Reasonable Cause & Tax Penalties
IRS Reasonable Cause for Abatement of Penalties: When it comes to the IRS and penalties, there are (generally) two situations in which reasonable cause is primarily used.
In the first scenario, a person may have already been issued an IRS Penalty, and they are seeking to abate the penalty by proving the mistake was reasonable.
In the second scenario, a person realizes they are already out of compliance for not properly reporting a form or paying the tax – and want to avoid being penalized for the noncompliance.
It is important to understand the concept of reasonable cause, how it is applied, and how it may be limited by the IRC (Internal Revenue Code).
What is Reasonable Cause?
When you make a mistake with your taxes, and you want to fix the mistake while avoiding penalties (or abating them), you can submit a reasonable cause package to the IRS.
The statement is a comprehensive and detailed legal and factual explanation about the mistake(s) that were made, and why you, the Taxpayer, should qualify as having reasonable cause sufficient to have the penalties waived.
There is no Reasonable Cause form to use when submitting the request.
There are other forms that may accompany the reasonable cause statement in some situations, such as a penalty abatement waiver request, CAP (Collection Appeals Process) or CDP (Collection Due Process) – but there is no specific “fill in the blanks” Reasonable Cause Form
Penalty Abatement & Reasonable Cause
The two main instances in which a person will rely on Reasonable Cause is:
- Avoid a penalty being issued (for example, failing to file international reporting forms); or
- Eliminating (or reducing) a penalty that was issued, such as a CP15 Notice
Reasonable Cause (Example 1)
Here is a common situation we deal with:
David has 3 foreign corporations.
His ownership requires him to file a Form 5471 for each corporation, each year. He did not file the form because he did not know about it.
There are no other U.S. shareholders, so nobody else filed the form either. David learns from his new CPA that the forms should have been filed.
David or his CPA reaches out to us to submit a Reasonable Cause Package on his behalf BEFORE filing for the current year, in order to avoid the quiet disclosure conundrum.
Reasonable Cause (Example 2)
Melissa is a foreign person now on H-1B and resides in the U.S.
Her foreign national parents have decided to gift Melissa $800,000 to help her purchase a condo. This is simply a gift from her foreign parents.
What Melissa did not know, was that she was required to report the gift to the IRS on Form 3520.
Melissa, goes back to her tax advisor who slaps together a sloppy and insufficient reasonable cause letter to accompany the late 3520-filing.
The IRS issues a 25% penalty on the late reported gift ($200,000) in accordance with a CP15 notice, and now Melissa has limited time to respond in order to try to abate the penalty.
IRM & Reasonable Cause
The IRM is the Internal Revenue Manual. It provides a framework on how the IRS agents work different types of cases.
As to Reasonable Cause, the IRS provides the following:
- Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise apply. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations.
- In the interest of equitable treatment of the taxpayer and effective tax administration, the non-assertion or abatement of certain civil penalties based on reasonable cause or other relief provisions provided in this IRM must be made in a consistent manner and should conform with the considerations specified in the IRC, Treasury Regulations (Treas. Regs.), policy statements, and IRM Part 20.1, Penalty Handbook.
- Reasonable cause relief is not available for all penalties; however, other exceptions may apply.
- For those penalties where reasonable cause can be considered, any reason which establishes that the taxpayer exercised ordinary business care and prudence, but nevertheless was unable to comply with a prescribed duty within the prescribed time, will be considered.
- If a reasonable cause provision applies only to a specific IRC section, that reasonable cause provision will be discussed in the IRM 20.1 section relating to that specific IRC section. See IRM 184.108.40.206.2 and Exhibit 20.1.1-1, Penalty Relief Application Chart.
- When considering the information provided in the following subsections, remember that an acceptable explanation is not limited to those given in IRM 20.1. Penalty relief may be warranted based on an “other acceptable explanation,” provided the taxpayer exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time. See IRM 220.127.116.11.2.2, Ordinary Business Care and Prudence.
- The wording used to describe reasonable cause provisions varies. Some IRC penalty sections also require evidence that the taxpayer acted in good faith or that the taxpayer’s failure to comply with the law was not due to willful neglect. See specific IRM 20.1 sections for the rules that apply to a specific IRC penalty section. See IRM 18.104.22.168.2, Organization of IRM 20.1.
- Taxpayers have reasonable cause when their conduct justifies the non-assertion or abatement of a penalty. Each case must be judged individually based on the facts and circumstances at hand. Consider the following in conjunction with specific criteria identified in the remainder of this subsection:
- What happened and when did it happen?
- During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax, and/or otherwise complying with the law?
- How did the facts and circumstances result in the taxpayer not complying?
- How did the taxpayer handle the remainder of his or her affairs during this time?
- Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
- Reasonable cause does not exist if, after the facts and circumstances that explain the taxpayer’s noncompliant behavior cease to exist, the taxpayer fails to comply with the tax obligation within a reasonable period of time.
- Any reason that establishes a taxpayer exercised ordinary business care and prudence but nevertheless failed to comply with the tax law may be considered for penalty relief.
- The following Treas. Regs. contain examples of circumstances that may be helpful in determining if a taxpayer has established reasonable cause:
Regulation Description Treas. Reg. 1.6664–4 Accuracy-Related Penalties (see IRM 20.1.5) Treas. Reg. 301.6651–1(c) Failure to File a Tax Return and/or Failure to Pay tax Penalties (see IRM 20.1.2) Treas. Reg. 301.6724–1 Information Returns Penalties (see IRM 20.1.7 ) Treas. Reg. 1.6694–2(e)(1)-(6) Tax Return Preparer Penalties (see IRM 20.1.6) Treas. Reg. 301.6707-1(e)(3) Material Advisor Penalties (see IRM 20.1.12)
- The following Internal Revenue Service policy statements contain specific criteria that may affect the imposition of penalties:
- Policy Statement 20–2, Penalties and Interest Not Asserted Against Federal Agencies. See IRM 22.214.171.124.2.
- Policy Statement 3–2, Reasonable Cause for Late Filing of Return or Failure to Deposit or Pay Tax When Due. See IRM 126.96.36.199.2.
- Policy Statement 3–3, Timely Mailed Returns Bearing Foreign Postmarks to Be Accepted. See IRM 188.8.131.52.3.
- Policy Statement 3–5, Unsigned Income Tax Returns Will Not Be Accepted for Processing; Delinquency Penalty Generally Will Not Be Imposed on Timely Filed Unsigned Income Tax Returns. See IRM 184.108.40.206.5.
See IRM 1.2.1, Servicewide Policies and Authorities-Policies of the Internal Revenue Service.
- Ordinary business care and prudence includes making provisions for business obligations to be met when reasonably foreseeable events occur. A taxpayer may establish reasonable cause by providing facts and circumstances showing that he or she exercised ordinary business care and prudence (taking that degree of care that a reasonably prudent person would exercise), but nevertheless were unable to comply with the law.
- Taxpayer’s Reason: The taxpayer’s reason should address the penalty imposed. To show reasonable cause, the dates and explanations should clearly correspond with events on which the penalties are based. If the dates and explanations do not correspond to the events on which the penalties are based, request additional information from the taxpayer that may clarify the explanation. See IRM 220.127.116.11.2, Reasonable Cause.
- Compliance History: Check the preceding tax years (at least three) for payment patterns and the taxpayer’s overall compliance history. The same penalty, previously assessed or abated, may indicate that the taxpayer is not exercising ordinary business care. If this is the taxpayer’s first incident of noncompliant behavior, weigh this factor with other reasons the taxpayer gives for reasonable cause, since a first- time failure to comply does not by itself establish reasonable cause.
- Length of Time: Consider the length of time between the event cited as a reason for the noncompliance and subsequent compliance. See IRM 18.104.22.168.2, Reasonable Cause. Consider: (1) when the act was required by law, (2) the period of time during which the taxpayer was unable to comply with the law due to circumstances beyond the taxpayer’s control, and (3) when the taxpayer complied with the law.
- Circumstances Beyond the Taxpayer’s Control: Consider whether or not the taxpayer could have anticipated the event that caused the noncompliance. Reasonable cause is generally established when the taxpayer exercises ordinary business care and prudence, but, due to circumstances beyond the taxpayer’s control, the taxpayer was unable to timely meet the tax obligation. The taxpayer’s obligation to meet the tax law requirements is ongoing. Ordinary business care and prudence requires that the taxpayer continue to attempt to meet the requirements, even though late.
We Specialize in Reasonable Cause & Offshore Voluntary Disclosure
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure.
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Recent Case Highlights
- We represented a client in an 8-figure disclosure that spanned 7 countries.
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- We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
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- 20-years experience as a practicing attorney
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