Avoiding IRS Penalties

Don’t get caught by surprise:
A particularly surprising penalty to many taxpayers caught for the first time, is for the late filing of a “no-tax” tax return of an LLC, partnership or s-corporation: Forms 1065 and 1120S.

The penalty is $195 for each participant / owner who was there at any time during the tax year, for each month or part of a month the return was filed late, for up to 12 months. Maximum $2,340 per Schedule K-1.  Filing an extension to September 15th sometimes means the month count starts with September, other times the IRS rolls it back to March (or April for a Form 1065 due before 2018)

Another surprising penalty is that RSED requires that a non-filer of Form 1040 forfeits all tax overpayments after three years.  There is generally no exception to allow a waiver or abatement of this penalty.



Relief from penalties falls into these categories:

  1. Reasonable Cause
    1. Including Rev. Proc. 84-35 small partnership late filing penalty waiver.
  2. General Penalty Relief – including disaster relief
  3. Statutory Exceptions or Administrative Waivers
    1. Including First Time Abate
  4. Correction of an IRS error
  5. Appeals
    1. third-party full or partial abatement of penalties (Appeals settlement usually involving a bulk or batch filer with one penalty issue, but multiple taxpayers)
    2. hazards of litigation, or other Appeals settlement, when the entire penalty is abated
    3. penalties are sustained by Appeals
    4. partial abatement (Appeals settlement where only part of the penalty is abated).


Ignorance of the law is not ordinarily considered an excuse worthy of abatement.
Nor are mistakes and nor is forgetfulness.



Rev. Proc. 2016–13 Adequate Disclosure Revenue Procedure Renewal
This revenue procedure identifies circumstances under which the disclosure on a taxpayer’s income tax return with respect to an item or position is adequate for the purpose of reducing the understatement of income tax under section 6662(d) of the Internal Revenue Code (relating to the substantial understatement aspect of the accuracy-related penalty), and for the purpose of avoiding the tax return preparer penalty under section 6694(a) (relating to understatements due to unreasonable positions) with respect to income tax returns.

This revenue procedure does not apply with respect to any other penalty provisions (including but not limited to the disregard provisions of the section 6662(b)(1) accuracy-related penalty, the section 6662(b)(6) accuracy-related penalty and the section 6662(i) increased accuracy-related penalty in the case of nondisclosed noneconomic substance transactions, and the section 6662(j) increased accuracy-related penalty in the case of undisclosed foreign financial asset understatements). If this revenue procedure does not include an item, disclosure is adequate with respect to that item only if made on a properly completed Form 8275 or 8275–R, as appropriate, attached to the return for the year or to a qualified amended return. See Treas. Reg. § 1.6664–2(c) for information about qualified amended returns.

This revenue procedure applies to any income tax return filed on 2015 tax forms for a taxable year beginning in 2015, and to any income tax return filed in 2016 on 2015 tax forms for short taxable years beginning in 2016



Excessive penalty & interest abated and some of the previously paid portion of the penalty & interest was refunded

In this case the IRS abated an assessment of penalty and interest, pursuant to IRC §6404(a)(1), because it was deemed to be excessive considering an amended return that was filed more than three years after the original return.  Normally, RSED says that tax cannot be refunded after three years, and normally the penalty and interest are not refunded following the filing of an amended tax return.  But in this case, the penalty and interest actually paid after the original tax return and paid within two years of filing the amended tax return, was refunded to the taxpayer.  see Chief Counsel Advice 5/15/2015 CCA 201520010


IRS – Penalties at a Glance

Understanding your CP71 Notice from the IRS

IRS Penalty Handbook

Exhibit 20.1.1-2 Penalty Reason Code Chart

IMF RC BMF RC PRC Definition/ Relief Criteria
062 062 022 Normal business care and prudence followed, but taxpayer was still unable to comply due to circumstances beyond their control. Generally used when the taxpayer establishes a single circumstance prevented compliance. See IRM 20.1.1.3.2.2
062 N/A 024 IMF – Death, serious illness, or unavoidable absence of the taxpayer or a member of their immediate family. IRM 20.1.1.3.2.2.1
062 062 025 Records inaccessible / Unable to obtain records / Records destroyed by fire or other casualty. IRM 20.1.1.3.2.2.3
N/A 062 026 BMF – Death, serious illness, or unavoidable absence of the person responsible for filing and/or paying taxes (i.e., owner, corporate officer, partner, etc.) or a member of their immediate family. IRM 20.1.1.3.2.2.1
062 062 030 Other – Combination of mistakes. Normal business care and prudence followed, but documentation shows non-compliance was due to circumstances beyond the taxpayer’s control. IRM 20.1.1.3.2.1
062 062 046 Y2K Relief.
N/A 062 071 Limited to Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation (MFT 44) – Allows a private foundation reasonable cause for FTF and FTP 90 days after it received a determination letter from the Service stating the organization is a private foundation or it cannot be expected to be a public charity.
N/A 062 072 Membership organization (MFT 67) has no full-time employees responsible for administering finances and was unable to timely file due to little continuity or understanding of duties due to frequent officer changes. Normal business care and prudence.
N/A 062 073 Membership organization (MFT 67) has no full-time employees responsible for administering finances and has no prior history of late filing and claims ignorance of the requirement.

 


T.C. Memo. 2015-203 discussing the 20% section 6662(a) accuracy-related penalty when there is an understatement of tax of the lower of 10% or $5,000 vs. an underpayment / deficiency of the lower of 10% or $5,000.