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PENALTY ABATEMENT WAVIER
The IRS’s first-time abatement penalty waiver (FTA), although introduced 12 years ago, is infrequently used by qualifying taxpayers. An FTA can be obtained for a failure-to-file, failure-to-pay, or failure-to-deposit penalty.
A taxpayer may claim an FTA for only a single tax period. To qualify, taxpayers must not have been assessed any other penalties of a “significant amount” on the same type of tax return within the past three years and must be in compliance with all filing and payment requirements.
IRS personnel use a decision-support software tool called the Reasonable Cause Assistant (RCA) to help determine whether a taxpayer is eligible for an FTA. However, the RCA has been criticized for yielding a high percentage of incorrect determinations of FTA eligibility that IRS personnel generally do not correct.
Through persistence, a practitioner can often persuade the IRS to reverse an initial incorrect determination that a taxpayer does not qualify for an FTA.
It is safe to assume that most taxpayers dislike paying taxes and hate paying IRS penalties, especially when the penalties seem unjust. While penalties can also seem arbitrary to taxpayers, IRS policy is clear and deliberate on their reason for existence: to deter taxpayer noncompliance, not to generate revenue. 1
For that reason, 12 years ago, the IRS created the first-time penalty abatement administrative waiver (FTA), 2 which allows typically compliant individual and business taxpayers to request abatement, or removal, of certain penalties that the IRS has assessed against them for the first time. In effect, the IRS rewards typically compliant taxpayers with one-time penalty amnesty, which can save the taxpayer hundreds—sometimes thousands—of dollars.
Despite the advantages of this IRS waiver, few taxpayers who qualify for FTA request it, according to a 2012 report by the Treasury Inspector General for Tax Administration (TIGTA). 3 According to the report, the problem is twofold: Most taxpayers and tax professionals do not know FTA exists, and IRS representatives often incorrectly disallow an FTA when using the IRS’s faulty automated decision tool to make penalty determinations.
In effect, FTA is hidden to most taxpayers and tax practitioners, who may not be aware of how it works, how to request it, or even its existence. This article explores the IRS FTA waiver and explains how to help clients remove certain penalties using it.
Penalties and Abatement
In fiscal 2012, the IRS assessed 37.9 million penalties against taxpayers totaling $26.8 billion. 4 Individual, business, and payroll penalties for failure to file, failure to pay, and failure to deposit (the types potentially eligible for FTA) were 74% of all penalties assessed in 2012. 5 The IRS assesses most of these penalties automatically, regardless of the taxpayer’s situation.
Methods for Requesting Penalty Relief
Taxpayers can request relief from failure-to-file, failure-to-pay, and failure-to-deposit penalties in three ways, depending on their situation:
Before the IRS assesses a penalty, the taxpayer can file a penalty nonassertion request with a paper return to request that the IRS not automatically assess a penalty.
After the IRS has assessed a penalty, the taxpayer can request penalty abatement, typically by writing a penalty abatement letter or by calling the IRS. Tax professionals can also request abatement using IRS e-services.
After the taxpayer has paid the penalty, the taxpayer can request a refund using Form 843, Claim for Refund and Request for Abatement. 6 The taxpayer must file the claim within three years of the return due date or filing date, or within two years of the date the penalty was paid.
Reasons to Request Abatement
Generally, relief from penalties falls into four separate categories: reasonable cause, statutory exceptions, administrative waivers, and correction of IRS error. Under the category of administrative waivers, the IRS may formally interpret or clarify a provision to provide administrative relief from a penalty it would otherwise assess. The IRS may address an administrative waiver in either a policy statement, news release, or other formal communication stating that the policy of the IRS is to provide relief from a penalty under specific conditions. The most widely available administrative waiver is FTA.
First-Time Abatement Waiver
In 2001, the IRS established FTA to help administer the abatement of penalties consistently and fairly, reward past compliance, and promote future compliance. This administrative penalty waiver allows a first-time noncompliant taxpayer to request abatement of certain penalties for a single tax period—one tax year for individual and business income taxes and one quarter for payroll taxes.
According to TIGTA, for tax year 2010, the average individual failure-to-file abatement qualifying under FTA was $240, and the average failure-to-pay abatement was $84. However, more than 90% of individuals who qualified for an FTA did not receive the waiver for 2010. 7 This is likely because taxpayers did not know they could request it. The IRS does not publicize FTA as a relief option on its penalty-related notices or on its website. 8
The remainder of this article discusses how to determine whether a client qualifies for FTA and how to request it from the IRS.
Penalties Eligible for an FTA
FTA applies only to certain penalties and certain returns filed. First, determine whether FTA applies to the client’s situation:
Individual taxpayers can request an FTA for failure-to-file and failure-to-pay penalties. Estate and gift tax returns do not qualify for FTA waivers. 9
Business and payroll taxpayers can request an FTA for failure-to-file, failure-to-pay, and/or failure-to-deposit penalties. The IRS is not explicit in its Internal Revenue Manual (IRM), but in practice, the IRS has granted FTAs for S corporation and partnership late-filing penalties. 10
For individual and business taxpayers, the estimated tax and accuracy-related penalties cannot be waived under FTA.
Clean Compliance Criteria
If FTA applies to the client’s situation, the practitioner must determine whether the client qualifies to receive it, which entails most of the complexity involved in requesting an FTA. To qualify, the client must demonstrate filing and payment compliance and a three-year clean penalty history.
To meet the rule for filing compliance, the client must have filed, or filed a valid extension for, all currently required returns and must not have an outstanding request from the IRS for an unfiled return. 11 To meet the payment compliance rule, the client must also have paid, or arranged to pay, any tax due. The client can have an open installment agreement, as long as installment payments are current. According to the IRM, the IRS should give a taxpayer not currently in compliance with these payment requirements an opportunity to comply and thereby qualify for an FTA before the IRS considers whether the penalty can be abated for reasonable cause. 12
To meet the rule for clean penalty history, the client cannot have had penalties of a “significant” 13 amount assessed in the prior three years on the same tax return for which the client is requesting abatement. IRS procedures do not publicly define a “significant” amount. In practice, the IRS has considered any penalty amount as significant in its application of the FTA qualification. 14 If the IRS rejects the client’s request because of a small penalty assessment, remind the IRS of the “significant” qualification in the IRM.
The client will not be disqualified from receiving an FTA based on lack of a clean penalty history if the client:
Had a penalty assessed more than three tax years prior to the tax return in question.
Had an estimated tax penalty assessed in the past three years. 15
Received reasonable-cause relief from penalties at any point in the past.
Received an FTA more than three tax years prior to the tax return in question.
Has penalties on subsequent tax years. 16
Requesting an FTA
By phone or e-services: A practitioner who determines that the client qualifies for an FTA can request it in several ways. Start with simple methods. If the client’s case does not involve a compliance function, call the IRS Practitioner Priority Service (PPS) line 17 or use the IRS e-services Electronic Account Resolution function. 18 The IRS representatives in Accounts Management have authority to grant an FTA.
When an IRS compliance unit assesses the penalty, requesting an FTA from a PPS representative or by e-services will not work. For example, for a taxpayer under audit or underreporter inquiry or with a case in IRS Collection or Appeals functions, the appropriate compliance unit will address penalties based on the taxpayer’s facts and circumstances. If a compliance unit assesses a penalty, penalty relief must typically be requested directly from that unit. 19
Keep in mind that there is an unpublished ceiling on the amount in penalties that the IRS will abate under FTA by phone or e-services (referred to as oral statement authority). 20 The IRS redacts the oral statement authority threshold amount in its IRM for tax administration purposes. 21
For reasonable-cause determinations, in lieu of accepting an oral request, the IRS can require taxpayers to send in documentation to support their claim. The IRS representative can accept “credible information” orally or in writing. The IRS’s automated Reasonable Cause Assistant (see below) prompts the representative to ask for documentation. 22 If the client’s penalties exceed the threshold, the waiver still applies, but IRS procedures require that the FTA request be in writing. 23 In practice, when requesting abatement of penalty amounts in thousands of dollars, be prepared to request an FTA in writing.24
In writing: When requesting an FTA in writing, provide any other relevant penalty relief arguments, including reasonable-cause arguments, to increase the client’s chances of having the penalty removed.
If the client has clear reasonable cause for the penalty, present the reasonable-cause argument first and request that the IRS abate the penalty on those grounds. This is a best practice because the client may need to use the FTA waiver for a subsequent year, and abatement due to reasonable cause will not disqualify the client from receiving an FTA.
If the client technically does not qualify for an FTA because of a penalty in the past three years but is otherwise compliant, present this history in conjunction with other arguments to the IRS for penalty abatement. Remind the IRS that although FTA does not apply, the client has a clean compliance history except for the one incident of noncompliance.
If the client has multiple years of penalties, request an FTA for the first year if the prior three years have a clean compliance history. If applicable, other arguments, such as reasonable cause, can be presented for subsequent years.
Example: C filed late returns with a balance due for 2010 through 2012. As a result, the IRS assessed C failure-to-file and failure-to-pay penalties for all years. She was also assessed an estimated tax penalty for all years as a result of not paying sufficient estimated taxes and withholding. These were the taxpayer’s first instances of noncompliance. C’s tax professional determines that she has a reasonable-cause argument for 2012, based on her facts and circumstances and the application of reasonable-cause criteria. The tax practitioner obtains an FTA for the 2010 failure-to-file and failure-to-pay penalties and submits a reasonable-cause penalty abatement request for 2012. The estimated tax penalties cannot be abated with the FTA waiver.
The written FTA request should be sent to the IRS service center where the client is required to file paper returns. 25
IRS Abatement Determinations Often Flawed
When the taxpayer or practitioner calls or writes the IRS to request an FTA, the IRS evaluates the request using an automated tool. To uniformly apply penalty abatements, the IRS developed a decision-support software program called the Reasonable Cause Assistant (RCA). The program was designed to help IRS employees make penalty relief determinations for individuals (failure-to-file and failure-to-pay penalties) and businesses (failure-to-deposit penalty). The IRS requires its employees to use this program to make determinations on penalty abatement requests, including requests for an FTA.
Although the IRS has tried to uniformly and consistently apply penalty abatement determinations, the use of the automated RCA has led to unfair determinations, including FTA decisions. According to a 2011 IRS Advisory Council (IRSAC) report, the RCA makes incorrect determinations in 55% of all penalty abatement requests. 26 A 2012 TIGTA report stated that, of its sample of abatements determined using the RCA, 89% were incorrect. Further, in the TIGTA study sample, IRS employees corrected none of the inaccurate determinations, even though the determinations conflicted with IRM penalty abatement procedures. 27 IRS employees can, however, abort the RCA process when its determination conflicts with penalty abatement policy. If the IRS employee aborts the RCA, he or she can then make a decision based on whether the taxpayer’s facts meet the clear criteria for FTA qualification.
Be prepared by researching the client’s clean compliance history and applying the qualification rules before contacting the IRS. If the client qualifies but the IRS representative says the client does not, ask the representative to override the RCA determination. If the representative will not override it, ask for the representative’s manager. Finally, if all other means have been exhausted, consider contacting the Taxpayer Advocate Service (TAS) for help. 28 Keep in mind that IRS representatives often simply do not know how to use the RCA, thus resulting in errors. 29 If the IRS representative is unsure about how to use the program, a practitioner who is sure the client qualifies can try calling back to request an FTA again.
In most circumstances, with proper knowledge of the client’s facts and qualification, a practitioner can obtain an FTA from the IRS PPS representative, who has oral statement authority on FTA.
A client to whom the IRS grants an FTA will receive Letter 3502C or 3503C 30 for individual failure-to-file and failure-to-pay penalty abatement and Letter 168C (or its equivalent) 31 for business failure-to-deposit penalty abatement. The letter usually arrives about four weeks after the IRS grants the FTA.
The Future of FTA
Encouraging compliance is one of the IRS’s major goals as it focuses on closing the $450 billion annual tax gap. 32 The proper use of penalties helps deter noncompliance, and it is clear that the IRS has been using penalties to that end. During the past 11 years, the number of penalties assessed increased by 34%, from 28.3 million penalties in 2002 to 37.9 million in 2012. 33 However, to increase voluntary compliance, the IRS must administer penalties fairly and consistently.
In the spirit of consistency, why not give an FTA to every qualifying taxpayer? The TAS has suggested this very concept to promote fairness. In its 2010 Report to Congress , 34 the TAS proposed that the FTA waiver be automatically applied before the penalty is assessed rather than requiring taxpayers to request an FTA. The intent of the FTA waiver is to reward past compliance and promote future compliance. However, as the TAS noted in its 2010 report, the total number of penalty abatements has decreased as the number of penalties assessed has increased, demonstrating that penalty relief options, including FTA, are not fulfilling their intended purpose of encouraging compliance.
However, granting an FTA to all qualifying taxpayers could undermine penalty administration. The fact that a taxpayer has to request abatement and receive a letter represents a tangible opportunity for the IRS to promote compliance. The abatement notice and accompanying discussion constitute a quantifiable event in which the IRS communicates with the taxpayer and the taxpayer understands the consequences of future noncompliance.
The IRS stated in its response to the 2010 TAS Report to Congress that it is studying whether FTA increases compliance and whether a system to grant FTA waivers prior to penalty assessment should be implemented. To date, the IRS has not concluded the study.
To ensure uniformity among all penalty abatement requests, the IRS needs to create a more uniform policy to remove errors caused by reliance on its RCA and train assigned personnel to review penalty abatement requests. In 2011, the IRSAC Small Business/Self-Employed subgroup recommended that the IRS develop a clear penalty abatement request form that would guide taxpayers in evaluating their circumstances against penalty abatement criteria, including FTA. This form would eliminate confusion about how to request penalty abatement, define the criteria for removing penalties, and facilitate fairness and consistency. Practitioners should look for this form in the future.
The report points out that Form 843, Claim for Refund , can be used for penalty abatement but that it is not designed for penalty abatement because it does not guide the taxpayer to address abatement requirements. IRSAC states that the Form 843 instructions for penalty abatement are “confusing at best.” The form is also not designed for unpaid penalties. The very name of the form implies that it should be used for post-payment refund requests, not penalty nonassertion or abatement requests prior to payment of a penalty. 35 Form 843 instructions were changed in December 2012, but not to enable it to better address possible penalty abatement arguments and simplify abatement requests.
With TIGTA and TAS reports highlighting the IRS’s inconsistent application of penalty abatement, the IRS will likely make some changes in its requirements and procedures for requesting and granting penalty abatements in the future. For now, if the client qualifies, the practitioner can effectively request and receive relief for the client’s penalties using this largely unknown and beneficial administrative waiver