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Avoiding Civil Penalties for Failing to File or Pay

Steven WalkerJanuary 15, 2020

The IRS can assess a penalty for the failure to timely file a tax return on or before the due date, and a penalty for failing to timely pay the balance shown on a return.  See § IRC 6651(a)(1) and (2).  The amount of the penalties can be substantial, and if unchecked, they can total up to 25 percent of the tax due on the return.  It is important to remember that an extension to file doesn’t extend the time to pay, and so the prudent course of action is to always timely file to avoid the failure to file penalty.

For example, suppose a taxpayer, Jane, timely files a tax return on July 16, 2020, but does not pay the amount due of $20,000 because she lacks the cash on hand to pay. Jane may be faced with a failure to pay penalty that can eventually reach $5,000 ($20,000 x 25%).  The penalty is equal to 0.5 percent of the amount due for each month or fraction of a month during which the tax remains unpaid up to 25 percent. IRC § 6651(a)(2).

Often, taxpayers facing collection issues are surprised to learn that the penalties are more than the tax and interest owed.  This can be avoided by acting proactively, timely filing the return, and offering a collection alternative. The tax code also limits the penalty on an individual’s failure to pay for the months during which the taxpayer is in an installment agreement.  IRC § 6159.  Consequently, a key move is to file the return on or before the filing deadline and promptly enter into an installment agreement to reduce the late-payment penalty.

Another advantage of an installment agreement is that it stops all collection action, which means the IRS cannot levy (seize) a taxpayer’s bank account or assets.  An installment agreement is robust and can provide a taxpayer with a piece of mind and needed time to get back into shape financially.

A taxpayer might be able to obtain penalty relief if the failure to file or pay was due to reasonable cause.  A taxpayer is liable for a civil penalty for failing to timely file or pay “unless it’s shown that such failure is due to reasonable cause and not willful neglect . . ..”  IRC § 6651(a)(1), (2). “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.”  Internal Revenue Manual 20.1.1.3.2 (11-21-2017).  The IRS has identified several categories of reasonable cause for a delayed filing and payment, including “the death or serious illness of the taxpayer” and “advice from a tax advisor.”  Internal Revenue Manual 20.1.1.3.2.2.1 (11-25-2011), 20.1.1.3.3.4.2 (11-21-2017).  The IRS has a Penalty Handbook that agents consult in determining whether relief can be granted.  Internal Revenue Manual 20.1.1.  Obtaining penalty relief is not always easy, and a taxpayer may want to consult with competent tax counsel to obtain assistance.

Some taxpayers employ the “wait and see” approach and hold to file their tax return until they have enough funds to pay the balance due.  The misplaced logistic is that if the taxpayer files the return by the due date, the IRS will assess the taxes and send a bill.  Unfortunately, this strategy never works because the IRS will assess failure to file and failure to pay penalties, and the taxpayer will be financially worse off.  Consequently, taxpayers should always timely file their tax returns, and then handle the balance due by, for example, paying part of the amount owed and entering into an installment agreement.

Finally, the FTB has similar penalties for failing to timely file and pay.  CA Rev. & Tax Code §19131 (failure to file) and §19132 (failure to pay). The FTB will follow the federal determination and impose similar penalties, but again, penalty relief is available based upon a showing of reasonable cause.

Summary Points

Given the unprecedented times, some taxpayers may simply lack the financial means to pay the taxes reported on the return by the due date.  There are options available for taxpayers in this situation, but the most crucial advice is to timely file the tax return by the due date to avoid the late filing penalty.  Once the return is timely filed, a taxpayer can offer a collection alternative, such as an installment agreement, offer in compromise, currently not collectible status (financial hardship).  Other options may also exist, such as penalty relief, innocent spouse relief, and bankruptcy.  Taxpayers facing collection issues should retain competent tax counsel, who can review the facts of their case, explain the options, and formulate a workable strategy.