Have you ever received an IRS letter and found that there are significant penalties on that tax notice? Or in extreme circumstances, have you ever seen that the penalties actually exceed the amount of the tax owed? There is potential relief available. The first-time abatement rules may potentially help you.
The first question that comes to mind is, can IRS penalties even be removed? Can they be abated? The short answer to that is, yes, it may be possible. There are two main provisions which govern the abatement of penalties. The first is the reasonable cause provisions. I’m not going to go into that in this article however I will have a separate training where I go through that in detail. I am going to go through the first-time abatement rules. This is something that most taxpayers and even many tax professionals don’t know about. They don’t even know that this exists and they don’t know that this could potentially provide them with relief. This strategy alone could potentially save you hundreds if not thousands of dollars, if applicable.
Which Penalties Can Be Abated?
What penalties can be abated? Let’s go through that first. There are three main categories of penalties that I’m going to discuss today. The first is called the failure-to-file penalty. This applies to individual, business, and payroll taxpayers. The second is called the failure-to-pay penalty. This also applies to individual, business, and payroll taxpayers. The third category is called the failure-to-deposit penalty. This applies to business and payroll taxpayers. You’ll see this commonly in the context of 941 filers.
You’ll also see these three penalties (failure-to-file, failure-to-pay, or failure-to-deposit) show up in two additional categories beyond just tax notices that you may be receiving in the mail. One example is the substitute for return category or SFRs. These are scenarios where the IRS will prepare a return for a taxpayer if the taxpayer doesn’t prepare and file a return. You may also see these penalties as additional taxes assessed or additional assessments, for example, in the outcome of a tax audit. First-time abatement can provide potential relief in these scenarios.
One thing you need to know is that abatement is only possible for tax years 2001, forward. Older tax years prior to 2001 no longer qualify. Also it’s important to know that there are some additional penalties which are not eligible. Specifically, the estimated tax penalty is not eligible (also known as the 2210 penalty). Also, the accuracy-related penalty is not eligible for first-time abatement. Lastly, estate and gift tax returns are not eligible for first time abatement.
Criteria To Meet
What criteria do you need to meet in order to determine if you qualify? The two main criteria you need to meet are (1) a clean compliance history and (2) a clean payment history. So what does that mean? Well that means that you need to have filed all your required tax returns. If you have unfiled tax returns, you need to make sure you get those filed. Unless you possibly didn’t need to file a tax return that year which is rare but it does happen. If it’s a current year return and you filed an extension of time to file, that’s OK as well. So you need to be compliant and compliance means getting all your required tax returns filed. Secondly, you need to have paid or arranged to pay any tax due. So, if you have an installment agreement in place (you owe money and you have a monthly payment plan), as long as you’re current on those monthly payments you will have met this particular criterion.
You need to know about the three-year lookback. This is the critical piece of this puzzle. There’s a three-year lookback which applies when determining eligibility. You need to look back to three prior years for the year that you’re looking to get abatement for. For example, if you’re looking for abatement for tax year 2014, you need to look back to 2011, 2012 and 2013 to see if you meet the appropriate criteria. What are the criteria? You cannot have any failure-to-file or failure-to-pay penalties in the three prior years. You also cannot have any failure-to-deposit penalties in the prior three years.
In the context of failure-to-deposit with 941 taxpayers, for example, you’ll be looking back at the prior 12 quarters. And notice that I’ve written no failure-to-file penalties, no failure-to-pay, no failure-to-deposit. That’s different from previously when the presence of a small penalty or an insignificant or de minimis penalty could still potentially qualify. Now the IRS has changed the rules and they are clearly stating that you must not have any penalties present. However, if you have an underpayment penalty show up, a 2210 penalty, that should not disqualify you.
You have to actually look at the transcripts and you have to look at the prior years. There is a look back period and you have to look at what penalties show up. If it’s a 2210 penalty that might still be OK in terms of requesting abatement. Also, you cannot have any accuracy-related penalties in the three prior years. So there’s a three year look back and you can’t have any penalties. If you do see a penalty and you notice that it’s relatively insignificant, (if it’s a small amount let’s say 20 dollars or 100 dollars) it might still be worthwhile to actually try to make the argument. There’s no harm in asking (you don’t ask, you don’t get). But unlike prior years the IRS has changed this. You can still try to ask fot it but it may not get through.
There are other strategic considerations. You only get one bite at this apple so taxpayers generally get one first-time abatement request in a lifetime. It’s called “first-time” abatement for a reason. You want to use your discretion when you select a tax year for first-time abatement. If there are multiple years that qualify, you want to use your judgement to see which year we’ll get the most benefit. Keep in mind that the failure-to-pay penalty will continue to accrue so timing is important. You don’t want to request abatement on one particular tax year too early because penalties are going to continue to accrue until a tax is fully paid. It may be worthwhile to actually wait a little bit and then request abatement once the tax is fully paid and the penalty has fully accrued (so that you can get the entire penalty removed and not just some portion of it). Timing matters. Use it when and use it where it will have the most benefit. You have to think through it. Also keep in mind that in certain cases it may be worthwhile to actually pass on first time abatement. You don’t want to use it if you can actually preserve it for future use when it will be more worthwhile. If you’re looking at a penalty that is de minimis (if it’s a small amount) you don’t want to waste first time abatement trying to save $30, for example. You may want to wait and use it in a circumstance where you can save $14,000, for example. When you look at the transcripts and you look at the case, keep in mind that it needs to be used when it makes sense to do so.
Also, interest charged on a penalty will be reduced or removed when the actual penalty is reduced or removed. This actually becomes interesting if there are multiple years that qualify. Which one should you actually request abatement for? For example, let’s say there’s an older tax year that has a smaller penalty amount but it has a higher interest component because it’s an older tax year. There’s been a larger amount of time that’s passed which results in more interest. This is in comparison to a recent tax year where you have a larger penalty but a smaller amount of interest. In that situation it may actually make sense to try to get the older amount abated because you’ve got a greater amount of interest (and penalty in the aggregate) that may actually be removed along with the associated penalty. So you’ve got to think through it to see what makes sense.
Keep in mind that first-time abatement is not just for 1040 taxes or individual income taxes. First-time abatement can actually work for C corporations, S corporations, partnerships, and nonprofits. So form 1120, 1120S, 1065, and 990 may also benefit as well. Don’t use first-time abatement if some other avenue is available for relief. So for example, if there’s a penalty showing up and there’s some other avenue for relief that the IRS has released (whether it’s temporary or permanent), you don’t want to use first-time abatement. You would rather save first-time abatement for when you actually need it and use the other avenue. Again, you only get one first-time penalty abatement request.
You also want to use your independent judgment and analysis to support your request. This is important because we do see that the IRS makes incorrect determinations when determining eligibility. They have a reasonable cause assistant and they use that to determine eligibility but it often produces the wrong conclusion. So, you want to use your own independent judgment and perform your own analysis. Determine eligibility by looking at the facts, looking at the transcripts, going back three years, and make your case. If the IRS makes an incorrect determination–if you have all your paperwork together and you have your analysis put together–you can provide that to the IRS. You may be able to persuade them otherwise or persuade a manager otherwise if you escalate it to somebody who can take a second look at it.
How To Request First-Time Penalty Abatement
How do you get first time abatement? Well you can simply pick up the phone and contact the IRS. Make your case over the phone and present the facts. Be prepared in that circumstance. You can submit a written request and write a letter. If the penalty has already been paid, you can also use form 843, Claim for Refund and Request for Abatement. Those are three common ways to request first-time abatement.
Resources To Learn More
Lastly, I want to share some resources with you to learn more if you want to dive into this further. I encourage you to look at the Internal Revenue manual directly. This is what the IRS uses. That citation is 184.108.40.206.3.2.1. If you Google that it’ll come up so just type in IRM and put in that citation and you’ll see the whole section on this. You’ll see the heading called First Time Abate (FTA) and you can look at this further. In fact, if you write a letter to request first time abatement, you can use this citation in your letter to support your request. Lastly, if you have any questions feel free to contact us. We’re here to support you. We’re here as a resource and happy to chat with you and answer any questions you have. Give us a call. Drop us an email. Or self-select a time on my calendar.