Civil Penalties exist for the purpose of encouraging voluntary compliance and support the public conviction that the tax system is fair and the penalty is in proportion to the severity of the non-compliance. In a way, civil penalties assure compliant taxpayers that tax offenders
are identified and punished.
Below, please find the requirements for IRS penalties:
The IRS has to apply penalties equally in similar situations. Taxpayers base their perceptions about the fairness of the system on their own experience and the information they receive from the media and others. If the IRS does not administer penalties uniformly (guided by the applicable statutes, regulations, and procedures) overall confidence in the tax system is jeopardized.
The IRS must arrive at the correct penalty decision. Accuracy is essential. Erroneous penalty assessments and incorrect calculations confuse taxpayers and misrepresent the overall competency of the IRS.
IRS employees are responsible for administering the penalty statutes in an even-handed manner that is fair and impartial to both the government and the taxpayer.
Taxpayers must be given the opportunity to have their interests heard and considered. Employees need to take an active and objective role in case resolution so that all factors are considered.
Types of Civil Penalties
1. Failure to File
Section 6651(a)(2): The Failure to File penalty is set by statute and is 5% for each month the return is not filed after the due date (April 15th). The Failure to File penalty is limited to a period of 5 months, which can add up to 25 percent to the amount of tax due. If the taxpayer has a valid extension for filing their return, they will not be assessed the Failure to File penalty during the time of the extension.
2. Failure to Pay
Section 6651(a)(1): The failure to pay penalty is .5% per month for each month there is a balance due (not to exceed 25%). Keep in mind that filing an extension to file a tax return does not give the taxpayer an extension of time to pay.
In order to avoid being assessed the Failure to Pay penalty, a taxpayer must meet specific requirements: (1) the taxpayer must have filed a valid extension to file; (2) Paid 90% of the tax due by the return due date (April 15th); (3) File the return by the extended due date: and (4) Pay any amount due with the return. If the taxpayer fails to meet any of these four requirements, the failure to pay penalty will be assessed from the original due date (April 15th). Treas. Reg. Sec. 301.6651-1©(3).
Penalty Relief: Reasonable Cause
Reasonable Cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause will be granted when the TP exercises ordinary business care and prudence in determining their tax obligations but nevertheless is unable to comply with those obligations.
Ignorance of Law
Reasonable cause may be established if the taxpayer shows ignorance of the law in conjunction with other facts and circumstances (e.g. taxpayer’s education, taxpayer’s tax history, recent changes in tax law, or recent the level of complexity of a tax or compliance issue). (IRM 18.104.22.168.1.2.1).
Not keeping with the ordinary business care and prudence standard does not generally provide a basis for reasonable cause. (IRM 22.214.171.124.1.2.2). Thus, “reasonable mistake” will only be accepted if it is within the realm of ordinary business care and prudence.
This is a very weak argument. An oversight by the taxpayer or another party is generally caused by not keeping with the ordinary business care and prudence standard and therefore, will not provide a basis for reasonable cause as a taxpayer’s responsibility may not be delegated. (IRM 126.96.36.199.1.2.3).
Death, Serious Illness, or Unavoidable Absence
Death, serious illness, or unavoidable absence of the taxpayer may establish reasonable cause for late filing, paying, or depositing. (IRM 188.8.131.52.1.2.4).
Fire, Casualty, Natural Disaster, or Other Disturbance
Relief from a penalty may be requested if there was a failure to timely comply with a requirement to file a return or pay a tax as a result of a fire, casualty, natural disaster, or other disturbance. (IRM 184.108.40.206.2.6).
IRS’s Factual Determination
The IRS will ask the following questions in order to determine the facts and whether to grant a taxpayer relief:
- What happened and when?
- During the time of non-compliance, what facts and circumstances prevented the taxpayer from filing a return, paying a tax or otherwise complying with the law?
- How do the facts and circumstances prevent a taxpayer from complying?
- How did the taxpayer handle the remainder of their affairs during the time?
- Once the facts and circumstances changed, what attempts did the taxpayer make to comply?
- Once the facts and circumstances cease to exist, did the taxpayer comply within a reasonable period of time?
In accordance with Internal Revenue Code (IRC) section 6601(a), 6601(b) and 6611, the payment of interest is required unless specifically prohibited by law.
IRC section 6601(a) states that if any amount of tax is not paid on or before the last date prescribed for payment, interest on such amount at the underpayment rate established under IRC section 6621 shall be paid for the period from such last date to the date paid.
Computation of Interest
The IRS is required to compound interest on a daily basis per IRC section 6622(a). This results in a daily recalculation of the principal amount plus accrued interest.
- Principal Amount (P) = underlying tax, accrued penalties, accrued interest
- Daily Interest Rate®
- Interest (I)
Interest = Principal Amount times Daily Interest Rate (I = P x R).
As a result, Principal Amount + Interest = New Principal Amount. Interest rate is determined every quarter.
Abatement of Interest
Unlike Penalties, reasonable cause is never a basis for abating interest. The IRS will abate or suspend interest only in the following
- Erroneously or illegally assessed (see IRC § 6404(a));
- Attributable to certain errors or delays by the IRS (see IRC § 6404 (e)(1));
- On an erroneous refund (see IRC § 6404(e)(2));
- Due on a deficiency that was not identified by the IRS in a timely manner (see IRC § 6404 (g)); or
- Due on an account for a taxpayer in a combat zone (see IRC § 7508).