On July 2, 2020, the IRS released a practice unit addressing a taxpayer’s reasonable cause and good faith defenses to civil penalties. IRS practice units are developed through internal collaboration and serve as both job aids and training materials on tax issues. Practice units provide a general discussion of a concept, process or transaction and are a means for collaborating and sharing knowledge among IRS employees. A list of the IRS practice units can be found here. Although practice units are not official pronouncements of law or directives and cannot be used, cited or relied upon, they provide insight to taxpayers and tax advisors.
The practice unit on reasonable cause and good faith defenses can be found here. Some of the highlights of the practice unit are:
- Taxpayers bear the burden of providing support to substantiate reasonable cause for penalty relief.
- An examiner applies a facts and circumstances test on a case-by-case basis to determine whether a taxpayer meets the reasonable cause and good faith exception.
- The taxpayer must have exercised the care that a reasonably prudent person would have used under the circumstances.
- The reasonable cause exception under IRC 6664(c) applies to:
- Accuracy related penalties under IRC 6662
- Civil fraud under IRC 6663
- Reasonable cause exceptions for penalty relief also apply to other IRC penalties such as:
- IRC 6651 - Failure to File and/or Failure to Pay
- IRC 6676 - Erroneous Claim for Refund or Credit
- IRC 6721 - Failure to File Correct Information Reporting Returns
- IRC 6694 - Understatement of Taxpayer’s Liability by Return Preparer
- The reasonable cause exception does not apply to an underpayment of tax that is due to:
- Transactions lacking economic substance as described in IRC 6662(b)(6), or
- A gross valuation overstatement from charitable deduction property.
- The most significant factor in determining whether a taxpayer has reasonable cause and acted in good faith is the taxpayer’s effort to report the proper tax liability.
- Other factors to consider are the taxpayer’s experience, knowledge, education
,and reliance on the advice of a tax advisor.
- The taxpayer’s experience, education
,and sophistication, with respect to the tax laws, are relevant in determining whether the taxpayer has reasonable cause.
- Reliance on advice from a tax professional must be objectively reasonable.
- The taxpayer must provide the advisor with all the necessary information to evaluate the tax matter.
- The advisor must have knowledge and expertise related to the tax matter.
- The examiner must determine whether the taxpayer acted with reasonable cause and in good faith based on all the facts and circumstances on a case-by-case basis.
- The examiner should look at the three preceding tax years for payment patterns and compliance and if this is the taxpayer’s first incident of noncompliance, this factor should be considered with the other reasons and circumstances the taxpayer provides.
Because the reasonable cause and good faith defenses to penalties are fact and circumstances driven and considered on a case-by-case basis, resolving IRS penalties is more of an art than a science. A request to abate penalties should be in writing and requires a full understanding of why and how the taxpayer failed to comply. In addition to reviewing the practice unit, a review of the IRS Penalty Handbook can be very helpful. The penalty handbook is the primary source of authority for the administration of penalties and it sets forth the general policies and procedural requirements for assessing and abating penalties.
For questions related to this or any other civil tax or criminal tax-related matter, please feel free to contact Joel Crouch at (214) 749-2456 or firstname.lastname@example.org.