**This article is part of a larger article series titled, The 941 Payroll Tax Resolution Process. There is a specific sequential order to this series, so we highly recommend that you start at the beginning.
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When a taxpayer does not comply with the tax code, those penalties shape a conversation. Compliance, encouraged self-assessment, and taxpayer education is the voice of that conversation.
Congress determined a long time ago that the financial consequences for failure to comply should be severe enough to deter noncompliance.
The tax code has been used unfairly in the past. To combat that, Congress now has a fairer system for everyone. Taxes cannot be used as a punishment against a specific group of people. It needs to be fair on a consistent basis. In addition, penalties need to be impartial, accurate, and still respect the right for representation.
This means that the IRS can’t just give out the abatement of penalties like candy. They are required to have an orderly way to help those that qualify, yet screen out others.
A penalty assessment is most often a direct result of an instigated event. An instigated event might be a 941 liability that goes unpaid. As a result, the trust fund recovery penalty is created. A penalty assessment can also come from a lack of an event. For example, the failure to file penalty is a repercussion from the lack of filing correctly.
Is is important to note that penalties are already set in stone. The IRS has a priority order in which penalties are to be assessed. These penalties have become law and cannot be changed. However, specific situations can warrant a removal of penalties on the backend by an IRS Personnel.
Penalty relief may be granted for those whose’ tax accounts are deemed correct and currently compliant. Meaning that if you want to challenge the tax liability, do that before you are trying to obtain a penalty abatement. This is the last thing you do in your tax resolution case.
You cannot be accumulating tax debt nor missing filings or not paying federal tax deposits to qualify for abatement.
Traditionally, there are four specific reasons why abatement is approved. Those four reasons are:
- Reasonable cause
- Statutory exceptions
- Administrative waivers (includes first time abate (FTA))
- Correction of IRS errors
An additional way to get penalty abatement is through Appeals. They may ultimately recommend penalty abatement based on litigation potential.
It is the job of the IRS Division of Appeals to prevent tax litigation. If they believe your case could wind up in court, they may negotiate to save costs on the legal side.
Statutory exceptions, administrative waivers, and correction of IRS errors are uncommon at best. The claiming of reasonable cause is the most common situation that taxpayers can request abatement through. Because of that, we will only be focusing on that option in this article.
Reasonable Cause Criteria
Reasonable cause is based on all the facts and circumstances regarding your tax situation. This does not include a bias on a specific industry type or specific group of taxpayers.
The IRS is required to apply a consistent ruling. It is common that an IRS Personnel will grant penalty abatement based on taxpayer conduct:
- How you conducted yourself before the tax debt?
- During the time you were accruing the tax debt?
- And after you started resolving the tax debt?
All of these are important factors that the IRS will consider.
Types of Reasonable Cause Penalty Abatement
The main types of reasonable cause penalty abatement categories, are:
- Death, serious illness, or unavoidable absence from business affairs
- Fire, casualty, natural disaster
- Loss of records beyond the taxpayer’s control
- Erroneous advice despite exercise of ordinary care and prudence
- Ignorance of the last despite good faith efforts to comply
- Bad advice from the IRS or tax professional
- “Undue economic hardship” – advanced penalty abatement strategy for business owners.
We will go through several of the more common ones below:
1. Death, Serious Illness, or Unavoidable Absence.
If you are an owner/operator of a construction or trade business and you die, are seriously ill, or have an unavoidable absence or a death or serious illness in your immediate family, you might qualify for this classification.
In a traditional business, the death, serious illness, or unavoidable absence of a keyperson or a member of that keyperson’s family and that person had sole authority to execute the return, make the deposit, or pay the tax, then you might qualify as well.
2. Fire, Casualty, Natural Disaster
If a business can not comply timely due a fire, casualty, or natural disaster, that business may get relief. A common occurrence is when the President of the United States declares a natural disaster area.
Reasonable cause may still be on the table if it is because of fire or another casualty.
Your ability to exercise ordinary business care and prudence given the situation will also go a long way.
Factors that the IRS will consider are:
- The timing after the event
- The effect on the taxpayer’s business
- Steps taken to attempt to comply
- And if the taxpayer complied when it became possible or not
3. Unable to Obtain Records
If a hurricane comes through and floods a business, or records are burned completely, you have reason to request abatement. The rule though is if there were circumstances beyond the taxpayer’s control.
The IRS will likely ask why the records were needed to comply? Why weren’t the records backed up in the cloud? When did the business become aware of the records not being there? Etc.
4. I Made a Mistake
You can attempt to establish reasonable cause by claiming a mistake was made. Generally, this is not in keeping with the ordinary business care and prudence standard and does not provide a basis for reasonable cause.
However, the reason for the mistake may be a supporting factor to be considered. If you can provide additional facts and circumstantial evidence that you exercised ordinary business care and prudence, but the end result was still a lack of compliance, you might have a case.
The question is, when did you become aware of the mistake? And to what extent did you correct the mistake? Expect the IRS to consider those questions.
5. Other Reasons
So far, we have not mentioned anything about a general economic decline. The IRS has a position that economic factors should not generally affect penalty abatement. The IRS believes that business owners should prepare for economic downturns. They believe you should have had resources to get through low economic points in time.
However, an acceptable explanation is not limited to those given in IRM 20.1. The IRS specifies that penalty relief may be warranted based on an “other acceptable explanation,”. However, you will need to provide evidence that you exercised ordinary business care but was nevertheless unable to comply within the prescribed time. The IRS will show leniency for situations like this. Make your case well!
6. Undue Economic Hardship
This is the big one, but what does the IRC specifically mention regarding economic hardship? Throughout the Internal Revenue Code, you can find a few specific concepts:
- An immediate threat of adverse action, incurring significant costs (including for representation) or the irreparable injury or long-term adverse impact (IRC 7811(a)(2))
- If a levy action by the IRS on tangible business property or assets is preventing from carrying on with a trade or business (generate revenue), then the IRS is creating hardship (IRC 6343)
- The term “undue hardship” means more than an inconvenience to the taxpayer. It must appear that substantial financial loss will result from selling business property or assets (26 CFR 1.6161-1(b))
These references create a general feeling that if the IRS’ actions would jeopardize the businesses ability to continue on or cause a substantial financial loss, then it may be undue hardship.
Again, it must be more than just an inconvenience to the taxpayer!
Generally, undue hardship does not impact the ability to file. Don’t plan on willing this argument regarding Failure to File (FTF) penalties.
The reverse could be said if you were claiming a fire caused a loss of records. That then might impact filing, but not paying the tax.
Writing Your Penalty Abatement Request
Once you believe you have a reasonable cause argument, you need to request penalty abatement in writing.
You can use Form 843, Claim for Refund and Request for Abatement to apply for relief from penalties. However, writing your own letter allows you to provide additional details and information. Doing so will give you a chance to go above and beyond what Form 843 allows.
As a general rule, you should include specifics in the letter, such as:
- Explain the business and how the business operates
- Provide color regarding initial circumstances before the issues started
- Why the problem continued after you found out about it
- The steps you took to resolve the problem and issue
- What you have done to prevent future issues
Leave nothing unturned. Write a novel here and explain to the IRS as many relevant facets that you can come up with. How does the business operation, what went wrong and how you are fixing the issues.
The IRS does not want to put people out on the street or push businesses out of business. If penalties and interest are creating a situation where that would occur due to hardship or other events, you have a potential case to get penalties and interest abated.
Remember, you first need to be in a resolution pathway, and then you can request this abatement.
**This article is the last article in this series. From here, continue your tax payroll education with other articles and resources provided on The Tax Blueprint.