Tax Penalties

The Internal Revenue Service (IRS) and State tax authorities, have the ability to penalize taxpayers who do not pay their taxes on time, or file their tax returns on time. In my practice, I spend a lot of time trying to get those penalties reduced or eliminated for my clients. Both the IRS and States charge a harsher penalty for not filing a tax return versus not paying the tax. Therefore, it is important to file your tax returns, even when you can not pay the tax debt owed to help minimize the tax penalties related to filing the tax return late.

The two typical methods to have a tax penalty waived is the first time penalty abatement, and the other method is to demonstrate reasonable cause. The first time penalty abatement waiver requires that in the last three years before the tax year with the penalty that you paid all taxes on time, and filed all your tax returns on time. If that is the case, the IRS will normally remove the tax penalty since you have demonstrated that the issue was a one time event and not a pattern. To demonstrate reasonable cause that something caused you not to be compliant with paying taxes or filing tax returns, it would typically have to be shown that you took ordinary and reasonable steps to follow the rules, and that something outside your control made that impossible. As an example, say a taxpayer before the great depression of 2008-2010 purchased a investment property for 1.5M, and it needed .5M to finish it. He hopes to sell the property for 2.5M, so to net a .5M gain. Then the economy slumps and the property is worth 1.5M. and he can not get a loan and risks the foreclosure of the property since it can’t maintain the cost of just holding it.   He then decides to take .5M from a retirement account to finish the house and sell it. Unfortunately, he does this but the home slumps to 1M of value and he can not sell it and get his investment back. When he took out the .5M from his retirement account,  he incurred about $140,000 in taxes. When he does not pay these taxes, the IRS and States will start charging a tax penalty of 1/2 of one percent per month for the failure to pay the taxes owed on time. Under this scenario, it will be difficult to show reasonable cause since the taxpayer had the money to pay the taxes when he withdrew .5M from he retirement account to pay the taxes, so it would not meet the definition of not being able to pay his taxes since it was within his control to do so.

Under these circumstances, we often need to go to the IRS office of appeals and ask for penalty relief. Each situation is unique, and the taxpayers case has to be developed to put it into the best light to prove that the taxpayer was being reasonable under the circumstances. If the penalty cannot be waived, a tax settlement through an offer in compromise may be available so the total tax bill is not paid.

By: Timothy S. Hart

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