If your tax problems result from your not having filed your federal income tax return, three specific penalties will likely be assessed by the IRS when you file your delinquent returns. These are the failure-to-pay penalty, the failure-to-file penalty and the estimated-tax penalty.
The non-filing and non-payment penalties can be waived for reasonable cause when circumstances beyond your control explain not filing your tax return.
Unfortunately, at the time you file your delinquent tax returns, more often than not the Internal Revenue Service will calculate and assess these delinquency-related penalties and you must then request that the IRS consider a waiver of the penalty assessment.
Failure To Pay Penalty
Under Internal Revenue Code (“Code”) Section 6651(a)(2), you have to pay a penalty for failing to pay the amount shown as tax on any return. The penalty is ½ percent of the amount of tax shown on the return if the failure to pay is for not more than one month, with another ½ percent for each additional month or fraction of a month, a penalty amount not to exceed 25% in the aggregate.
The failure-to-pay penalty is increased from ½ percent to one percent through the remaining maximum 25%, 10 days after IRS notice and demand is given to the taxpayer, as provided in Code Section 6651(d).
If both the penalty for late filing under Code Section 6651(a)(1) and the penalty for late payment under Code Section 6651(a)(2) are imposed, the late-filing penalty will be reduced by the amount charged for late payment. As a result, the maximum amount of both penalties is 47.5%.
Tax returns prepared by the IRS will incur the failure-to-pay penalty as if the tax return was a return filed by you – the taxpayer. You are still liable for the failure-to-file penalty since it will not be tolled by the preparation of a substitute return.
When you enter into an Installment Agreement under Code Section 6159, Code Section 6651(h) provides that if a penalty is being assessed for failure to pay with regard to a timely filed return, the penalty will be computed at ¼ percent monthly instead of ½ percent monthly. The maximum penalty of 25% remains the same.
A failure to pay estimated tax results in assessment of the estimated tax penalty under Code Section 6654. This penalty is in the nature of nondeductible interest for the period for which an estimated payment was not made. “Reasonable cause” does not apply to this penalty as a way by which to have it waived. This penalty will not be assessed if the tax due on the return is $1,000 or less, or there was no tax liability for the previous year.
The rate for the estimated tax penalty is determined under Code Section 6621 (the underpayment interest rate times the amount of the underpayment for the period of the underpayment). This rate is determined quarterly. Even if you request a refund you can still be subject to the estimated tax penalty because the penalty is determined based on the requirement to make timely payment during each quarter.
Penalty For Failure To File
This penalty is calculated on the net amount of tax due and on the number of months for which the return is filed late. The penalty is 5% of the amount of tax due if the failure to file is not more than one month. Another 5% is charged for each additional month or fraction thereof, not to exceed 25%. Code Section 6651(a)(1) is the penalty for failure to file a tax return.
The penalty is calculated on the amount of tax required to be shown on the return less payments and credits. As a result, a return that requests a refund is not subject to the penalty. However, a minimum penalty exists for failure to file income tax returns which is the lesser of $1,000 or 100% of the amount required to be shown as tax on such return if the return is not filed within 60 days of its due date.
When the failure to file a return is fraudulent, Code Section 6651(f) increases the penalty for a fraudulent failure to file by substituting 15% for 5% and increasing the maximum penalty to 75%. IRS has the burden of proving fraud.
Those who fail to file tax returns generally do not pay the tax either. It is common for non-filers, especially those who simply stop filing returns, to request an IRS extension. Often, those who request these extensions make no payment at all toward the tax liability. This results in imposition of the failure-to-pay penalty, despite properly submitting to the IRS an extension to file.
Properly submitting to the IRS an extension does not avoid the failure-to-pay penalty and interest charges.
Waiver of Penalties
If you haven’t filed your tax returns and then decide to do so, attempt to have penalties waived for reasonable cause. The determination of reasonable cause requires an examination of all facts and circumstances. Emphasize your use of ordinary business care and prudence. Perhaps some of the following items may be helpful in demonstrating reasonable cause:
The circumstances beyond your control;
The dates and explanation, which should clearly correspond with the events on which the penalties are based;
The length of time for non-compliance; and
Prior compliance history.
Beyond these items, the IRS may look at the attempts you made to comply. Death, serious illness, or your unavoidable absence may establish reasonable cause. The unavailability of funds to pay any tax is generally not considered grounds for waiver. Reliance upon a competent tax professional to prepare and file a tax return may not necessarily prove reasonable cause.
Once the Service Center has processed any delinquent tax returns and assessed penalties, you will have the opportunity to protest the penalty assessment. An administrative procedure exists to have post-assessment penalties reviewed by the IRS Appeals Branch without full payment and without filing a refund claim.
If – and that is a very big if – the Service Center agrees, the penalties will be abated.
Most of the time you will be sent a form letter that explains the reason for denial, along with instructions to submit a written protest to the Service Center Penalty Appeal Coordinator. Next, your protest will be sent to the IRS Appeals Branch Office. The Appeals Officer will review the file and will hear the appeal on its merits.
When the penalties have been assessed, you can also avail yourself to the Penalty Appeal Process by filing Form 843 (Claim For Refund Or Abatement) and marking the form “Penalty Appeal.” The grounds for reasonable cause waiver should be stated in full. This penalty appeal will be handled by the IRS Appeals Branch. The form can be filed with a Revenue Officer, if one is involved, or with the IRS Service Center. The IRS will often require that you pay all non-disputed tax and interest before it will consider a waiver of penalties.
If you are having tax problems of this nature and would like to consult with a tax attorney, call Mitchell A. Port at (310) 559-5259.