When you pay your taxes late the IRS assesses penalty and interest. After all, by paying your taxes late you are effectively borrowing money from the Federal government as they lack those funds by the due date, and the government being the government isn’t a forgiving creditor. Accordingly, the federal government assesses interest on the “borrowed funds” which is generally the federal short-term rate plus 3 percentage points. To make matters worse for taxpayers, interest is also assessed on late-filing penalties. In essence, taxpayers who underpay their taxes by the due date face interest on both the amount of the underpayment and the late filing penalty.
If you have been assessed a late-filing penalty and interest on the underpayment, your best option is usually to pay off the balance ASAP. However, in cases where the underpayment is substantial or the amount has snowballed over the years, other tax relief options may be necessary. Often the first tax relief option to evaluate is tax penalty abatement. In brief, in some cases, the IRS may be willing to forgive certain tax penalties. If granted, your tax bill will be lowered as the penalty and interest on the penalty will be removed, making an installment agreement or other tax resolution option more affordable.
Examples of “Reasonable Cause” For Tax Penalty Abatement
Getting the IRS to forgive tax penalties is called penalty abatement, and it’s only warranted if there is “reasonable cause” for the abatement. In general, reasonable cause means that you used ordinary care and prudence to meet your federal tax obligations but were unable to do so. For example, if a taxpayer could not file and pay by the April deadline as they were under a forest fire evacuation order during the time, the taxpayer may have reasonable cause for failing to file and pay by the April deadline. Moreover, if their supporting tax documents were destroyed in that fire, they may have another basis for reasonable cause.
Now, what situations constitute reasonable cause according to the IRS? The Internal Revenue Manual Policy Statement 3-2 cites the following examples:
- Death or serious illness of the taxpayer or a death or serious illness in his/her immediate family. In the case of a corporation, estate, trust, etc., the death or serious illness must have been of an individual having sole authority to execute the return or make the deposit or payment or of a member of such individual’s immediate family.
- Unavoidable absence of the taxpayer. In the case of a corporation, estate, trust, etc., the absence must have been of an individual having sole authority to execute the return or make the deposit or payment.
- Destruction by fire or other casualties of the taxpayer’s place of business or business records.
- The taxpayer was unable to determine the amount of deposit or tax due for reasons beyond the taxpayer’s control. However, this cause will be acceptable for taxpayers required to make deposits or payments of trust fund taxes only when the taxpayer was unable to have access to his/her own records.
- The facts indicate that the taxpayer’s ability to make deposits or payments has been materially impaired by civil disturbances.
- Lack of funds is an acceptable reasonable cause for failure to pay any tax or make a deposit under the Federal Tax Deposit System only when a taxpayer can demonstrate the lack of funds occurred despite the exercise of ordinary business care and prudence.
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