Penalties and Abatement
In fiscal 2012, the IRS assessed 37.9 million penalties against taxpayers totaling $26.8 billion. Individual, business, and payroll penalties for failure to file, failure to pay, and failure to deposit (the types potentially eligible for FTA) were 74% of all penalties assessed in 2012. The IRS assesses most of these penalties automatically, regardless of the taxpayer’s situation.
Methods for Requesting Penalty Relief
Taxpayers can request relief from failure-to-file, failure-to-pay, and failure-to-deposit penalties in three ways, depending on their situation:
- Before the IRS assesses a penalty,the taxpayer can file a penalty nonassertion request with a paper return to request that the IRS not automatically assess a penalty.
- After the IRS has assessed a penalty, the taxpayer can request penalty abatement, typically by writing a penalty abatement letter or by calling the IRS. Tax professionals can also request abatement using IRS e-services.
- After the taxpayer has paid the penalty, the taxpayer can request a refund using Form 843, Claim for Refund and Request for Abatement. The taxpayer must file the claim within three years of the return due date or filing date, or within two years of the date the penalty was paid.
Reasons to Request Abatement
Generally, relief from penalties falls into four separate categories: reasonable cause, statutory exceptions, administrative waivers, and correction of IRS error. Under the category of administrative waivers, the IRS may formally interpret or clarify a provision to provide administrative relief from a penalty it would otherwise assess. The IRS may address an administrative waiver in either a policy statement, news release, or other formal communication stating that the policy of the IRS is to provide relief from a penalty under specific conditions. The most widely available administrative waiver is FTA.
First-Time Abatement Waiver
In 2001, the IRS established FTA to help administer the abatement of penalties consistently and fairly, reward past compliance, and promote future compliance. This administrative penalty waiver allows a first-time noncompliant taxpayer to request abatement of certain penalties for a single tax period—one tax year for individual and business income taxes and one quarter for payroll taxes.
According to TIGTA, for tax year 2010, the average individual failure-to-file abatement qualifying under FTA was $240, and the average failure-to-pay abatement was $84. However, more than 90% of individuals who qualified for an FTA did not receive the waiver for 2010. This is likely because taxpayers did not know they could request it. The IRS does not publicize FTA as a relief option on its penalty-related notices or on its website.
The remainder of this article discusses how to determine whether a client qualifies for FTA and how to request it from the IRS.
Penalties Eligible for an FTA
FTA applies only to certain penalties and certain returns filed. First, determine whether FTA applies to the client’s situation:
- Individual taxpayers can request an FTA for failure-to-file and failure-to-pay penalties. Estate and gift tax returns do not qualify for FTA waivers.
- Business and payroll taxpayers can request an FTA for failure-to-file, failure-to-pay, and/or failure-to-deposit penalties. The IRS is not explicit in its Internal Revenue Manual (IRM), but in practice, the IRS has granted FTAs for S corporation and partnership late-filing penalties.
- For individual and business taxpayers, the estimated tax and accuracy-related penalties cannot be waived under FTA.
Clean Compliance Criteria
If FTA applies to the client’s situation, the practitioner must determine whether the client qualifies to receive it, which entails most of the complexity involved in requesting an FTA. To qualify, the client must demonstrate filing and payment compliance and a three-year clean penalty history.
To meet the rule for filing compliance, the client must have filed, or filed a valid extension for, all currently required returns and must not have an outstanding request from the IRS for an unfiled return. 11 To meet the payment compliance rule, the client must also have paid, or arranged to pay, any tax due. The client can have an open installment agreement, as long as installment payments are current. According to the IRM, the IRS should give a taxpayer not currently in compliance with these payment requirements an opportunity to comply and thereby qualify for an FTA before the IRS considers whether the penalty can abatefor reasonable cause.
Requesting an FTA
By phone or e-services: A practitioner who determines that the client qualifies for an FTA can request it in several ways. Start with simple methods. If the client’s case does not involve a compliance function, call the IRS Practitioner Priority Service (PPS) line or use the IRS e-services Electronic Account Resolution function. The IRS representatives in Accounts Management have authority to grant an FTA.
When an IRS compliance unit assesses the penalty, requesting an FTA from a PPS representative or by e-services will not work. For example, for a taxpayer under audit or underreporter inquiry or with a case in IRS Collection or Appeals functions, the appropriate compliance unit will address penalties based on the taxpayer’s facts and circumstances. If a compliance unit assesses a penalty, penalty relief must typically be requested directly from that unit.
IRS Abatement Determinations Often Flawed
When the taxpayer or practitioner calls or writes the IRS to request an FTA, the IRS evaluates the request using an automated tool. To uniformly apply penalty abatements, the IRS developed a decision-support software program called the Reasonable Cause Assistant (RCA). The program was designed to help IRS employees make penalty relief determinations for individuals (failure-to-file and failure-to-pay penalties) and businesses (failure-to-deposit penalty). The IRS requires its employees to use this program to make determinations on penalty abatement requests, including requests for an FTA.
Be prepared by researching the client’s clean compliance history and applying the qualification rules before contacting the IRS. If the client qualifies but the IRS representative says the client does not, ask the representative to override the RCA determination. If the representative will not override it, ask for the representative’s manager. Finally, if all other means have been exhausted, consider contacting the Taxpayer Advocate Service (TAS) for help. Keep in mind that IRS representatives often simply do not know how to use the RCA, thus resulting in errors. If the IRS representative is unsure about how to use the program, a practitioner who is sure the client qualifies can try calling back to request an FTA again.
FTA Confirmation
A client to whom the IRS grants an FTA will receive Letter 3502C or 3503C for individual failure-to-file and failure-to-pay penalty abatement and Letter 168C (or its equivalent) for business failure-to-deposit penalty abatement. The letter usually arrives about four weeks after the IRS grants the FTA.
The Future of FTA
Encouraging compliance is one of the IRS’s major goals as it focuses on closing the $450 billion annual tax gap. The proper use of penalties helps deter noncompliance, and it is clear that the IRS has been using penalties to that end. During the past 11 years, the number of penalties assessed increased by 34%, from 28.3 million penalties in 2002 to 37.9 million in 2012. However, to increase voluntary compliance, the IRS must administer penalties fairly and consistently.
The IRS stated in its response to the 2010 TAS Report to Congress that it is studying whether FTA increases compliance and whether a system to grant FTA waivers prior to penalty assessment should implemented. To date, the IRS has not concluded the study.
With TIGTA and TAS reports highlighting the IRS’s inconsistent application of penalty abatement. The IRS will likely make some changes in its requirements and procedures for requesting and granting penalty abatements in the future. For now, if the client qualifies, the practitioner can effectively request and receive relief for the client’s penalties using this largely unknown and beneficial administrative waiver.
