The COVID-19 pandemic caused 2020 to shape up as one of the most difficult years ever for taxpayers and tax practitioners alike. Taxes and other financial matters have also been significantly complicated by new relief provisions, both for tax professionals to interpret and advise clients on and for the IRS to execute and enforce. Nationwide shutdowns and a historic volume of unopened IRS mail add to these complexities as the IRS's automatic notice stream continues to churn out notices and its services continue to be limited.
These extenuating circumstances likely mean that practitioners will need to help more clients than usual with IRS penalty and collection issues. Here are some strategies and best practices that practitioners should keep in mind when requesting penalty abatement from the IRS on behalf of clients.
TALKING THE 'IRM' TALK
It's important to understand and refer to the IRS's Internal Revenue Manual (IRM). This administrative handbook explains the procedures IRS employees should follow in the course of their work. Part 20 of the IRM discusses penalties and interest. Specifically, IRM Section 126.96.36.199 (10/19/20), Criteria for Relief From Penalties, spells out the four categories of penalty relief:
- Correction of IRS error;
- Statutory and regulatory exceptions;
- Administrative waivers (e.g., first-time penalty abatement); and
- Reasonable cause.
The underlying guidance for each category in the IRM gives practitioners the criteria they need to fight penalties effectively for their clients. And quoting IRS language (and providing the IRM citation) in a penalty abatement request can often help the IRS process the request more quickly and improve the taxpayer's odds for a successful penalty abatement.
FIRST-TIME ABATEMENT AND REASONABLE-CAUSE DEFENSES
Though corrections of errors and statutory/regulatory exceptions are certainly viable options in certain circumstances, practitioners are likely finding their go-to penalty abatement defenses are either the first-time penalty abatement waiver (an administrative waiver) or reasonable cause.
As a refresher, first-time penalty abatement is based on a clean compliance history and can be applied only against failure-to-file, failure-to-pay, and failure-to-deposit penalties. It does not apply to other types of penalties, such as the accuracy-related penalty. Essentially, it helps taxpayers who have an isolated, rare filing/payment compliance issue. But it is only available to use once every three years, meaning taxpayers should use it conservatively and weigh the dollar amount of the penalty carefully so as to potentially preserve this option. See the AICPA Tax Section's IRS First-Time Penalty Abatement page for more guidance.
Reasonable cause is a facts-and-circumstances test where taxpayers spell out their situation and try to prove how they exercised ordinary business care and prudence. Many types of penalties allow for reasonable-cause defenses (and a reasonable-cause defense can be applied to multiple tax years/periods). The IRM describes categories of reasonable cause, several of which may be invoked for COVID-19—related issues and complications:
- Death, serious illness, or unavoidable absence (IRM §188.8.131.52.2.2.1): For example, the taxpayer could have been sick or caring for a loved one with COVID-19.
- Fire, casualty, natural disaster, or disturbance (IRM §184.108.40.206.2.2.2): COVID-19 was declared a natural disaster.
- Unable to obtain records (IRM §220.127.116.11.2.2.3): Office closures and shutdowns may have prevented taxpayers from obtaining their records on time.
- Erroneous advice or reliance (IRM §18.104.22.168.2.2.5): Tax legislation came out quickly, yet guidance sometimes lagged, making it hard to effectively advise clients.
It's noteworthy that COVID-19's having been declared a natural disaster may help with proving reasonable cause. On March 13, 2020, President Donald Trump declared a nationwide emergency pursuant to Section 501(b) of the Robert T. Stafford Disaster Relief and Emergency Assistance Act, P.L. 100-707, to avoid governors' having to request individual emergency declarations. All 50 states, the District of Columbia, and four territories have been approved for major disaster declarations to assist with additional needs related to COVID-19.
Often, a compelling reasonable-cause defense may argue multiple categories in the IRM to showcase how the taxpayer's circumstances were complicated but the taxpayer nonetheless exercised ordinary business care and prudence.
TAXPAYER RELIEF INITIATIVE
The IRS in November announced a new program, the Taxpayer Relief Initiative, to help taxpayers who are unable to pay their taxes because of the pandemic (News Release IR-2020-248). Taxpayers who can't pay their tax debt have always had options such as short-term extensions, installment agreements, and offers in compromise, but now they have more flexibility with these agreements. The initiative also highlights reasonable-cause and first-time penalty abatement options to help with penalties.
Tip: For clients who need a payment arrangement, it's wise to wait until the tax is paid in full before requesting penalty abatement. The failure-to-pay penalty will continue to accrue until the tax is paid in full. Thus, to help clients get the entire penalty removed (and not just a piece of it), wait until the balance is paid off to request abatement of the full penalty.
A COLLABORATIVE PROCESS
Remember that those who don't request penalty abatement won't receive it. Many penalty issues can be resolved fairly quickly over the phone with the IRS; other issues may require a straightforward letter to the IRS.
And don't forget that the IRS's Independent Office of Appeals is always a viable option if the issue can't be resolved through normal channels. Appeals employees have more flexibility with penalty abatement, as they are instructed to apply the "hazards of litigation" standard. Also, for special circumstances that can't be resolved with the IRS, the Taxpayer Advocate Service is there to help (see "Tax Practice Corner: Enlist an Ally in TAS," JofA, Jan. 2021).
As we navigate this unprecedented time, the AICPA continues to advocate for streamlined and improved penalty abatement procedures, and the IRS continues to work collaboratively with tax practitioners and taxpayers. Fortunately, the IRS has now expanded the avenues by which taxpayers may defend against or seek abatement of tax penalties. Tax practitioners who understand how to conduct their clients along these routes to obtain penalty waivers will be performing a much-appreciated service.
Susan C. Allen, CPA/CITP, CGMA, is an AICPA senior manager—Tax Practice & Ethics. To comment on this article or to suggest an idea for another article, contact Paul Bonner, a JofA senior editor, at Paul.Bonner@aicpa-cima.com or 919-402-4434.
AICPA member and Tax Section resources
- COVID-19 IRS Penalty Abatement Template (free to all AICPA members)
- IRS Penalty Abatement Templates (free to AICPA Tax Section members): template letters for first-time and reasonable-cause penalty abatement requests
- Federal Taxpayer Penalties Guide (free to AICPA Tax Section members): Learn about common federal tax penalties assessed by the IRS and how to explain penalty abatement options to clients.
- IRS First-Time Penalty Abatement: general background and guidance
- "Tax Practice Corner: Abating IRS Penalties," JofA, Jan. 2017