How IRS Penalties Can Be Eliminated Using a Simple Strategy

How to Eliminate IRS Penalties 

The strategies discussed here are not the only ways to deal with penalties and interest. In other library aricles we discuss offers to settle, bankruptcy, partial pay, and other solutions that can get tax liability forgiven.Example of Penalty Abatement Letter from IRS I have scanned in an IRS document eliminating penalty. This is from a client file.

Penalties Can Double or Triple What You Owe. Penalties overwhelm citizens more than interest. Over 145 penalties exist within the IRS code. The most common penalties are for (A) not paying on time and (B) not filing on time. For those who owe the IRS back income taxes, penalties are a big chunk of it.

The IRS Late Payment and Late Filing Penalty

Late Payment Penalty: The penalty for late payment is one-half of 1 percent of the tax owed for each month it remains unpaid. The penalty increases by one-half of 1 percent for every month a balance is due. The first month the IRS will charge you a half percent of the balance due, the second month 1%, the third month 1.5%, and so on. The late payment penalty maxes out at a whopping 25% of the tax bill.

Late Filing Penalty. The penalty for filing late is 5% of the tax owed the first month and increases by 5% every subsequent month for five months until it maxes out at 25%.

Late Payment and Late Filing Penalty Equals 47.5%. When both penalties run concurrently, the late-filing penalty is reduced from 5% to 4.5% monthly and maxes out at 22.5%. However, the late-payment penalty still maxes out at 25%. Simple math tells us that the combined penalty for not paying on time and not filing on time is 47.5% penalty. In other words, if you owe $1000 to the IRS and you do not pay the $1000 when due, you will owe $1475. These two penalties create government-sanctioned indentured servitude.

Example. Dan files his return more than five months late. He owes $25,000 on the return, but Dan can’t pay the tax. An additional $11,875 in penalties is imposed. Dan will also owe at least $1,250 a year in interest. In five years, interest is $6,250, and that’s without calculating the interest on the penalties. The IRS inflicts $18,125 of interest and penalties on a $25,000 tax bill.

Other Expensive IRS Penalties. The IRS will impose a 20% accuracy penalty if it concludes that your tax return understated tax liability. If the IRS finds that you fraudulently underreported income, it can add a fraud penalty of 75% of the amount you underreported. There are also penalties for failure to file, filing in careless disregard for IRS rules, failure to include identifying information, and many more.

TIP One of the best-kept secrets is the extension of time to pay the tax. (Code §6161). Complete Form 1127, known as an Application for Extension of Time for Payment of Tax, to apply for an extension of six months to pay the tax penalty-free.

Two Secrets to Forgiveness of IRS Penalties:

[1] Good Faith and [2] Reasonable Cause

The IRS uses the terms abatement or abate when they refer to forgiving or cancelling penalties. And the government routinely abates penalties when the taxpayer has established two things: [1] Good Faith and [2] Reasonable Cause.

Good Faith and Reasonable Cause. The Internal Revenue Penalty Handbook requires “good faith and “reasonable cause” in order for the IRS to abate penalties. Good faith means your actions, even in error, were not intended to break the law and you possessed a sincere belief you were acting properly. Reasonable cause means that, by applying common sense and considering existing circumstances, you had good reason to act or for your failure to act.

Examples of Good Faith and Reasonable Cause

The list of what constitutes good faith and reasonable cause is extensive. So that you have an idea of how the IRS defines good faith and reasonable cause, here are some examples from case files.

Example: You’re new to being a business owner and you did not know you had to make quarterly estimated tax payments. The penalties are abated because the IRS takes into account ignorance of the law based on your rookie status. This excuse will not work if it happens again.

Example: You suffer from severe depression and you fail to file on time. Depression is a recognized medical condition affecting how people feel, think, and behave. This illness can interfere with normal day-to-day activities, such as filing tax returns or paying bills on time. The IRS may accept this reason and eliminate penalties. Be sure to document your condition with a letter from a medical professional.  

Example: You rely on the advice of a CPA to make a deduction that is disallowed, and a so-called accuracy penalty is imposed. The IRS may abate the penalty if you acted in good faith by relying on the tax expert.

Example: Surgery prevents you from filing your return on time, and you are assessed a late filing penalty. Explain your medical condition to the IRS, include documentation, and you may get the penalty abated.

Example: Serious financial issues due to job loss prevent you from paying on time. This may constitute good faith and reasonable cause.

Example: A fire or flood destroys documents needed to prepare your tax return. Again, document your loss.

Example: Your father got sick and you had to travel to another state to care for him. You did not file on time or pay the tax because of this unexpected event.  You had a sincere belief you were acting properly, and common sense dictates this failure to act could not be avoided.

Example: You adopt a son. His last name was changed to your last name. You claim your son as a deduction, but the IRS disallows it and sends you a deficiency notice with penalty and interest. This is cause for elimination of penalties and interest.   

Example: You file your 2013 tax return a year late when you file your 2014 tax return. You are owed a refund for 2013, but not for 2014. You send both 2013 and 2014 to the IRS in one envelope. The IRS accepts your 2013 tax return, but claims it never received your 2014 tax return and penalizes you.   

Use the Right Documents With the Right Message

This is vital in eliminating IRS penalties. Use Form 843 as your cover page and complete all information requested. Where it asks for a reason, write “See Attached Letter” and then attach your letter to Form 843. Include supporting documents. Keep the originals, and mail the copies by certified mail to the attention of “Penalty Abatement Coordinator” at the service center that issued the penalty.

Affidavits. Tax attorneys use a very simple document to establish facts. It’s called an affidavit. It is simply a written statement of facts, sworn to and signed before a notary public. Where the IRS has no evidence to the contrary, an affidavit may force the IRS to accept an adverse position as true. A few key words can literally prevent financial ruin.

Don’t Take No for an Answer! You have 30 days from the date of denial to appeal the decision. Experience, persistence, and understanding the process at each level get results.

Abatement of penalties constitutes forgiveness in the true sense of the word because the penalties often make up more than half the tax liablity. In some situations, we may choose to abate or cancel the penalties before we negotiate with the IRS to settle the tax liablity. Our thinking is that if we are not successful with one strategy, we have a second opportunity to eliminate most of the tax debt. And often we are successful both cancelling the penalties and settling the tax!

To solve your tax problem, feel free to call Michael Mack 24 hours a day, 7 days a week at 1 800 659 0525.