IRS Penalties and First Time Abatement

I drafted a letter this past Monday. Later in the day I saw a report from the Treasury Inspector General of Tax Administration (TIGTA) on the same topic. Serendipity.

We have a newer client who set-up an S corporation in 2011. That’s fine, except that he had not spoken with an accountant and did not meet us until April, when his individual tax return was due. This meant that his S corporation return was already late, as corporate returns are due a month earlier than individual returns.

Sure enough, he received a letter from the IRS asking for $195 – because the S corporation return was a month late.

So I drafted a letter that included the following magic words:

The taxpayer requests first-time abatement under IRM 20.1.1.3.6.1. Tax year 2011 was the taxpayer’s initial year of existence.”

The “IRM” is the Internal Revenue Manual.

The idea behind the first-time abatement (FTA) is “get out of jail free.” You haven’t had problems with the IRS before, and the IRS spots you a mulligan.

IRS penalties normally do not work this way. One usually has to provide “reasonable cause”for why one failed to file, pay or whatever. Penalties can add up. There are two common ones:

(1) The failure-to-file (FTF) penalty is usually 5 percent of the unpaid taxes for each month or part of a month that a tax return is late, not to exceed 25 percent. If you file the tax return more than 60 days late, figure the minimum FTF penalty to be the smaller of $135 or 100 percent of tax due.

(2) If you file but do not pay in full, then the failure-to-pay (FTP) is usually one-half of one percent each month or part of a month that the taxes remain unpaid. This penalty can be as much as 25 percent of the unpaid taxes.     

The IRS can abate both penalties if one shows reasonable cause. A top-of-the-line reasonable cause is to get hit by a bus and be in the hospital. As you can guess, the IRS does elevate the bar a bit for reasonable cause. “I was busy” is almost a guaranteed loser.

Let’s circle back to the FTA. You do not need to show reasonable cause; all you have to do is ask for it. And with that we have the following from the TIGTA report:

“Penalty waivers should not be granted only to taxpayers or preparers with knowledge of IRS processes,” said TIGTA Inspector General J. Russell George.

TIGTA estimated that for 2010, approximately 250,000 taxpayers with FTF penalties and 1.2 million taxpayers with FTP penalties qualified for FTA but not receive abatement. The reason? The taxpayers did not to ask for it. TIGTA estimated the unabated penalties at more than $181 million.

TIGTA is requesting that the IRS review its procedures for penalty assessment, especially with an eye toward first-time abatement. For example, perhaps the IRS could send a notice but immediately apply the FTA. It would inform the taxpayer of the penalty and abatement, thereby saving on IRS manpower and reducing the number of times folks like me have to write an FTA letter. Sounds like a winner.

Until then, remember that first-time abatement is available. Do not be one of the $181 million.