The Internal Revenue Manual (IRM) contains a Penalty Handbook intended to serve as the foundation for addressing the administration of penalties by the IRS. It is the “one source of authority for the administration of penalties. . .”[i] and provides a “fair, consistent, and comprehensive approach to penalty administration.” As such, the IRM is often the first stop for IRS examiners attempting to determine whether conduct should be subjected to further review and, potentially, civil penalties.
Objectives in Penalty Administration. Similar cases and similarly-situated taxpayers are to be treated in a similar manner with each having the opportunity to have their interests heard and considered. Penalty relief is to be viewed from the perspective of fair and impartial enforcement of the tax laws in a manner that promotes voluntary compliance. Penalties are designed to encourage voluntary compliance by defining standards of compliant behavior, defining consequences for noncompliance, and providing monetary sanctions against taxpayers who do not meet the standard.[ii]
In this regard, the objective of penalty administration by the IRS is to be severe enough to deter noncompliance, encourage noncompliant taxpayers to comply, be objectively proportioned to the offense, and be used as an opportunity to educate taxpayers and encourage their future compliance.[iii]
IRM Approach to Penalty Administration. The IRM’s approach to penalty administration provides:
Consistency: The IRS should apply penalties equally in similar situations. Taxpayers base their perceptions about the fairness of the system on their own experience and the information they receive from the media and others. If the IRS does not administer penalties uniformly (guided by the applicable statutes, regulations, and procedures), overall confidence in the tax system is jeopardized.
Accuracy: The IRS must arrive at the correct penalty decision. Accuracy is essential. Erroneous penalty assessments and incorrect calculations confuse taxpayers and misrepresent the overall competency of the IRS.
Impartiality: IRS employees are responsible for administering the penalty statutes and regulations in an even-handed manner that is fair and impartial to both the government and the taxpayer.
Representation: Taxpayers must be given the opportunity to have their interests heard and considered. Employees need to take an active and objective role in case resolution so that all factors are considered.[iv]
First Time Abatement. The IRS Reasonable Cause Assistant (RCA) is a decision-support interactive software program developed to reach a reasonable cause determination within the IRS.[v] The IRS will use the RCA after normal case research has been performed, (i.e., applying missing deposits/payments, adjusting tax, or researching for missing extensions of time to file, etc.) for the Failure to File (FTF), Failure to Pay (FTP), and Failure to Deposit (FTD) penalties.
RCA provides a valuable option for penalty relief known as the “First Time Abate” for the FTF [Code sections 6651(a)(1), 6698(a)(1), and 6699(a)(1)]; FTP [Code sections 6651(a)(2) and 6651(a)(3)], and/or FTD [Code section 6656] penalties if the taxpayer has not previously been required to file a return or if no prior penalties (except the Estimated Tax Penalty) have been assessed on the same account in the prior 3 years and has filed, or filed a valid extension for, all currently required returns and paid, or arranged to pay, any tax due.[vi]
If the taxpayer is not currently in compliance but all other FTA criteria are met, the IRM provides that the taxpayer is to be given an opportunity to fully comply before considering reasonable cause and the First Time Abate. If the tax is not paid in full on the tax period when the request for abatement is received and the taxpayer is current with installment agreement payments, the first-time abate/clean compliance history will be allowed with respect to an assessed failure to pay (FTP) penalty.
A previously assessed penalty that has subsequently been reversed in full will generally be considered to show compliance for that tax period. If the RCA determines a “First -Time Abate” is applicable, the taxpayer will be advised that the penalty(s) was removed based solely on their history of compliance, that this type of penalty removal is a one-time consideration available only for a first-time penalty charge, and that any future (FTF, FTP, FTD) penalties will only be removed based on information that satisfies the previously mentioned reasonable cause criteria.[vii]
Penalty relief under First Time Abate does not apply to the following (non-exclusive list):
- Returns with an event-based filing requirement, generally returns filed once or infrequently such as Form 706, U.S. Estate Tax Return, and Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
- The daily delinquency penalty (DDP), see e.g., IRC 6652(c)(2)(A).
- Form 1120, U.S. Corporation Income Tax Return/Form 1120-S, U.S. Income Tax Return for an S Corporation if, in the prior 3 years, at least one Form 1120-S, was filed late but not penalized.
- Information reporting that is dependent on another filing, such as various forms that are attached.
The First Stop in A Penalty Abatement Request. Civil tax penalty administration pending any potential comprehensive tax reform must continue to promote and enhance voluntary compliance. Most taxpayers attempt to comply with their filing and payment obligations under the Code. Others comply because of a concern for the imposition of penalties. Somewhere in between are taxpayers who are subjected to penalties for conduct they failed to realize was somehow wrongful.
The first stop in attempting to determine if certain penalties can be abated should be consideration of the First Time Abate provisions set forth in the IRS Internal Revenue Manual IRM 184.108.40.206.6.1. If the IRM provisions regarding a First Time Abate apply, request it from the IRS representative assigned to the penalty assessment.
Various states have conformed or are currently considering conformity with the First Time Abate provisions.
[i] Internal Revenue Manual (IRM) 220.127.116.11.1 (11-25-2011). Refer to IRM 9.1.3, Criminal Investigation – Criminal Statutory Provisions and Common Law, for Criminal Penalty provisions.
[ii] Penalty Policy Statement 20-1 (IRM 18.104.22.168.1; June 29, 2004)
[iii] IRM 22.214.171.124.1 (11-25-2011)
[iv] IRM 126.96.36.199.2 (11-25-2011
[v] IRM 188.8.131.52.6.1 (11-25-2011)