The IRS penalizes taxpayers for failing to timely file their federal income tax returns or for failing to timely pay their federal income taxes, pursuant to IRC Secs. 6651(a)(1) and 6651(a)(2), respectively.
Tax returns for partnerships and S Corps are due on March 15th of the year succeeding the taxable year. Tax returns for individuals, C corporations and trusts are due on April 15th of the year succeeding the taxable year. Tax payment due dates follow taxpayers’ return filing deadline. While a taxpayer can get up to a six-month extension on its filing deadline, payment deadlines cannot be extended. The penalty computation is based on the amount of a taxpayer’s tax liability that remains outstanding as of the tax payment due date.
The penalty for late filing a tax return is a monthly charge of 5% of the taxpayer’s outstanding tax liabilities starting from the first month that the taxpayer failed to timely pay its taxes. However, the total penalty can not to exceed 25% of the taxpayer’s unpaid tax liability for the year. The penalty for late paying an income tax obligation is a monthly charge .05% of the taxpayer’s outstanding tax liabilities starting from the taxpayer’s tax payment due date. The delinquent payment penalty cannot exceed 25% of the taxpayer’s outstanding tax liability for the year. If both the failure to file and failure to pay penalties apply for the same month, then the maximum penalty due for that month will be 5%.
Taxpayers are also liable for interest on unpaid taxes and unpaid penalties. Consequently, taxpayers who fail to timely file and fail to timely pay their federal income tax obligations will be liable for interest on the unpaid tax, for penalties on the unpaid tax and for interest on the unpaid penalties.
Taxpayers have two alternatives for seeking an abatement of their delinquency penalties namely “first time abatement (“FTA)” and “reasonable cause”. Under the FTA, the IRS can abate delinquency penalties assessed against a taxpayer if the taxpayer has not incurred any delinquency penalties during the three years prior to the year a delinquency penalty is assessed. However, once a taxpayer has penalties waived under FTA, the taxpayer cannot avail itself of FTA for another three years.
The IRS will also waive delinquency penalties where a taxpayer can show that the taxpayer acted in “good faith” and had “reasonable cause” for the delinquency. A taxpayer has reasonable cause if a taxpayer can show that the taxpayer exercised ordinary care and business prudence in a good faith attempt to timely compute and pay the correct amount of tax. A determination regarding reasonable cause is made on a case by case basis taking into account the efforts the taxpayer made to meet its federal income tax obligations along with considerations regarding the taxpayer’s experience, knowledge and education. For example, an American tax attorney might be held to a different standard of care than an artist who was born and educated in a foreign country and did not complete high school.
Further, courts also look at “mitigating factors” which are factors that prevented the taxpayer from timely meeting federal income tax obligations. These factors can include a major illness or trauma experienced by the taxpayer or someone close to the taxpayer that disabled the taxpayer from timely meeting its obligations. Other factors could include accidents, storms or explosions that destroyed records or prevented the taxpayer from obtaining necessary records despite the taxpayer’s best efforts.
A taxpayer also has reasonable cause where the taxpayer relied on the faulty or incompetent advice of a tax professional. Hiring tax professionals and advisors indicates that a taxpayer has taken great efforts to correctly compute its income tax liabilities. However, a taxpayer cannot delegate away its tax obligations. In other words, all taxpayers know that they need to file and pay income taxes on annual base. Taxpayers cannot shelter themselves from delinquency penalties by hiring tax professionals to file and pay taxes for them. If a taxpayer’s tax professional fails to timely file or pay income tax on behalf of a taxpayer, then the taxpayer remains liable for delinquency penalties. However, the IRS may consider the extent to which the taxpayer remained in communication with its tax advisors regarding its income taxes. For example, the IRS will be less likely to abate delinquency penalties for a taxpayer who engages a business manager to handle all of their tax obligations and does not participate in his or her tax preparations than a taxpayer who engages a tax preparer and remains in contact with the tax preparer, constantly inquiring about the status of their tax return and receives an erroneous letter from the tax preparer stating that the taxpayer’s income tax return was filed.
Penalty abatement is a complex area of tax law. A successful penalty abatement request requires a comprehensive explanation of why the taxpayer failed to timely file and/or timely pay federal income taxes. The explanation should include a description of the taxpayer’s background, efforts to correctly compute and pay its federal income taxes and mitigating factors that may have derailed the taxpayer’s best efforts along with an analysis of the relevant tax law.