There may be errors in spelling, grammar, and accuracy in this machine-generated transcript.
Jeremy Wells: Wayne Lee, a Florida surgeon, hired a CPA named Kevin Walsh in 2017 to prepare and file his tax returns. In fact, he started working with Walsh before that to prepare and file [00:00:30] his 2014 through 2016 tax returns. Now, as a surgeon, Lee was actually making relatively decent money, and each of those years he wound up with a mid-six figure tax liability. In 2014, though, because of the payments he had made, he was actually due a pretty substantial refund and elected to have that refund [00:01:00] applied to future years. The idea being that he could roll over that refund into the 2015 and 2016 returns, and to offset any balances due from those years. Lee trusted Walsh. Provided Walsh with all the information that he needed to prepare and file those returns over the years, Walsh each year sent Lee a form 8879 IRS file signature [00:01:30] authorization to file the returns. So as far as Lee was concerned, Walsh was doing the job that Lee was paying him for meaning, preparing and filing all of those tax returns. And in fact, each of those returns, because of the payments that Lee was making, was due a six figure refund for each of those years. It turns out that the CPA, Kevin [00:02:00] Walsh, never informed Wayne Lee, his client, about a software issue that Walsh claimed prevented him from being able to e-file Lee's returns. So for those three tax years 2014, 2015, 2016, each of them with substantial tax liabilities and with six figure refunds due, Walsh never filed [00:02:30] any of those returns.
Jeremy Wells: Lead discovered the issue when an IRS agent showed up at his office on December 5th, 2018. Now remember, Lee hired Walsh to prepare his 2014, 15 and 16 returns, so that would have been somewhere around late 2014, early 2015, probably if they weren't already working together in years before that. So that's at least three years, almost four [00:03:00] years later, when Lee finally discovers that Walsh never filed his 2014 or 15 and 16 returns, Lee did not receive any letters from the IRS about those Unfiled returns, because his mailing address on file with the IRS was incorrect. And according to Lee, the client here, his CPA Walsh, never actually submitted [00:03:30] any address updates to the IRS, even though Walsh had promised Lee he would do so. So for years, we've got a situation where we have a CPA preparing but never actually filing returns, despite having e-file authorization signed by the taxpayer by Lee. We've got relatively large six figure refunds due for each of those tax years, and we have notices [00:04:00] piling up but not actually getting delivered to the taxpayer to Lee now, Lee ended up filing his 20 1415 and 2016 returns in December of 2018, about the time that he discovered the issue. But that meant that his claim for a refund of the overpayment from that 2014 return, which was $288,000, was outside the statute of limitations. [00:04:30]
Jeremy Wells: That's right. It had been more than three years since any of the payments toward his 2014 tax liability were recorded, and so he was supposed to get that refund of $288,000. That refund was supposed to be applied to later tax years, but because he did not claim that refund within the three year statute of limitations that was denied, and he [00:05:00] lost that refund. Now, if you're curious about how the refund statute of limitations works, or you're not sure what the three year rule is, go listen to episode number six of this show where I cover the refund statute of limitations. It's all about how that works. Once you listen to that episode, you'll understand why this was incredibly problematic for Lee. So instead of getting that $288,000 refund for his 2014 return and being able to [00:05:30] roll that over into future tax years instead, Lee ended up paying $289,000 to the IRS in 2019 to settle unpaid tax liabilities, plus penalties and interest for those tax years. Lee ended up suing Walsh and his firm. They ended up settling outside of court, could not find any details on the terms of that settlement. However, [00:06:00] it probably involves some money being paid back to Lee to cover probably at least the penalties and interest, if not some of that missed refund as well. However, Lee also sued the government in US District Court for a refund because Lee never responded to the notices that were sent regarding his 2014 through 2016 returns.
Jeremy Wells: The rules had passed as [00:06:30] far as when he could approach the Tax Court, and so instead, Lee took the option of paying the liabilities and then suing for a refund in US District Court. Now, the district court granted the government summary judgment motion, concluding that Walsh's failure to file timely returns was not reasonable cause under IRC section 6651. We're going to talk about what all that means [00:07:00] in this episode, because there are a couple different issues all combined here, and they all come back to a topic I want to cover in this episode on the delinquency penalties in section 6006 51 and administrative relief under what's called first time abatement. We'll also talk about reasonable cause and the differences between reasonable cause and first time abatement. So let's look at a few of these related issues in Lee's [00:07:30] case. First of all, what are the failure to file and failure to pay penalties? That's what ended up causing problems for Lee in this case. What are those penalties? What does IRC section 6006 51 tell us about those penalties? What relief can taxpayers use to avoid these penalties. In other words, once those penalties are assessed, what can the taxpayer do in order to avoid having to pay those penalties? [00:08:00] There are a couple of options. If the taxpayer qualifies, we'll talk about what those options are starting off with reasonable cause and what qualifies and what doesn't qualify as reasonable cause.
Jeremy Wells: We'll also look specifically at what the IRS offers in terms of first time abatement and how that can help taxpayers. And then we'll look at whether reliance on a tax professional fits in to any of this discussion. So let's jump right into IRC section [00:08:30] 6651 and look at these two common delinquency penalties. And if you've ever worked with a taxpayer as a tax professional, or if you as a taxpayer have ever been behind on your tax filings, then you should already be familiar with these two penalties. The first one is the failure to file penalty. This is under IRC section 6651 A. This applies for individuals and corporations in any [00:09:00] other entity that has to pay tax directly for pass through entities such as partnerships and s corporations. Those are covered under separate sections, although the penalties work very similarly, and they also are eligible for the relief that we're going to talk about later on. So I'll include these in the discussion as well. So that's IRC section 6698 for partnerships. Is the failure to file penalty for a partnership return or an IRS form 1065. And then for [00:09:30] S corporations it's IRC section 6699. And that has to do with a late filed form 1120 s or return for an S corporation. But mainly we're going to talk about 6651, a failure to file penalty and then also the IRC section 6650 1A2 failure to pay penalty.
Jeremy Wells: Often these two penalties go hand in hand because a lot of times when taxpayers are late to file, they're also late to [00:10:00] pay. However, they don't necessarily have to go together. You can timely file returns, but if you haven't paid your balance due by the due date, then you'll be subject to the failure to pay penalty. So we'll talk about how these two penalties interact with each other where they come from. So these penalties are assessed, collected and paid as additions to tax. And that's the phrasing you'll see in the IRC. In fact, IRC section 6651 [00:10:30] is titled Additions to Tax that comes under IRC section 6665. What does that mean? Why? Why? What's the important part here? Well, it's important because we have to think about these penalties as additions to the balance due. In other words, a couple of things happen one when a taxpayer makes a payment. That payment is applied to the balance due. It's not applied only [00:11:00] to the tax. It's also applied to any additions to tax coming from these penalties. The second, and probably the more important issue here is that because these penalties are considered additions to tax, any interest that is charged on a balance due over time and therefore accrues the additions to tax is included in the principal amount on which that interest is going to be charged and accrued. So not only [00:11:30] do you have the original balance due from the return, and we'll talk about what we mean by that in a little bit.
Jeremy Wells: But you also have the penalties that are assessed that are additions to that tax or to that balance due. And then the interest is assessed on that full amount or calculated on that full amount, and that amount accrues over time. Because of that, depending on the balance, due how much [00:12:00] the taxpayer owes, when the return is ever filed, the penalties and especially the interest can become relatively substantial. So it's important to understand these two penalties. Failure to file and the failure to pay penalty. It's important to understand them and also understand that just like the original tax balance due, there is an accrual of interest that applies to that complete balance due not [00:12:30] just to the tax amount, but to the combined tax and penalty amount. Now, failure to file for individuals under IRC section 6651 A1 along with other non pass through entities such as corporations. That penalty is 5% of the net amount due on the return for each month, or fraction of a month. The return [00:13:00] is not filed by the due date, including extensions. This is important to keep in mind. This is why we file six month extensions and that time period has changed over the years. Now it's a six month extension and if you properly file the paperwork, meaning that there is a form filed with a an estimate of the tax due, or if [00:13:30] the taxpayer makes a payment online through the IRS's website or through some other options, their FTP might also qualify.
Jeremy Wells: If the taxpayer makes that payment, then that also is treated as filing an extension. And that gets the a proper extension, gets the taxpayer an automatic extra six months to file the return. Notice that that is a six month extension of time to file. [00:14:00] We'll talk about payments in a minute when we get around to the failure to pay penalty. But for now we're focusing on failure to file. So if the taxpayer files a return timely meaning by the original due date, or if a proper extension is filed than by the extended due date, then the taxpayer avoids the failure to file penalty. However, if the taxpayer meets that deadline or the extended deadline, then there is a penalty imposed of 5% [00:14:30] of the net amount due on the return for each month or fraction of a month. The return isn't filed by the due date. Now that or fraction of a month is important here. If the due date of the return, let's say the normal due date is April 15th and no extension was filed on April 16th, that return is late and it's only late by one day, but it's late. And so it's late a full month. So a full 5% [00:15:00] of the net amount due on the return is added to the balance due, and therefore increases that balance due by by way of the failure to file penalty.
Jeremy Wells: So it's important to file tax returns on time. 5% is can be depending on the balance you a relatively substantial penalty, especially in comparison to the failure to pay penalty, which we'll talk about in a minute. [00:15:30] So in general, if we're advising taxpayers or if we're deciding whether to file our own return, the general rule here is always file the return on time if you can. Uh, unless there is some significant reason preventing you from filing that return, which we'll talk about reasonable cause a bit later on. But if you can file that return file the return, even if there is a balance due that you can't afford to pay, failure [00:16:00] to file the return will result in a significant, potentially significant penalty depending upon the balance due. Now, the penalty is not imposed if the failure to file is due to reasonable cause and not due to willful neglect, we'll talk about what reasonable cause means later on. Again, willful neglect is a tough bar to to to cross over, though. In other words, you as the taxpayer [00:16:30] have to prove that you didn't intentionally not file the return. Now, what does that look like? Well, imagine that you knew the return was due due on April 15th. It's April 15th, late in the evening. You know that you should have filed the return. You just never got around to it.
Jeremy Wells: Is that willful neglect? Probably. Do you have a significant reason that's going to rise to the level of qualifying as reasonable cause? Maybe we'll [00:17:00] talk about what it would take to achieve that later on. Now the net amount due of tax on the return means the tax liability shown on the return less any withholding credits. Estimated payments or any other payments made on or before the due date. That's the definition of net amount due given in IRC section 6651 B1. So that's critical. To keep in mind, we're thinking about the net amount [00:17:30] due on the return. What can often help taxpayers is making a payment, even if they can't file the return on time. Now, I understand that that contradicts what I just said, where we generally are recommending filing the return even if the taxpayer can't make a payment. But I don't think that those are actually contradictory statements. Let me explain that. So if we're working with a taxpayer and we're getting close to April [00:18:00] 15th or October 15th, if we're talking about an individual income tax return and we filed a six month extension, then we're always going to recommend that the taxpayer file the return on time if possible, even if there is a balance due and the taxpayer can't afford to pay that balance due, filing the return on time is always preferable over to not filing the return on time, because we avoid [00:18:30] the 5% failure to file penalty.
Jeremy Wells: Now, if we have a taxpayer that's coming up on April 15th for a 1040 for an individual tax return, and we know that there is a significant balance due. And we filed the six month extension. So we actually have until October 15th to file the return. But [00:19:00] we still only have until April 15th for the taxpayer to pay the balance due. Then we'll recommend that the taxpayer make a payment that will cover what we're projecting, or at least estimating the balance due to be. We'll talk about the failure to pay penalty in a minute, but that can help us mitigate any potential failure to pay penalties. And then even if for some unforeseen [00:19:30] reason, we can't file the return by October 15th by the extended due date. Then, even if there is a failure to pay and and failure to file penalty will be calculating those penalties on a much smaller net amount due because that payment was made by April 15th. The ultimate goal here, of course, is to file on time. But if we can't [00:20:00] for some reason file on time, even including extensions, then we're especially going to want to recommend to the taxpayer and advise the taxpayer as strongly as we can to minimize that net amount due as much as possible. That is what the penalty is actually calculated on. Now, in a minute I'm going to talk about the minimum penalty. And that will kick in.
Jeremy Wells: But we still want to make sure that we've got that net amount due as small [00:20:30] as possible. Now, it's important to keep in mind, especially when we get to the failure to pay penalty, to keep in mind that these penalties are capped. The aggregate penalty will not exceed 25%. So even though it's 5% per month for the failure to file penalty, that penalty normally, unless there is some exceptional circumstance here, that penalty normally will not exceed [00:21:00] 25% of the net amount due. Now, one of those exceptional situations is if the failure to file is fraudulent, if the taxpayer's failure to file is due to fraud. And at that point we're talking about criminal activity, then the penalty triples. So it goes from 5% per month up to 15% per month. And then that maximum goes from 25% up to 75% [00:21:30] of the net amount due, and that's under IRC section 6651 F. Now, the thing to keep in mind here is that if we're talking about fraud, then we're probably talking about not only several other penalties, but really just criminal activity. That's probably going to be way beyond the scope of just failure to file and failure to pay penalties. So that will definitely be part of the penalties that the taxpayer will have to [00:22:00] pay. There will probably be lots of other penalties, as well as criminal penalties that the taxpayer is going to have to worry about in that case.
Jeremy Wells: But it is important to keep in mind that if fraud is at play in the taxpayer situation, then the failure to file penalties due triple under those situations. Now, IRC 6651 A includes in the language of that subsection [00:22:30] a minimum penalty if the return is not filed within 60 days of the due date, including extensions. So even if there is a failure to file and there is no net amount due, then there is a minimum penalty assessed, which is the lesser of an inflation indexed amount, or 100% of the [00:23:00] tax shown on the return. Now this is not the net balance due. This is the tax shown on the return. Now those inflation indexed amounts for tax years 2025, 2026 and 2027 are $510, $525 and then $535, respectively. So you might wind up in a situation where the taxpayer is going to wind up paying some [00:23:30] amount of penalty, even if the net amount due, uh, is is relatively low. Uh, but it's still important to keep in mind that the failure to file and, uh, what I'm about to turn to here, the failure to pay penalties are generally based on that net amount. Uh, you however, in the case where you've got a taxpayer that has [00:24:00] relatively significant, uh, tax, even with no net balance due, there could still be a failure to file penalty assessed based on those minimum penalties. Now that's a failure to file penalty. Let's look at the failure to pay penalty.
Jeremy Wells: This is from IRC section 6650 1A2. That Paragraph imposes a penalty of 0.5% [00:24:30] of the net amount due on the return for each month, or fraction of a month, again, that the tax is not paid by the due date, including extensions. Now, stick with me for a second because I said including extensions. There is an extension of time to file for an individual tax return as well as other tax [00:25:00] returns, but that extension of time to file is never an extension of time to pay. And that is in Treasury regulation section 1.681 for C explicitly states that an extension of time to file an individual tax return does not extend the time to pay. It doesn't say that there is no way to extend the payment of tax, but there is no either [00:25:30] statutory or regulatory process for extending the time to pay. So this is why we often say, and when we're educating other tax professionals or especially taxpayers, that an extension of time to file is just that. It's an extension of time to file, not of time to pay. So what that automatic extension request does is it gives us six more months from the original deadline [00:26:00] to file a return to avoid the failure to file penalty, but it does not get us out of the failure to pay penalty. It's important to educate taxpayers, especially on this point. Now go back and compare the failure to file penalty to the failure to pay penalty.
Jeremy Wells: The failure to file penalty is 5% of the net balance due every month or part of a month. [00:26:30] The failure to pay penalty is 0.5%, or just one tenth of the amount of the net amount due per month, or part of a month. So again, back to what I was discussing earlier. When we're advising clients taxpayers, we always recommend that they file on time, even if there is a balance due. And really especially if there is a balance due, because we [00:27:00] want to avoid that 5% per month penalty that could rack up and be pretty substantial. However, not that 0.5% is okay. Uh, you know, it's never okay to pay a penalty if you can avoid it. However, if we have to choose within that six month window of that extension of time to file, we would much rather avoid a 5% penalty and pay a 0.5% penalty. [00:27:30] Why pay 5% when you only have to pay 0.5%? And that's why it always, in my opinion, always pays to file that extension. Now there is the counter-argument against filing extensions. Because they do extend statutes of limitations. They extend the refund statute of limitations, which can be helpful. But they also extend the assessment statute of limitations, which I suppose in certain circumstances could [00:28:00] work against the taxpayer. However, in general, for me and the clients that I work with, the extra six months to avoid the failure to file penalty is always, always, always, maybe with just an extremely isolated exception here and there is always going to be worth it.
Jeremy Wells: So we generally file extensions for every return that comes through. So uh, and uh, on top [00:28:30] of that, we also recommend estimated payments, especially safe harbor estimated payments. Of course, those deal with the underpayment penalty, which is a different penalty, uh, from what we're talking about here. But they also help mitigate the failure to pay penalty if those estimated payments are made by April 15th. And really, uh, we push tax projections and try to, uh, get an idea of what a taxpayer's net amount due would be well before April [00:29:00] 15th. In fact, we try to get that done, uh, before November, actually, of the tax year to give the client a about 5 or 6 months to be able to pay what we think that net amount due will be in order to avoid the failure to pay penalty as well. But always, always, always keep in mind that an extension of time to file is never an extension of time to pay. Now the penalty, just like the failure [00:29:30] to file penalty for failure to pay penalty, is not imposed if the failure to pay is due to reasonable cause and not due to willful neglect. Again, we'll talk later on about what constitutes reasonable cause as opposed to willful neglect. And again, just like with the failure to file penalty, the net amount due means the tax liability shown on the return less any withholding credits, estimated payments, and any other payments made on or before the due date.
Jeremy Wells: And that definition [00:30:00] comes from IRC section 6006 50 1B2. Now, the penalty for failure to pay increases from 0.5% to a full 1%, beginning on the earlier of the day. That is, ten days after the date on which a notice of levy is given, or the day on which notice and demand for immediate payment is given under a [00:30:30] jeopardy! Assessment. So it's important to watch those notices, especially if you have clients with balances due. In fact, we generally try. We don't always do this with every client, but we try to get authorization either under form 8821, which gives us, uh, access to transcripts or under form 2848, which is Power of Attorney. We try to get access [00:31:00] to the client's IRS account, and we always check the box to have notices sent to us so that if the taxpayer receives any notices, we get copies of those notices as well, because we definitely want to avoid doubling the failure to pay penalty. That is from IRC section 6651 D that those penalties double [00:31:30] in the case of a notice of levy or a notice and demand for immediate payment. Now the penalty decreases from 0.5% to 0.25% for any month during which an installment agreement is in effect. For the payment of tax that's under IRC 6651 H.
Jeremy Wells: So if you have clients, or if you're a taxpayer with a balance due that you can't afford to immediately pay off, then [00:32:00] always, always, always request an installment agreement from the IRS that effectively halves the failure to pay penalty. Now, it doesn't eliminate the accrual of penalty and interest on a balance due, but it does help by having that penalty. Uh, by by cutting that penalty in half, that could make a relatively significant difference in the total amount paid. Uh, [00:32:30] over time, if you're dealing with a relatively significant balance due now you have these two different penalties. You have 5% per month or part of a month for failure to file. You have 0.5% per month or part of a month for failure to pay. What happens if the taxpayer has both at the same time? So the return has not been filed on time and there is a balance due for that return. So if a taxpayer is [00:33:00] subject to both the failure to file and the failure to pay penalties, both penalties are imposed. But the amount of the failure to file penalty is reduced by the amount of the failure to pay penalty for each month that both penalties apply. That's IRC section 6651 C. So think about what that means. If you do not file an [00:33:30] automatic extension request in April, and so on April 16th, assuming a normal April 15th deadline filing deadline, then on April 16th, if there is an unfilled 1040 with a balance due, then there would be a 5% failure to file penalty.
Jeremy Wells: There would also be a 0.5% failure to pay penalty. However, the failure to [00:34:00] file penalty is reduced by the amount of the failure to pay penalty so that the combined penalty is still just 5% per month or part of a month. So effectively what happens is the failure to file penalty is knocked down to 4.5%, and the failure to pay penalty is 0.5%, so the combined penalty is 5%. This is also important to keep in mind. It can be helpful. Also, [00:34:30] the combined maximum penalty is still going to get up to that 25% for the balance due. But it's important to keep in mind that if there is a balance due and an unfilled return, that that 25% penalty, depending on the balance due could be substantial. That effectively is adding 25% of the balance due to that taxpayer's [00:35:00] effective tax rate. And depending on how much that balance due, if it's an unfilled return with a balance due, and especially if you're dealing with self-employed people where there is little or no withholding. If the taxpayer didn't make any estimated payments, didn't pay anything with the extension. So virtually all of the tax is a balance due. 25% of that could be a fairly significant hit for the taxpayer. [00:35:30] So it's important to file extensions. It's important to recommend estimated payments if you're dealing with, uh, business owners who have who own corporations.
Jeremy Wells: So they effectively are self-employed, but they're employed by their own businesses. It's important to use withholding to offset, uh, as much of their tax liabilities as possible through payroll. If you're advising them on payroll and reasonable compensation. So [00:36:00] there are several tools that we as advisors can use to try to minimize all of this for taxpayers. But at the end of the day, it's ultimately up to the taxpayer to pay their taxes on time and to get you the information you need to file their returns on time, even with extensions. And if you're going to file an extension, either have the taxpayer make a payment online so that they're effectively applying for their own automatic [00:36:30] extension, or have the information you need to run a projection, or at least provide some sort of reasonable estimate of their tax liability and therefore balance due for the year, so that you're filing a valid extension request for that taxpayer. Now, I also included partnerships and s corporations in the failure to file penalties here because these are pass through [00:37:00] entities and they don't generally pay income tax on their own. There's really no failure to pay penalty to worry about. But the flip side of that is that the failure to file penalties can be substantial, so IRC section 6698 imposes a failure to file penalty on partnerships. Irc section 6699 imposes a similar failure to file penalty on corporations.
Jeremy Wells: Now the penalty is an inflation indexed amount assessed per [00:37:30] month or again per fraction of a month, that the return is not filed by the due date, including extensions. Per partner or shareholder, and this is incredibly important to remember. By definition, a partnership has at least two partners. So if you have a late 1065, then whatever the penalty is, at minimum it will be [00:38:00] doubled. If you have three partners, it'll be tripled for partners quadrupled, and so on. So even a relatively small partnership of just a handful of partners could very quickly have significant penalties. With just a few months of a late filed return for an S corporation, because you could have a solo owned S corporation if and most of them are, most of our clients that are s corporations are just a single owner, then [00:38:30] the penalty, although it's still, uh, a significant amount and we still want to avoid it as much as possible. It doesn't rack up quite the same way, uh, that it does for a partnership. However, you could easily have more than one shareholder for an S corporation. You could have a partnership that elects S and then has multiple shareholders. So again, you have to remember that this is per shareholder or partner per month. The inflation indexed amounts for years 2025, [00:39:00] 2026 and 2027 are $245, $255 and $60, respectively. It's important to keep in mind that these amounts are assessed for the year in which the return is supposed to be filed, not the tax year of the return.
Jeremy Wells: The return in which the, uh, the year in which the return is supposed to be filed. So that penalty [00:39:30] will always be a little bit more than the tax year for what you think because it's inflation index. And typically that means it increases each year. So if you're if you have a late filed 2024 1065 or 1120 and you're filing that in 2025, then you're going to use the penalty amount from 2025, not from the tax year, not from 2024. So you have to look at the year in which you're filing [00:40:00] the return. This probably has to do with the logistics of the fact that so many partnerships are on a on a specific tax year for uh, or a fiscal tax year for the partnership. Also, uh, could have to do with the fact that partners can be on different tax years from the partnership itself, but the year in which the return is supposed to be filed is the year you use for the penalty. [00:40:30] Now let's get into what taxpayers can do about these penalties. Let's talk about penalty abatement. So generally relief from penalties falls into four separate categories unless otherwise specified in the Internal Revenue Manual. And this is this is where the IRS is going to extend uh penalty abatement. So in the IRS the essentially the IRS employee handbook right.
Jeremy Wells: It's operational handbook. This is where penalty relief where we're going to look at how the IRS [00:41:00] is going to process, uh, penalty relief. So the URM la. Lists four different types of relief in chapter 20, which is all about penalties and abatement. And if the taxpayer meets the criteria, then relief is offered in the following order. So first is a correction of an IRS error. If the IRS made a mistake, then the IRS will fix that mistake and will abate the penalty. Second is statutory [00:41:30] and regulatory exceptions. Third is administrative waivers, which we'll talk about first time abatement in a minute. And then fourth is reasonable cause. So notice that the IRS is going to apply its own administrative waiver. In other words FTA before it applies reasonable cause. Even though reasonable cause is provided for by statute. This is actually an issue that the National Taxpayer Advocate raised back in November of 2025 [00:42:00] when she spoke at the AICPA National Tax Conference. It's also an issue that is brought up in the Taxpayer Advocate Services 2024 objectives report to Congress. This incongruence between the fact that reasonable cause is provided by statute, and for some reason, IRS will apply its own administrative waiver ahead of reasonable cause. That doesn't seem fair to the taxpayer. Um, and in general, [00:42:30] there's an argument that it's not. But for now, that's the way the IRS processes, uh, penalty relief.
Jeremy Wells: Now, taxpayer can avail themselves of two main types of penalty abatement correction of IRS error or statutory and regulatory exceptions. Those are going to be automatic, uh, based on IRS catching the air or statute or regulation providing that exception. However, when it comes to administrative waivers or reasonable cause, those are going to be up to the IRS. And so [00:43:00] those are the two that the taxpayer is going to have to request. Now. Reasonable cause from the IRS's perspective is discussed in IRM 20.1 .1.3.2 IRM citations are just unwieldy like that, but that particular part of the IRM provides a breakdown of the major categories of acceptable cases for reasonable cause. So some of the specifically mentioned ways a taxpayer can try to demonstrate [00:43:30] reasonable cause includes death or serious illness of the taxpayer, or a member of the taxpayer's immediate family, or a key person responsible for filing or paying tax. Now, that key person responsible means somebody inside the organization, such as within a corporation or a tax exempt organization, for example, it does not mean a tax professional. And we'll come back to that here in a minute. [00:44:00] Fire, casualty, natural disaster, or other significant disturbances that directly cause the taxpayer's failure to comply could be eligible for reasonable cause abatement. A legitimate inability to obtain essential records after the taxpayer has made reasonable efforts to acquire the original documents or replacements. Now, this does not include poor or inadequate record keeping.
Jeremy Wells: The taxpayer just can't say [00:44:30] I didn't keep track of things, and so I don't really have access to the records. Now go back and listen to episode 13 of Tax in Action on what tax law considers sufficient record keeping. And I also give some tips in that episode about how to encourage and provide services to clients, to get them to have sufficient record keeping, and also with a focus on not becoming a bookkeeper yourself. If your tax professional who's not interested in doing bookkeeping. Obviously, [00:45:00] having a bookkeeper for small business owners is is going to help with record keeping and, and, uh, having sufficient records for the IRS. However, when that's not the case, then in that episode, I discussed some ways to encourage good record keeping habits, uh, and why those are important based on existing tax law. Another way to qualify for reasonable cause is reliance on erroneous written advice from the IRS [00:45:30] that is specifically addressed to the taxpayer's facts. Now, general reliance on IRS guidance does not qualify. And so this is why I remind colleagues, as well as taxpayers, that information on the IRS website or in IRS publications is not authoritative. Now, there are some IRS publications that are such as revenue rulings, revenue procedures. And if you are the A taxpayer. Then something like [00:46:00] a private letter ruling is authoritative for you. However, relying on any advice, either oral or written but not addressed directly to the taxpayer is not authoritative and it's not going to qualify for reasonable cause if reliance on that advice causes an issue in the taxpayer's filing.
Jeremy Wells: And then finally, ignorance of the law, but only if the taxpayer meets [00:46:30] certain criteria. In other words, had no prior filing requirement exercised ordinary business care to learn the law and the issue is genuinely complex or obscure. This is the flimsiest, probably of all of these when it comes to qualifying for reasonable cause. I would be very careful with this. Ignorance of the law generally is not a good excuse. However, it is specifically provided for in the URM as a potential qualifier for reasonable [00:47:00] cause, but it's going to be rare. It's going to be rare to convince the IRS, or especially a court, that the issue was complex or obscure, and so the taxpayer decided to try to learn the law and actually exercised ordinary business care, learning the law on his or her own. Yet never actually consulted a professional. I would have a hard time making and buying that argument. Now, specifically, reasonable [00:47:30] cause does not include reliance on attack. Professional reasonable cause requires the taxpayer to demonstrate that he or she exercised ordinary business care and prudence, but was nevertheless unable to file or pay within the prescribed time. This includes circumstances beyond the taxpayer's control, such as a debilitating illness. However, if the taxpayer remains demonstrably competent enough to carry on other transactions [00:48:00] than reasonable cause won't work.
Jeremy Wells: This is in chief counsel advice 20 1116 oh 18 and this includes working with a tax professional. So you can say that due to some debilitating illness or injury, that you can't file your returns on time. However, if working with a professional, uh, is part of that, then it's going to be difficult to [00:48:30] say that either you or the professional were incompetent enough to not be able to actually file and pay on time. Now, in a seminal Supreme Court ruling on this question, US v Boyle 469, US 241. This was in 1985. The Supreme Court actually reversed an appeals court decision in favor of the taxpayer. The appeals court ruled in favor of the taxpayer. The Supreme Court overturned that in favor of [00:49:00] the government, because the taxpayer relied on an attorney to prepare and file an estate tax return. The attorney missed the filing deadline, and the court held that a taxpayer cannot delegate filing and payment deadlines to a tax professional. Moreover, reliance on a professional doesn't earn the taxpayer a reasonable cause exception. The district court, the appellate court, argued and found on behalf of the taxpayer [00:49:30] that the taxpayer could in fact claim a reasonable cause exception to penalties if the tax professional did not file on time. The Supreme Court overturned that and essentially held that you cannot delegate those responsibilities as a taxpayer, even if you rely on a tax professional. And that tax professional tells you that the professionals doing what they promised to do, you still cannot rely on that when it comes to these [00:50:00] penalties to late filing and late payment penalties.
Jeremy Wells: Now, the 11th Circuit applied this position from Boyle to Wayne Lee's case that I discussed at the top of the episode in Wayne Lee v us. Uh, this is in the 11th circuit. Uh, in 2023, the appellate court found that e-filing does not change the taxpayer's duty. This was the argument. Uh, the main argument that Lee tried to make in district court and then in the appellate [00:50:30] court, that e-filing changes the logic of Boyle, that Boyle doesn't hold to e-filing. The appellate court rejected this argument. It doesn't matter how the returns are filed, it doesn't matter how the information is distributed, how the information is transmitted to the IRS. E-filing doesn't change the taxpayer's duties. These courts are not sympathetic to technology based excuses. Basically is one of the key takeaways here from Wayne. Leave us [00:51:00] reasonable cause is narrow and difficult to demonstrate in court. It's a legal defense. It's not a plea. It's not an equitable plea. Don't take reasonable cause to the courts hoping to get a, uh, you know, a fair deal or what you think is a fair deal from the courts. Generally, reasonable cause is not going to get very far unless you have a pretty significantly compelling story for the courts. Now, that said, reasonable cause is just one way that a taxpayer can try to, [00:51:30] uh, get a penalty abated.
Jeremy Wells: The other way is administrative relief offered by the IRS through what's called first time abatement. And again, go to chapter 20 of the IRS. There's an entire section on first time abatement. It's an administrative waiver under IRS policy. It's not provided for in either statute or regulations, covers three types of penalties the failure to file and the failure to pay penalties discussed earlier in the episode. [00:52:00] It also includes the failure to deposit penalty, which is similar but different, one penalty that is not covered by first time abatement, or really any other of these types of abatement is the underpayment penalty, and that's a separate type of penalty that is assessed on any underpayment for an individual tax return that has had not enough withholding and payments made for each of those quarterly [00:52:30] payment deadlines. It's a separate penalty. Fta does not apply to the underpayment penalty. It only applies to the failure to file, failure to pay, and failure to deposit penalties. Now, to qualify, the taxpayer has to meet specific eligibility criteria. Taxpayer has to have have a clean penalty history for three prior years, taxpayer has to have filed all required returns and has to have paid the tax or have a payment arrangement in [00:53:00] place. That three year rule is critical to understand, and this changed in early 2023. I've heard tax professionals say that they want to avoid using first time abatement on a relatively small penalty in order to be able to save it for a future penalty.
Jeremy Wells: That strategy does not work, and it hasn't worked since early 2023. And here's why. The taxpayer has to have a clean record, meaning [00:53:30] no unreversed penalties within the last three years. So if you have a taxpayer with a relatively small penalty and you don't ask for first time abatement, and then the following year they get an even bigger penalty, guess what? First time abatement is not available because it should have been used on that first penalty. So don't think you can save first time abatement. According to the AIA, as it's revised [00:54:00] in March of 2023. That strategy is no longer viable. Now, it's important to keep in mind that a penalty can't be abated before it's assessed. So wait, if you know that a taxpayer is going to be assessed a penalty because you know the return was filed late, you know the payment was made late, wait until the taxpayer receives a notice such as a CPE 14 or CPE 162, but let the taxpayer know to send you a copy of that notice as [00:54:30] soon as they get it. Have them watch the mail, or even better, get a form 88, 21, or 2848 authorization and make sure that you check the box to have notices forwarded to your office as well. Then immediately Advise the taxpayer on either how to request relief or if you include notice response in your paid services.
Jeremy Wells: Then either send in a response or for a quicker resolution, then [00:55:00] call the Practitioner Priority Service. And as long as you've got either that power of attorney or you've got third party authorization through the tax return itself, you should be able to request abatement on the taxpayer's behalf. Avoid waiting until the taxpayer receives collection notices if possible. Now, taxpayers don't always send us the notices that they get, but if you've got the notices in hand, then try to respond to that notice or call as quickly [00:55:30] as possible. Now, in November of 2025, as I mentioned, the National Taxpayer Advocate, Erin Collins announced at the AICPA National Tax Conference that the IRS will begin automatically applying first time abatement to eligible penalties for tax year 2025, in 2026. Until then, FTA is still manual and the penalties wouldn't be assessed until April 15th of 2026 anyway. So we're going to [00:56:00] have to wait probably until the summer of 2026 to see this kick in. But know that according to the Taxpayer Advocate Service and National Taxpayer Advocate, automatic FTA is on the way. Penalty abatement is really less about proving innocence and more about understanding the timing, the procedures and how the IRS operates in terms of penalty abatement. I strongly recommend reading through IRM section 20 or chapter 20, and understanding [00:56:30] the IRS position on penalties and how penalty abatement works.