October 15, 2022 | Tax Penalties | Tax Relief
NYS and IRS Penalty Reduction
Penalty relief can be successfully sought by negotiating penalty reduction with the IRS, and NYS Department of Taxation and Finance. In order to achieve penalty relief from either agency it may require being able to prove reasonable cause. Penalty reduction is important since the amount of overall tax debt attributable to penalties can be close to 50% of the total tax bill owed before penalties are added in. If this is your first time with a tax penalty being assessed against you, you may be lucky and be entitled to the first-time penalty abatement discussed below.
In this post, I will discuss penalty reduction with the IRS and NYS Department of Taxation and Finance for failure to file tax returns on time, negligence penalties, fraud penalties (tax evasion), late filing penalties, and failure to pay on time, which includes underpayment penalties, and estimated taxes penalty for individual taxpayers (but not businesses).
The failure to file penalty is assessed when a taxpayer fails to timely file a tax return. The penalty is generally 5% of the unpaid taxes for each month or part of a month that the return is late, up to a maximum of 25%. The penalty for failure to pay tax debt on time is assessed when a taxpayer does not pay the taxes owed by the original due date of the tax return. The penalty is 0.5% of the unpaid taxes for each month or part of a month, up to a maximum of 25%. There is an offset of the two penalties, so the total penalty for failure to file and pay on time is generally about 47.5%.
As stated above typically the best way to seek penalty relief is to prove Reasonable Cause. Reasonable Cause may be established if the taxpayer can demonstrate that he or she exercised ordinary business care and prudence in meeting the tax obligations, but nevertheless failed to file or pay on time. The penalty relief will be granted if it can be shown that there was a reasonable cause for the failure to timely file or pay taxes or that the penalty would create a current undue financial hardship to pay and a financial issue existed at the time of the missed tax payment. This standard is hard to meet in practice, and that is why getting help is often needed.
First Basis: First Time Penalty Abatement
If this is your first time being charged a penalty, the First-Time Penalty Abatement Policy applies if all of your tax returns have been filed, and you have either paid or arranged to pay all tax currently due (for example, by setting up an Installment Agreement and staying current with monthly payments), you may qualify for penalty relief under the IRS First-Time Abatement Policy (FTA). The policy was implemented to reward past tax compliance and promote future compliance, thus it is a one-time consideration for a single tax year and granted only for a taxpayer’s first penalty charge. This policy does not require a showing of reasonable cause before relief is granted.
This First-Time Penalty Abatement Policy relief is not available for some penalties, such as those returns with an event-based filing requirement. These include, for example, the Form 706 (U.S. Estate Tax Return), Form 709 (U.S. Gift Transfer Tax Return), Form 1120, or Form 1120S if a return was filed late and a penalty was not assessed within the past three years.
Second Basis: Reasonable Cause
Taxpayers not eligible under the FTA requirements may still qualify for penalty relief if they are able to show reasonable cause for the late filing, late payment or late deposit. A showing of reasonable cause requires an explanation that the taxpayer exercised ordinary business care and prudence in determining his tax obligation, but nevertheless failed to comply with his obligation due to some specific circumstances.
It is important to note that penalty relief is not automatically granted, but rather must be requested by the taxpayer. Given how quickly penalties accumulate, it is important to consult with a tax professional to learn more about your options for penalty relief.
Each case is unique and should be evaluated carefully by a competent tax attorney. The first step is to determine the amount you owe, and what type of penalty was charged. The next step is to apply for penalty abatement. It is important to keep in mind that the penalty abatement request alone will not resolve penalty issues. It serves as a starting point but it does not typically end there since in most cases the initial penalty relief is denied and then needs to be appealed. The actual form to request the penalty abatement is Form 843.
After the form 843 is filed, the next step to seek penalty relief is through penalty negotiation. The Taxpayer Advocate Service (TAS) within the IRS has a very effective penalty abatement program which accepts penalty reduction requests from taxpayers who have been unable to resolve their penalty issues with field personnel at the IRS. It also takes penalty reduction requests from taxpayers outside of the United States, residents of U.S territories, and those individuals who are seriously ill or disabled. Although it is not a guarantee the penalty abatement is granted by involving the TAS, it guarantees a fair shot to get the penalties reduced or waived as part of the settlement agreement.
Reasonable cause can be shown in this example: The taxpayer did not receive the K-1 from his or her partnership, but otherwise filed and paid his taxes on time. In this example penalty relief would be granted because the taxpayer exercised ordinary business care and prudence in meeting tax obligations, but nevertheless filed a return by the due date.
In addition, penalty abatement may be available if undue financial hardship is shown. Undue financial hardship can include an extended illness of a family member where uninsured medical expenses are incurred totaling a considerable amount of money. Other examples would include foreclosure on a home, eviction, bankruptcy filing which results in unaffordable payment arrangement with creditors where people are unable to pay their bills including tax bills. Another example is if someone was unexpectedly laid off from their job resulting in a sudden loss of income or a health issue caused them to need hospital care for an extended period of time.
Therefore, there are mechanisms to achieve penalty relief, and penalty negotiations can often be helpful to lower the overall tax bill.