IRS Penalty Removal Criteria

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 abatement is one of the things that is least understood and grossly exaggerated by salespeople in our industry.

First of all, let’s get this out of the way: There is no reasonable cause interest reduction request 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 you should seek help elsewhere.

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

1. Any IRS employee gives you false information, which you acted upon and resulted in interest. This is one of the reasons why all IRS correspondence must be done and followed up in writing.
2. Since 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 penalty for failing to make federal tax deposits. 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 reached the limit on all of these penalties, and therefore more than half of your total debt is penalties.

The IRS actually has a compassionate side, and is usually in the process of abatement of penalties. Fine abatement requests can also be appealed if initially denied, so you can always get a second set of eyes on the issue. What you need to keep in mind is that the IRS has very strict guidelines for granting penalty reductions, and these guidelines are known as the “reasonable cause criteria.”

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

Why is this? Here’s the logic of the IRS: You earned the money, and you should have paid taxes at that time on that money. If you’re self-employed and you get a check, then you DID have the money, you just didn’t give the IRS your share. The same is true of employment taxes, particularly taxes on trust funds (money you withhold from employees’ paychecks for income tax and Medicare/Social Security): if you expected to pay a certain amount of salary, so theoretically I HAD the money stashed away somewhere to pay for that. person, and you should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have fired people 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 applications of reasonable cause criteria, 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 fine reduction. This list of questions should be seriously thought through before applying for a fine reduction, as you are more likely to get what you want if you cover 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 problems that affected the business or ability to earn income? Was there a natural disaster that affected you or your company? Did you rely on the advice of a CPA or IRS employee in making tax decisions?

• Were there any circumstances that created substantial financial hardship, to the point where your business came close to bankruptcy?

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