The IRS charges dozens of different types of penalties, but the three that we most commonly talk about are the late filing penalty, the late payment penalty, and the penalty for not making Federal Tax Deposits. These three penalties combined can add a whopping 65% to your total IRS bill. If your tax debt is more than two years old, you’ve maxed out all these penalties, and therefore over half your total debt is penalties.
The IRS does actually have a compassionate side, and it’s generally found in the penalty abatement process. Penalty abatement applications can also be appealed if initially denied, so you can always get a second set of eyeballs on the issue. The thing to keep in mind is that the IRS has very strict guidelines for granting penalty abatements, and these guidelines are referred to as “reasonable cause criteria”.
It should be noted up front that “we didn’t have the money” is NOT a reasonable cause criteria. A drop in revenue, by itself, is insufficient argument for obtaining penalty relief. Any request for penalty abatement simply citing the economic recession will be immediately denied.
Why is this? Here is the IRS’ logic: You made the money, and should have paid the taxes at the time on that money. If you are self-employed and receive a check, then you HAD the money, you simply didn’t give the IRS their chunk of it. Same goes with payroll taxes, particularly trust fund taxes (money you withhold from employee paychecks for income tax and Medicare/Social Security): If you had the expectation to pay some amount of wage, then you theoretically HAD the money sitting somewhere to pay that person, and should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have laid people off or cut back their hours.
There are ways to argue around this, and we have done so very successfully, but there has to be some other circumstance. For example, you had the money to pay the tax, but paying the tax instead of something else would have created an “undue hardship”. Examples could include a large medical expense that unpaid would have left a condition untreated, or a court ordered payment that would have resulted in other legal consequences, or a bill such as a large automobile repair which would have left you unable to work and resulted in job loss. These arguments are difficult to make and require significantly more work than standard reasonable cause criteria applications, but they CAN be won.
The primary IRS penalty abatement reasonable cause criteria center around natural disasters, loss or destruction of vital business records, bad advice from the IRS or an accounting professional, criminal activity, medical issues, substance abuse problems, and other serious circumstances.
We developed a standard list of questions to ask clients to assist us in preparing their penalty abatement. This list of questions should be given some serious thought before requesting penalty abatement, as you are more likely to get what you want if it covers one of these areas:
- Were any business records lost or destroyed?
- Were there any circumstances that led to a substantial drop in collecting on accounts receivable?
- Was there any transition in the business that lead to the failure to pay taxes?
- Was there a death or serious illness that directly affected the business or personal wages?
- Was there any embezzlement of funds, theft of valuable property, or identity theft?
- Were there any alcohol or drug abuse issues that affected the business or wage earning capability?
- Was there a natural disaster that impacted you or your business?
- Did you rely on the advice of a CPA or IRS employee in making tax decisions?
- Were there any circumstances that created substantial financial hardship, to the point where your business was close to going bankrupt?
These questions cover all of the IRS reasonable cause criteria to one extent or another, so finding an answer to your personal or business situation that covers one or more of these questions is the key to a successful penalty abatement application.