in attempting to comply with your foreign informational return obligations to the best of your knowledge and ability, the IRS may be inclined to grant reasonable cause relief, provided it was the first time that you were penalized for that type of reporting obligation. However, reasonable cause is still a difficult bar to clear, and if you haven’t yet been penalized for foreign informational reporting failings, it’s usually advisable to partake in one of the IRS’s disclosure programs rather than filing the return late or incomplete and asking for any penalties to be abated after the fact.
IRM §20.1.9 is a fairly good resource which provides an overview of the different international reporting penalties that can be assessed and the standards that the IRS uses to evaluate reasonable cause requests for each penalty type. Though bear in mind that while the IRM states the IRS’s position regarding these penalties and options for abatement, court decisions sometimes run contrary to the guidance in the IRM, so it’s always worth doing some outside research to determine whether precedential court cases may be leveraged for relief, even when the IRM may indicate that relief isn’t available.
A Few Key Things to Keep in Mind:
While reasonable cause abatement can apply to both a failure to file taxes as well as a failure to pay taxes, the IRS will determine the sufficiency of your grounds for reasonable cause with respect to each failure on its own merits. Therefore, if your tax records were lost in a flood, for example, and you could not file your tax return on time, that may give rise to reasonable cause relief with respect to your failure to file, but unless you were impacted financially and unable to pay your taxes, they might still find that you did not act with ordinary business care and prudence in paying at least a good faith estimate of the taxes owing by tax time. The inverse can be true as well. In instances where you can’t afford to pay your taxes, so you simply don’t file, the IRS may grant relief for your failure to pay, but they’re unlikely to grant relief for your failure to file; even in instances where you cannot afford to pay your taxes, you have an obligation to timely file your return and should do so.
Additionally, timing is very important to a successful reasonable cause claim. Reasonable cause will only exist for the time period where the grounds supporting the claim for reasonable cause are still actively impacting you. If you’re hospitalized and cannot meet your filing or payment obligations, the IRS may grant penalty relief for the time period that you were hospitalized. However, when you’re out of the hospital the IRS expects you to make it a priority to get back into compliance as soon as it is practicable. In some instances, they may grant relief only through the period in time when they deem you were no longer impacted by the event giving rise to reasonable cause. In some instances, if there is a considerable delay in your efforts getting back into compliance, the IRS may use those grounds to deny penalty relief in toto. Therefore, if you find yourself in a situation that might give rise to reasonable cause, make sure you do your best to document when the situation first arose, how long it impacted you, and the efforts that you made to promptly come into compliance once the situation subsided.
Finally, remember that, as in most instances with the IRS, an initial unfavorable determination is appealable. From experience, the vast, vast majority of reasonable cause requests will be denied upon initial review by the IRS. If you believe there are real merits to your request and the IRS initially denies your request, be sure to file an appeal. In most instances, the Appeals/Settlement Officer assigned to review your appeal will be a bit more lenient in reviewing your request, and Appeals employees, unlike IRS front-line employees, have the authority to grant abatement or settle penalty balances based on the “hazards of litigation.” In other words, if you can demonstrate to the Settlement Officer that there are sufficient merits to your request that the IRS might run the risk of losing if the case were brought before the Tax Court, they may agree to abate or settle (i.e. reduce) the penalty assessment in order to avoid the case coming before a court and setting precedent detrimental to the IRS, as was the case in Congdon.