As a small-business owner, you have good odds of someday facing a penalty for late filing and/or late payment of your or your company’s federal income or payroll taxes.
When you receive the penalty notice from the IRS, it’s likely you will think that you have to pay the penalties.
Expensive Mistake
The IRS charges steep penalties for failing to file tax returns on time:
- For your individual or C corporation return, the penalty is generally 5 percent of the total tax owed on the return for each month the return is unfiled, up to a maximum penalty of 25 percent of the total tax owed.
- For your partnership or S corporation return, the penalty is $200 per partner or shareholder per month, up to a maximum of 12 months.
Integrated with the late filing penalty is a late payment penalty. The late payment penalty is 0.5 percent of the tax owed on the return for each month the tax is unpaid, up to a maximum of 25 percent of the total tax owed.
Example 1. You forgot to file an extension and then filed your Form 1040 tax return on May 20. You owed $3,000 on the return and paid it in full when you filed it on May 20, two months late. The IRS hits you with $300 in penalties —$270 for late filing and $30 for late paying.
Example 2. You forgot to file your S corporation tax return. You filed it on March 20, only five days late. If your S corporation has 10 shareholders, that’s a whopping $2,000 penalty
We know many of the rules of the penalty road, and it’s quite possible that we can use one of those rules to either make your penalties go away altogether or substantially reduce them.
Quick Relief Is Possible
Your penalty relief could take only minutes. That’s true IRS mercy: (1) just minutes on the phone and (2) forgiveness of your penalty.
You just need to know how to ask for relief and what buzzwords to use with the person on the phone.
If the IRS forgives your $2,000 penalty in 15 minutes, you are paying yourself for this effort at the rate of $8,000 an hour in after-tax dollars!
Strategy 1: First-Time Abatement
If the IRS has never hit you with a failure-to-file penalty or a failure-to-pay penalty, simply ask for a first-time abate.
The IRS will remove your penalty, provided you have no other tax compliance issues, such as unfiled returns.
Beware, though: this is a one-time grace; you get only one first-time abate per return type.
First-time abatement is the easiest way to get a penalty removed since you don’t have to give the IRS a reason or explain why it happened.
First-time abatement usually is your first line of attack against IRS late filing and late payment penalties. In fact, the IRS tells its employees to look for this relief first before considering other reasons.
Strategy 2: Partnership Relief
The IRS carved out a little-known loophole over 30 years ago for late-filed partnership returns. It still works.
The IRS will abate your partnership late filing penalty if:
- the partnership has 10 or fewer partners, and
- all the partners reported their shares of partnership tax items on their timely filed tax returns.
To qualify, you and your partners must be individuals or estates, and you must allocate all partnership items according to the partnership interest.
When you call the IRS, tell them you want relief under Rev. Proc. 84-35. It’s that easy.
Strategy 3: Reasonable Cause
If you don’t qualify for first-time abatement or partnership relief, penalty removal gets trickier because you now have to give the IRS a legitimate reason and a clear explanation for why you failed to file and/or pay on time. The tax code calls this “reasonable cause.” You can make your reasonable cause pleading on the phone, at least to start with.
Your idea of legitimate reasonable cause likely differs, perhaps even greatly, from what the IRS considers legitimate reasonable cause. To get a penalty removed using reasonable cause, you need to make your plea for mercy specific and use key words that the IRS likes.
The IRS lists a few specific situations that are often reasonable cause, provided you can give specific details:
- Death or serious illness—yours or an immediate family member’s. Assuming the death is not your death, be prepared with the relationship of the person, the date of death or dates of illness, how the situation prevented you from meeting your tax requirements, how the death or illness impacted your life negatively, and whether you promptly resolved your tax matters once a reasonable amount of time passed.
- Fire, casualty, natural disaster, or other disturbance. If you were located in an officially declared disaster area, that’s important to disclose; however, it is not a requirement. Here, you need to describe the timing of the event, the effect on your personal life or business, how you attempted to comply, and how you complied as soon as possible.
- Inability to obtain records. You’ll need to explain why the records were important, why they were unavailable, what steps you took to acquire the records, why you weren’t able to use an estimate, and whether you promptly filed the return and paid the tax once you secured the records. Any documentation you have that shows your efforts to get the information is also helpful.
If none of the above apply, you’ll need to provide detailed information showing that you exercised ordinary business care and prudence but still weren’t able to meet your filing and payment requirements. Be ready to give a clear reason with a timeline, an explanation of how you complied with the law after you resolved the issue, why that time frame was reasonable, and why you could not have anticipated the issue in advance.
Avoid saying things like “I forgot,” “I just made a mistake,” or “I wasn’t aware of the law.” These statements don’t make your case.
And don’t try to blame your tax preparer for your failure to file or pay. The Supreme Court has held this is not reasonable cause. It boils down to this: you are responsible for your tax filings and payments—period.
But if you need some help with a large penalty or other tax resolution problem, give us a call, we know the procedures to help get you relief.