Objectives in Penalty Administration. Similar cases and similarly-situated taxpayers are to be treated in a similar manner with each having the opportunity to have their interests heard and considered. Penalty relief is to be viewed from the perspective of fair and impartial enforcement of the tax laws in a manner that promotes voluntary compliance. Penalties encourage voluntary compliance by defining standards of compliant behavior, defining consequences for noncompliance, and providing monetary sanctions against taxpayers who do not meet the standard.[2]
In this regard, the objective of penalty administration is to be severe enough to deter noncompliance, encourage noncompliant taxpayers to comply, be objectively proportioned to the offense, and be used as an opportunity to educate taxpayers and encourage their future compliance.[3]
IRM Approach to Penalty Administration. The IRM’s approach to penalty administration provides:
Consistency: The IRS should 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.
Accuracy: 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.
Impartiality: IRS employees are responsible for administering the penalty statutes and regulations in an even-handed manner that is fair and impartial to both the government and the taxpayer.
Representation: 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.[4]
Relief Due to Reasonable Cause. Many penalties may be avoided based upon a determination that reasonable cause existed for the positions maintained within a return. Reasonable cause is based on a review of all relevant facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted when the taxpayer exercises ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations.[5] Ordinary business care and prudence includes making provisions for business obligations to be met when reasonably foreseeable events occur. A taxpayer may establish reasonable cause by providing facts and circumstances showing that they exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless were unable to comply with the law.[6]
Examiners are to consider various factors in determining penalty relief based on reasonable cause. What happened and when did it happen? During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax, and/or otherwise complying with the law? How did the facts and circumstances result in the taxpayer not complying? How did the taxpayer handle the remainder of their affairs during this time? Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
Death, serious illness, or unavoidable absence of the taxpayer may establish reasonable cause for filing, paying, or delinquent deposits. Information examiners consider when evaluating a request for penalty relief based on reasonable cause due to death, serious illness, or unavoidable absence includes, but is not limited to, the relationship of the taxpayer to the other parties involved, the date of death, the dates, duration, and severity of illness, the dates and reasons for absence, how the event prevented compliance, if other business obligations were impaired, and if tax duties were attended to promptly when the illness passed, or within a reasonable period of time after a death or return from an unavoidable absence.[7]
Explanations relating to the inability to obtain the necessary records may constitute reasonable cause in some instances, but may not in others. Reasonable cause may be established if the taxpayer exercised ordinary business care and prudence, but due to circumstances beyond the taxpayer’s control, they were unable to comply. Relevant information includes, but is not limited to, an explanation as to why the records were needed to comply, why the records were unavailable and what steps were taken to secure the records, when and how the taxpayer became aware that they did not have the necessary records, if other means were explored to secure needed information, why the taxpayer did not estimate the information, if the taxpayer contacted the IRS for instructions on what to do about missing information, if the taxpayer promptly complied once the missing information was received, and supporting documentation such as copies of letters written and responses received in an effort to get the needed information.[8]
Reliance on Advice. In certain situations, reliance on the advice of others may justify relief from penalties. Relevant information regarding a request for abatement or non-assertion of a penalty due to reliance on advice includes, but is not limited to, a determination of whether the advice in response to a specific request and was the advice received related to the facts contained in that request and if the taxpayer reasonably relied upon the advice. The taxpayer is entitled to penalty relief for the period during which they relied on the advice. The period continues until the taxpayer is placed on notice that the advice is no longer correct or no longer represents the IRS’s position.
The IRS is required to abate any portion of any penalty attributable to erroneous written advice furnished by an officer or employee of the IRS acting in their official capacity.14 Administratively, the IRS has extended this relief to include erroneous oral advice when appropriate. Relevant inquiries include: Did the taxpayer exercise ordinary business care and prudence in relying on that advice? Was there a clear relationship between the taxpayer’s situation, the advice provided, and the penalty assessed? What is the taxpayer’s prior tax history and prior experience with the tax requirements? Did the IRS provide correct information by other means (such as tax forms and publications)? What type of supporting documentation is available?
Reliance on the advice of a tax advisor generally relates to the reasonable cause exception in Code Section 6664(c) for the accuracy-related penalty under Code Section 6662.[9] However, in certain situations, reliance on the advice of a tax advisor may provide relief from other penalties when the tax advisor provides advice on a substantive tax issue.
First Time Abatement. The IRS Reasonable Cause Assistant (RCA) is a decision-support interactive software program developed to reach a reasonable cause determination within the IRS.[10] The IRS will use the RCA after normal case research has been performed, (i.e., applying missing deposits/payments, adjusting tax, or researching for missing extensions of time to file, etc.) for the Failure to File (FTF), Failure to Pay (FTP), and Failure to Deposit (FTD) penalties.
RCA provides an option for penalty relief known as the “First Time Abate” 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) have been assessed on the same account in the prior 3 years.[11] A penalty assessed and subsequently reversed in full will generally be considered to show compliance for that tax period. If the RCA determines a "First -Time Abate" is applicable, the taxpayer will be advised that the penalty(s) was removed based solely on their history of compliance, that this type of penalty removal is a one-time consideration available only for a first-time penalty charge, and that any future (FTF, FTP, FTD) penalties will only be removed based on information that satisfies the previously mentioned reasonable cause criteria.[12]
Summary. Civil tax penalty administration pending any potential comprehensive tax reform must continue to promote and enhance voluntary compliance. Penalties should only be imposed in proportion to the misconduct. Penalties should not be asserted for the purpose of raising revenue or offsetting the costs of tax benefits nor merely to punish behavior without also promoting compliance.
Most taxpayers attempt to comply with their filing and payment obligations under the Code. Others comply because of a concern for the imposition of penalties. Somewhere in between are taxpayers who are subjected to penalties for conduct they failed to realize was somehow wrongful. In most situations, the IRS has the experience and dedicated staff to make the proper determination.
The penalty provisions set forth within the Code must retain the discretion of the IRS to appropriately punish those most deserving and not punish what are, at most, an inadvertent foot-faults. Those who appropriately respect their obligations to our system of taxation should be cautioned and educated about their present and future tax compliance without having to waltz through an almost unintelligible legislative minefield of civil tax penalties.
[1] Internal Revenue Manual (IRM) 20.1.1.1.1 (11-25-2011). Refer to IRM 9.1.3, Criminal Investigation - Criminal Statutory Provisions and Common Law, for Criminal Penalty provisions.
[2] Penalty Policy Statement 20-1 (IRM 1.2.20.1.1; June 29, 2004)
[3] IRM 20.1.1.2.1 (11-25-2011)
[4] IRM 20.1.1.2.2 (11-25-2011
[5] IRM 20.1.1.3.2 (11-25-2011)
[6] IRM 20.1.3.2.2 (11-25-2011) .
[7] IRM 20.1.1.3.2.2.1 (11-25-2011)
[8] IRM 20.1.1.3.2.2.3 (11-25-2011)
[9] IRC § 6404(f) and Treas. Reg. 301.6404–3
[10] IRM 20.1.1.3.6.1 (11-25-2011)
[11] Id.
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