Penalty Games: Reducing IRS Penalties

Presenter(s):Robert E. McKenzie Arnstein & Lehr LLP Chicago, ILWebsite: www.mckenzielaw.com

Date:Time: 2:00-4:00PM Eastern

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Origins

• TP files w/o payment• TP audited • TP loses in Tax Court• TP fails to file and IRS prepares a substitute for Return (SFR)

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Filed Return

• IRS receives return w/o payment and sends a bill in about 5 weeks

• Bill includes penalties and interest• Rate dropped to 3% in October, 2011

Bad Checks

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The 2% penalty for bad checks or money orders increases to a minimum of $25 applicable to checks or money orders.

FAILURE TO FILE TAX RETURN

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• 5%: Max 25%• 4.5% if FTP applied: Max 22.5%• Coordination between FTF and FTP Penalty Rates

• Minimum Failure to File: The lesser of: $100.00 or 100 percent of the amount required to be shown as tax on the return. After 2008 penalty increased to $135.

Failure to Pay Tax (FTP)

• 5%: Max 25%• 1% after Sec. 6331 Notice: Max 25%• .25% after acceptance of an installment agreement: 8.5%

PENALTY COMPUTATION

Example 1 Failure to File and Failure to Pay Form 1040

Return Due Date (041599) - Tax year 1998

Code Date Received Amount Comments

TC 150 122699 $1,753.00 Amount of tax on returnTC610 112199 $953.00 Payment received with the returnTC660 061798 $800.00 Estimated tax payment

PENALTY COMPUTATION

$ 953.00x .045 $ 42.89 Amount per month x 5 Number of months $214.45 Failure to file penalty

PENALTY COMPUTATION

$ 953.00X .005$ 4.77 Amount per monthx 8 Number of months$ 38.16 Failure to pay penalty$ 214.45 FTF+ 38.16 FTP$ 252.61 Total penalty

Fraudulent Failure to File

• 15% per month • Max 75%

FAILURE TO DEPOSIT PENALTY• ⋅2 percent for deposits 1-5 days late,• ⋅5 percent for deposits 6-15 days late,• ⋅10 percent for all direct payments and those deposits

made more than 15 days late , but paid on or before the 10th day following notice and demand.

• ⋅15 percent (actually, a 5 percent addition to the 10 percent for late payment above for all undeposited taxes still unpaid after the 10th day following the first balance due notice or the day on which notice and demand for immediate payment is given

Cascading PenaltiesIRC Sec. 6656 • Right to direct payments to timely deposits• IRS computer uses an unfair system• Example:

Company owes weekly deposit of $10,000Misses first depositPays remainder of deposits on timeIRS applies each deposit to the prior week5% penalty on $120,000 = $6,00010% penalty on one deposit of $10,000 =

$1,000Total penalty $7,000

Cascading Failure to Deposit Penalty

Correction:One late $10,000 deposit = $1,000

NET SAVINGS: $6,000

REASONABLE CAUSE

• Any reason that establishes a taxpayer exercised ordinary business care and prudence but was unable to comply with the tax law may be considered for penalty relief.

Ordinary Business Care and Prudence Ordinary

• Ordinary business care and prudence includes making provision for business obligations to be met when reasonably foreseeable events occur.

• Facts and circumstances showing the taxpayer exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless was unable to comply with the law

Reasons for Penalty ReliefAlthough the IRM provides: • “When considering the information provided in

the following subsections, remember that an acceptable explanation is not limited to those given in IRM 20.1. Penalty relief may be warranted based on an "other acceptable explanation," provided the taxpayer exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time.” See IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence.

• Your chance of prevailing is better if you cite to one of there favorite reasons

REASONABLE CAUSE

• Death, Serious Illness, or Unavoidable Absence Pg. 14

• Fire, Casualty, Natural Disaster, or Other Disturbance Pg. 15

• Unable to Obtain Records Pg. 16• Mistake was Made Pg. 16• Erroneous Advice or Reliance Pg. 17• Ignorance of the Law Pg. 18• Forgetfulness Pg. 18• Statutory Exceptions or Waivers Pg. 19

Statutory ExceptionsLegal Reference Title IRM Reference

IRC 6654(e)(1), (2), or (3)

Estimated Tax Penalties (ES) IRM 20.1.3

IRC 7502(a) and IRC 7502(e) (IRC 7502(e))

does not apply to deposits due after Dec.

31, 2010)

Timely Mailing Treated as Timely Filing and Paying

IRM 20.1.2 and IRM 20.1.4

IRC 6724(a) or IRC 6724(c)

Waiver; Definitions and Special Rules, Information Return Penalties

IRM 20.1.7

IRC 6404(f)

Abatement of any Penalty or Addition to Tax Attributable to

Erroneous W ritten Advice by the Internal Revenue Service

IRM 20.1.1.3.3.4.1

IRC 7508

Time for Performing Certain Acts Postponed by Reason of Service in

Combat Zone. This provision applies only in a Presidentially

declared Combat Zone

IRM 20.1.2.1.2.1, Combat Zone - IRC

7508

IRC 7508A

Authority to Postpone Certain Deadlines by Reason of

Presidentially Declared Disaster or Terroristic or Military Actions

IRM 25.16, Disaster Assistance and

Emergency Relief

REASONABLE CAUSE

• Undue Hardship Pg. 23• Written Advice From IRS Pg. 26• Oral Advice From IRS Pg. 26• Advice from a Tax Advisor Pg. 27• Official Disaster Area Pg. 28• Service Error Pg.28

Reasonable Cause Assistant• When you request reasonable cause relief IRS

personnel use a computer program: Reasonable Cause Assistant (RCA) to determine if relief is appropriate. Pg. 28

• RCA relies on the skill set of the person completing the computer generated questionnaire.

• You can enhance your clients chances of prevailing by citing to the IRM & concisely setting forth the facts of your case because it will reduce the chances of operator error.

First Time Abatement• RCA provides an option for penalty relief for the FTF, FTP, and/or

FTD penalties if the taxpayer has not previously been required to file a return or if no prior penalties (except the Estimated Tax Penalty, TC 17X) have been assessed on the same MFT This First-time Abate (FTA) aspect is an Administrative Waiver and does not carry any Oral Statement Authority (OSA) dollar threshold.

• The FTA Administrative Waiver can only apply to a single tax period for a given MFT.

• For example, if a request for penalty relief is being considered for 2 or more tax periods on the same MFT and the earliest tax period meets FTA criteria, penalty relief based on FTA only applies to the earliest tax period, not all tax periods being considered. Penalty relief for all subsequent tax periods will be based on the showing of reasonable cause (and absence of willful neglect).

Abatement Request

• Submit separate for each period• Ask for abatement based upon reasonable

cause in first paragraph• Statement of facts• Law• Discussion• Conclusion

Sec. 6404

• Suspension of P&I. The time period where IRS suspends charging P&I until a taxpayer has been notified of the additional tax is extended from the current 18 months to 36 months effective for notices after November 25, 2007

• Interest immediately after the IRS proposes a deficiency

• Exception: tax shelters

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