The IRS assesses most penalties automatically, by computer, the moment a return is filed late, a payment is missed, or an adjustment is made on examination. The system that adds them does not consider your circumstances. The procedures for removing them do.
The penalties most taxpayers face
The failure-to-file penalty under §6651(a)(1) is 5% of the unpaid tax for each month or part of a month a return is late, up to 25%. The failure-to-pay penalty under §6651(a)(2) is 0.5% per month, also capped at 25%, and continues to accrue on any unpaid balance even after an installment agreement is in place (at a reduced rate). The estimated tax penalty under §6654 applies when an individual does not pay enough tax during the year through withholding or estimated payments. The accuracy-related penalty under §6662 is 20% of any underpayment attributable to negligence or a substantial understatement, and is routinely proposed at the close of an examination. For businesses, the trust fund recovery penalty under §6672 is a separate and serious matter, imposing personal liability on individuals responsible for unpaid employment taxes.
Interest accrues on penalties as well as on tax. By the time a liability is several years old, penalties and interest frequently approach or exceed the original tax.
First-time abatement
The IRS has an administrative policy, set out in the Internal Revenue Manual, under which it will remove failure-to-file, failure-to-pay, and failure-to-deposit penalties for a single tax period if the taxpayer has a clean compliance history: no penalties (other than estimated tax penalties) for the three prior years, all required returns filed, and any balance paid or under a payment arrangement. First-time abatement does not require you to show a reason for the failure. It is a matter of eligibility, and it can often be obtained by a single properly framed request. It is also widely overlooked.
Reasonable cause
Where first-time abatement is not available, the statute itself provides that the failure-to-file and failure-to-pay penalties do not apply if the failure was due to reasonable cause and not willful neglect. The IRS evaluates reasonable cause on the facts: serious illness or death in the immediate family, natural disaster, inability to obtain records, reliance on incorrect advice from a tax professional, and other circumstances beyond the taxpayer's control. The request must be in writing, must set out the facts with dates, and should be supported by documentation. A well-prepared reasonable cause request looks very different from a letter explaining that things were difficult that year, and the difference frequently determines the outcome.
The accuracy-related penalty has its own defense under §6664(c): it does not apply where the taxpayer acted with reasonable cause and in good faith with respect to the underpayment — which often turns on whether the taxpayer relied on a competent professional after providing complete information.
What the firm does on a penalty matter
- Transcript review to identify every penalty assessed, the period, and the basis
- First-time abatement requests for every period where you qualify
- Written reasonable cause requests, with a factual narrative and supporting documentation
- Reasonable cause and good faith defenses to accuracy-related penalties proposed on examination
- Appeals of denied abatement requests to the IRS Independent Office of Appeals
- Representation in trust fund recovery penalty interviews and protests for business owners and officers
- Audit reconsideration or amended returns where the underlying assessment is itself incorrect