Criteria for IRS Penalty Removal

One of the most common questions I get has to do with reducing interest and penalties on IRS accounts. I am adamant about correcting the myths, lies, and half-truths perpetuated by unlicensed tax resolution salespeople, and IRS penalty reduction is one of the most misunderstood and grossly hyped things by salespeople in our industry.

First, let’s get this out of the way: There is no reasonable cause interest reduction application process within the IRS. It just doesn’t exist, period. If someone tells you that you can lower your interest, you are obligated to do so and should seek help elsewhere.

There are two, and precisely two, cases in which interest is reduced:

1. Any IRS employee gives you false information, on which you acted and resulted in interest. This is one of the reasons all IRS correspondence must be done and followed up in writing.
2. Since the interest is calculated based on the tax liability, if an amended return is filed and the tax itself is reduced, the interest is also reduced.

Now to penalties. The IRS charges dozens of different types of penalties, but the three we talk about most often are the late filing penalty, the late payment penalty, and the federal tax failure deposit penalty. These three penalties combined can add a whopping 65% to your total IRS bill. If your tax debt is more than two years old, you have maxed out all of these penalties, and therefore more than half of your total debt is penalties.

The IRS actually does have a compassionate side, and it’s usually found in the penalty reduction process. Fine reduction requests can also be appealed if initially denied, so you can always get a second set of eyes on the issue. What you should be aware of is that the IRS has very strict guidelines for awarding penalty reductions, and these guidelines are known as the “reasonable cause criteria.”

It should be noted at the outset that “we didn’t have the money” is NOT a reasonable cause test. The drop in income, by itself, is not a sufficient argument to obtain relief from the sanction. Any request for a fine reduction simply by citing the economic downturn will be immediately denied.

Why is this? Here’s the IRS logic: You earned the money and should have paid taxes on that money at the time. If you are self-employed and get a check, then you HAD the money, you just didn’t give the IRS your share. The same goes for payroll taxes, particularly taxes on trust funds (money you withhold from employees’ paychecks for income tax and Medicare/Social Security): If you were expecting to pay a certain amount of salary, so theoretically I HAD the money stashed away somewhere to pay for that. person, and should have retained it and turned it over to the IRS. If he couldn’t cover the taxes, he shouldn’t have had the employee and should have laid people off or reduced their hours.

There are ways to discuss this, and we have done so very successfully, but there has to be some other circumstance. For example, you had the money to pay the tax, but paying the tax instead would have created an “undue hardship.” Examples might include a large unpaid medical expense that would have left a condition untreated, or a court-ordered payment that would have resulted in other legal consequences, or a bill such as a major car repair that would have left you unable to work and would have resulted in job loss. These arguments are difficult to make and require much more work than standard reasonable cause applications, but they CAN be won, especially in the Appeals process.

The main reasonable cause criteria for IRS penalty reduction focus on natural disasters, loss or destruction of vital business records, poor advice from the IRS or an accounting professional, criminal activity, medical problems , substance abuse problems and other serious circumstances.

A couple of years ago, I developed a standard list of questions for clients to help me prepare for their penalty abatement. This list of questions should be given serious thought before applying for penalty reduction, as you are more likely to get what you want if it covers one of these areas:

• Were any business records lost or destroyed?
• Were there any circumstances that led to a substantial drop in the collection of accounts receivable?
• Was there a transition in the business that led to the non-payment of taxes?
• Was there a death or serious illness that directly affected business or personal wages?
• Was there embezzlement, theft of valuable property, or identity theft?

Were there alcohol or drug abuse issues that affected the business or ability to earn income? Was there a natural disaster that affected you or your business? Did you rely on the advice of a CPA or IRS employee in making tax decisions?

• Were there any circumstances that created substantial financial difficulties, to the point where your business was on the brink of bankruptcy?

These questions cover all of the IRS reasonable cause criteria to one degree or another, so finding an answer to your personal or business situation that meets one or more of these questions is the key to a successful penalty reduction application.