Legacy Law Blog

When resolving a tax debt, the initial tax balance is only part of the overall balance that must be resolved. The penalties and the interest on the initial balance can grow over time to be a significant portion of the total tax due. These penalties are designed to encourage timely and accurate tax filing and payment.

For many taxpayers, a tax balance is the result of a significant life event that made filing or paying tax impossible or impractical for a period. For others, an entire history of timely tax filing and payment can be overshadowed by an unfortunate oversight for just one tax year.

Fortunately, the Internal Revenue Service (IRS) provides relief for taxpayers who meet certain criteria to be able to reduce or eliminate their tax penalties through a penalty abatement. Understanding the different types of penalty abatements and the qualifications for each can help taxpayers navigate the process more effectively.

First-Time Penalty Abatement (FTA)

A First-Time Penalty Abatement (FTA) is the most common and easiest to obtain penalty abatement. An FTA is a one-time waiver for taxpayers who have a good compliance history. Provided that a taxpayer filed the required tax returns of the same type as the return that generated the penalty and didn’t have any additional penalties for the prior three years, they are generally eligible for an FTA. This abatement applies to penalties for failure to file, failure to pay and failure to deposit.

If granted, the IRS will abate the penalties for the oldest tax year. For example, if a taxpayer has balances and penalties for 2019, 2020 and 2021 and is granted an FTA, the IRS will abate the penalties for the 2019 tax year.

Qualification Summary

• Clean Compliance History: The taxpayer must not have had any penalties for the three tax years prior to the tax year in which the penalty was assessed. Minor penalties that were later removed for reasons other than FTA do not count against this requirement.
• Filing Compliance: The taxpayer must have filed all required tax returns or extensions for the prior three years.
• Payment Compliance: The taxpayer must have paid, or arranged to pay, any tax due.

The easiest way to request an FTA is to call the IRS directly and request it over the phone. The IRS will review the transcript for the taxpayer, determine that the eligibility criteria are met and decide to grant or deny the request. This process is often very mechanical. If a taxpayer qualifies, the IRS will generally grant the FTA regardless of the size of the abatement.

An FTA can also be requested by mail. To do so, submit IRS Form 843, "Claim for Refund and Request for Abatement," to the IRS at the address provided on the form.

Reasonable Cause Penalty Abatement

A reasonable cause penalty abatement is available when a taxpayer can demonstrate that they exercised ordinary business care and prudence but were unable to comply with tax obligations due to circumstances beyond their control. Unlike the FTA, the IRS can grant a reasonable cause abatement for any available penalties.

The IRS will grant a reasonable cause abatement for the following reasons:

1. Death or serious illness: A taxpayer's spouse or immediate family member passes away shortly before the tax filing deadline, causing significant emotional distress and logistical challenges. The taxpayer or a close family member suffers a severe illness or injury that requires hospitalization or extensive medical care, preventing the taxpayer from meeting tax obligations.
2. Natural disasters or casualties: The taxpayer's home or business is affected by a natural disaster such as a hurricane, earthquake, flood or wildfire, leading to the loss of records and disruption of normal operations or the taxpayer’s records are destroyed in a fire or stolen.
3. Inability to obtain records: The taxpayer is unable to obtain necessary tax records from a third party, such as an employer or financial institution, despite making reasonable efforts to do so.
4. Mistake or misunderstanding: The taxpayer made an honest mistake in interpreting the tax laws or in the preparation of their tax return, despite exercising ordinary business care and prudence. The taxpayer relied on incorrect advice from a tax professional or the IRS, leading to a filing or payment error.
5. Undue hardship: The taxpayer experiences a significant financial hardship, such as a job loss or substantial reduction in income, that makes it impossible to pay the tax owed by the due date.

Qualification Summary

• Ordinary Business Care and Prudence: The taxpayer must demonstrate that they exercised ordinary business care and prudence but were unable to comply with tax obligations due to circumstances beyond their control.
• Supporting Documentation: Provide evidence such as medical records, death certificates or insurance claims to substantiate the claim.

Reasonable cause penalty abatements request approvals are heavily influenced by the facts and circumstances that caused the penalties. For this reason, taxpayers will be required to draft a written explanation and request for an abatement that is supported by all related documents, such as medical records, death certificates, or proof of natural disasters. This written request should be submitted to the IRS along with the supporting documentation and Form 843.

Administrative Waiver

Administrative waivers are granted by the IRS under specific programs or initiatives, often in response to widespread issues affecting many taxpayers. One notable example of an administrative waiver is the relief provided by the IRS in response to the COVID-19 pandemic. While not as common as an FTA or abatement for reasonable cause, an administrative waiver can still provide relief for taxpayers impacted by circumstances outside of their control.

Qualification Summary

• Specific IRS Programs: Certain administrative waivers are available under specific IRS programs or initiatives, such as disaster relief provisions.
• IRS Discretion: The IRS may grant administrative waivers based on policy decisions or special circumstances.

To request an administrative waiver, follow the specific guidelines provided by the IRS for the applicable program or initiative. This may involve calling the IRS or submitting specific forms as directed.

Statutory Exception

Statutory exception penalty abatements are provided under specific provisions of the tax code that allow for penalty relief in certain circumstances. A statutory exception penalty abatement can occur when a taxpayer receives incorrect written advice from the IRS and reasonably relies on that advice, leading to a penalty.

Qualification Summary

• Erroneous Written Advice: The taxpayer must have received written advice from the IRS that was incorrect.
• Reasonable Reliance: The taxpayer must have reasonably relied on the erroneous advice.
• Documentation: The taxpayer must provide a copy of the written advice and demonstrate how it led to the penalty.

Examples

• Penalties waived for newly retired or disabled individuals under certain conditions.
• Penalties waived if the taxpayer received incorrect written advice from the IRS and reasonably relied upon it.
• Late-filing penalties waived if the taxpayer can show they mailed or e-filed their return before the deadline.

To request a statutory exception, follow the IRS guidelines for the specific statutory exception being sought. This may involve submitting a written request or specific forms as required by the IRS.

Understanding these different types of penalty abatements and their qualifications can help taxpayers effectively manage and potentially reduce their tax penalties.