In the case of the most common penalties – those for lateness in filing your tax return or paying your tax liability – the penalty may be excused by IRS if you can establish “reasonable cause” for your actions. Reasonable cause can also excuse a variety of other civil tax penalties. What types of events will support a reasonable cause claim? The following are the most common that have been successful:
- Erroneous information was given the taxpayer by an IRS employee or publication. If this occurred in your case, you would be in the strongest position if you kept detailed records of the phone call, meeting, or publication in which IRS erred.
- Erroneous information was given the taxpayer by a tax practitioner. General reliance on a tax expert for tax help doesn’t relieve a taxpayer who will be considered to be aware of commonly-known facts such as the filing and payment deadlines. However, where a tax expert, for example, incorrectly advised taxpayer that he is not obligated to file or that he will have no tax liability upon an analysis of the tax law, the reasonable cause excuse may be available.
- Death or serious illness of the taxpayer or a member of his immediate family.
Payment extensions due to financial hardship
You may qualify for payment extensions due to financial hardship. However, by itself, financial hardship has rarely been found to support a reasonable cause excuse. IRS, and some courts, support a “bright line” rule under which financial difficulties can never be reasonable cause for purposes of the penalty for failure to pay taxes, but most courts have not been willing to go quite that far.
What will not Establish Reasonable Cause to IRS
The following won’t establish reasonable cause: (1) Lack of necessary information to prepare the tax return. (2) General overwork, stress, or health problems of the taxpayer or tax return preparer. (3) Ignorance of the law (not based on the advice of a tax expert). But, a taxpayer may have reasonable cause for failure to file or pay due to ignorance of the law if a reasonable and good faith effort was made to comply with the law, or the taxpayer was unaware of a requirement and could not reasonably be expected to know of the requirement. (4) Constitutional, religious, etc., objections. Philosophical arguments, such as arguments that the tax laws are unconstitutional, are consistently given short shrift by the courts and IRS.
No reasonable cause defense to the accuracy-related penalty
There is no reasonable cause defense to the accuracy-related penalty for underpayments attributable to transactions lacking in economic substance and the reasonable cause defense to the penalty for reportable transaction understatements doesn’t apply to any portion of a reportable transaction understatement which is attributable to one or more transactions lacking economic substance. If you are filing or paying late but can establish reasonable cause, don’t wait for the penalties to be assessed. A statement establishing reasonable cause for your situation should be attached to the return and may prevent the penalties from the start.