You have options for requesting abatement of federal income tax penalties. For example, penalties can be abated for reasonable cause, when a statutory exception applies, when the IRS allows an administrative waiver, or when the IRS makes an error in computing or assessing tax or crediting your account.
You’re probably familiar with reasonable cause. You can request relief based on reasonable cause when you exercise ordinary business care and prudence when figuring out your taxes and you end up making a mistake anyway.
Statutory exceptions are reasons for penalty relief that are included in legislation. For example, section 7502 of the Internal Revenue code is called the “timely mailing treated as timely filing and paying” rule (also known as the “mailbox” rule). This exception says that, in general, when you mail your return before the deadline, it’s considered timely even if the IRS receives it after the deadline.
The IRS typically grants relief under administrative waivers in specific situations, such as when there’s a delay in publishing guidance or forms.
Several of this week’s tax court decisions involved requests for relief from penalties. Which ones do you think the court granted?
In T.C. Memo. 2014-45 (Wolfington), the taxpayers failed to file federal income tax returns for 2005 and 2006. The IRS prepared substitute returns for those years. In 2011, after receiving a notice about the substitute returns, the taxpayers filed both returns. The 2005 return reported severance payments from a job as the CEO of a limousine company, a home sale, and income tax withholding of $64,916, with a tax liability of $137,433. The IRS assessed failure to file and failure to pay penalties.
The taxpayers claimed reasonable cause for penalty abatement on two grounds. First, they did not file a 2005 return because they thought they owed no tax, and second, they did not file a 2005 return on time because they needed additional time to gather information about the cost basis of their home, which was sold at a gain during that year.
In T.C. Memo. 2014-48 (Fields), the taxpayer liquidated her retirement plan account with her employer and received a $7,383 distribution during 2010. She requested that all required taxes be withheld from the distribution, and her employer withheld 20%.
The taxpayer was not age 59-1/2 at the time of the distribution, nor was she disabled, and she admitted she did not use the money to pay any expenses that would qualify for a statutory exception to the 10% early withdrawal penalty. However, when she completed her return, she did not calculate or pay the penalty.
She requested relief from the penalty because she had asked that all taxes be withheld from the distribution and she believed her employer had done so.
Taxing Lesson: Don’t do what you’ll have to find an excuse for.
The court said: Neither explanation suffices to demonstrate the ordinary business care and prudence the regulations require. First, the taxpayers’ belief that a return for 2005, if prepared, would show no payment due provides no justification for neglecting to prepare and file that return. Even if the tax liability for 2005 had been fully satisfied by withholding at the source, the taxpayers would still have been required to file a return because their gross income for 2005 exceeded the threshold for nonfilers. A taxpayer’s mistaken belief that he or she need not file a return is not reasonable cause.
Second, taxpayers’ assertion that they needed five additional years to gather information concerning the cost of their home improvements is both unconvincing and misguided. If the taxpayers could not access the relevant records by the extended 2005 filing deadline, they should have filed a return to the best of their ability and later filed an amended return to correct any errors. A person does not need tax expertise to recognize this common sense solution.
The court said: The withdrawal does not fit within any of the statutory exceptions. Despite her good intentions, the taxpayer should have reported a 10% additional tax on the distribution on line 58 of her return. Failure to do so caused her to improperly claim a refund. While we are sympathetic to her plight, we find that she is liable for the 10% additional tax on the distribution under section 72(t)(1).