Tax issues bring with them penalties and interest that can significantly increase the amount you owe. If you’re dealing with a tax issue or have in the past, you’re likely already aware of this. What you might not know is that sometimes it’s possible to have penalties abated (removed or reduced) from tax debt. In this article, we’ll look at how these penalties work and how you may be able to reduce or remove them, as well as how interest accumulates.
Common Tax Penalties
There are many reasons that penalties may be assessed. The most common ones are
- Failure to file a tax return on time
- Failure to pay a tax liability on time
- Underpayment of estimated tax payments
- Inaccurate reporting
The penalties for failure to file typically accrue at a rate of 5% of the total amount owed for each month that the return is late, up to 5 months, for a maximum penalty of 25%. The penalty for failure to pay is also capped at 25%, but accrues more slowly, at a rate of 0.5% per month for up to 50 months.
The penalties for failing to make appropriate estimate tax payments begin to accrue at the time the payment should have been made, not when a year-end return is filed. You can fill out form 2210 to determine whether you owe any penalties for underpayment of estimated taxes.
The penalties for inaccurate reporting typically are assessed a rate of 20% of the additional amount owed. As an example, if an IRS audit determines that a taxpayer filed a return that showed they do not owe anything, but left off information that results in a $1,000 tax debt, they would also accrue a $200 penalty.
These are the most commonly encountered tax penalties that individuals may receive, but there are numerous others. The good news is that most of them can be reduced or eliminated. There are three specific types of abatement that may apply:
- First time Penalty Abatement
- Reasonable Cause Penalty Abatement
- Penalty Abatement due to Statutory Exception
Let’s take a closer each of them and discuss which criteria a taxpayer must meet in order to qualify for these penalty abatements.
First Time Penalty Abatement
This abatement option can be applied to penalties assessed for failing to file on time, failing to pay a tax debt, or failing to make estimated payments. It is generally only available for the oldest tax year in which a penalty was accrued. Here are the specific criteria you must meet to qualify for a first time penalty abatement:
- You either didn’t accrue penalties or didn’t have to file a tax return in the three years before receiving a penalty.
- Your tax returns are all filed and up-to-date, or you have an extension filed.
- You’ve paid or setup a payment plan with the IRS.
Reasonable Cause Penalty Abatement
The reasonable cause abatement applies when circumstances beyond your control have prevented you from filing a return or paying the taxes you owe, leading to a penalty. Some of the situations which may be considered reasonable cause include
- Natural disasters such as flood and water damage, fire, etc.
- Difficulty obtaining records
- Serious medical issues, particularly with hospitalization
- The taxpayer or an immediate family member becoming incapacitated
The IRS will require proof of reasonable cause in order to apply this abatement to any penalties you may have occurred. You’ll need to provide sufficient answers to these questions:
- What happened, and when?
- Why specifically were you prevented from filing or paying on time?
- How did these circumstances affect your daily life and responsibilities?
- What action did you take to file your returns or pay taxes when possible?
You’ll need to include documentation in your abatement request. Depending on the circumstances, this could be hospital records, a letter from a doctor, court records, or documentation of a disruptive natural disaster. Remember that if you’re submitting a request for more than one year’s worth of penalties, you’ll have to provide sufficient documentation for each year.
Penalty Abatement Due To Statutory Exception
If you’ve received written advice from the IRS, and following that advice led to a tax debt, you can request an abatement of penalties due to statutory exception. This is the least common of these three ways to receive an abatement.
To file for this kind of abatement, you’ll need to use Form 843, Claim for Refund and Request for Abatement. You’ll need to provide your initial written request for advice from the IRS, their written response, and a report showing the results of that erroneous advice.
Dealing with Accrued Interest
Unlike penalty abatements, there aren’t specific things you can do to reduce accrued interest on a tax debt. You will continue to accrue interest until you’ve fully paid off your tax debt. However, some interest reduction is possible. If your debt or penalties are reduced, your interest will also be adjusted. If there was an unreasonable error or delay caused by an officer or employer of the IRS that resulted in additional interest, it can be removed. Treasure Regulation § 301.7508A-1(b)(1) allows for a postponement period of up to one year before interest starts accruing in the case of a taxpayer being affected by a federally declared disaster.
The IRS will always seek penalties in addition to repayment of a tax debt. However, it is possible to remove or reduce these penalties if you meet the criteria for certain abatement policies. In some cases, interest can also be reduced, but the requirements for this are much stricter, and in general, you can expect to have to pay interest on any tax debt you owe.
If you want to seek an abatement, please contact us today by phone or email. It is never a good idea to approach complex financial decisions without sound advice from a team who really understands the choices you’re weighing therefore we are here to assist you when it comes to tax debt relief.