Taxes are stressful enough - having a tax liability does not make it any easier. However, there are a few options to consider when looking for ways to either reduce or eliminate your tax liability. This article covers the common types of IRS penalties as well as the forgiveness programs you might be eligible for.
Please keep in mind, each person's situation is unique. Some situations are complex and require professional guidance to pick the right path for your needs. Consult with a Tax Professional to better prepare you for the next step in resolving your tax bill.
According to the IRS, there are over 150 kinds of civil penalties in the U.S. Internal Revenue Code! The most common types of IRS penalties are due to filing your taxes late, failing to pay your taxes, or not filing your taxes at all.
1: The Estimated Tax Penalty: Equal to the interest lost by not having sufficient withholding or paying estimated taxes throughout the tax year.
2: The Failure to Pay Penalty: 0.5% per month of balance due, maximum of 25%.
3: The Failure to File Penalty: 5% per month on the balance due, maximum of 25%.
This chart depicts the 2019 individual taxpayer penalties by type. The 3 most common penalties make up close to 95.5% of all IRS civil penalties for individual taxpayers.
As a taxpayer, you have the ability to file and request relief from your penalties. There are 2 types of tax relief: Offer in Compromise and Penalty Abatement. Please keep in mind, not everyone is eligible for these programs. It is best to speak to either a Tax Attorney or CPA to see which program you are eligible for and best fits your tax needs.
The OIC program is an agreement between a taxpayer and the IRS that settles a taxpayer's tax liabilities for less than the full amount owed. Taxpayers who can fully pay the liabilities through an installment agreement or other means, generally won't qualify for an OIC in most cases.
There are three types of OIC conditions - 1 of the 3 must be met in order to be considered eligible for this program.
1: Doubt as to Collectability: This is the most common type of OIC and the easiest to prove.
This means as a taxpayer, you will never be able to fully pay your tax liability. However, the IRS may consider a settlement based on certain criteria. You will be required to submit a full financial profile to determine whether or not you have disposable income, equity and/or assets that can be used to pay the IRS back.
*Short-term unemployment is not grounds for receiving a settlement. Common disallowed disposable income expenses such as college tuition payments for a dependent and credit cards payments will not be accepted.
2: Doubt as to Liability: This is the most cut and dry type of OIC.
Plain and simple, you don't owe the money (even if there is a claim that you do). If there is a legitimate doubt that you owe any part of the money in question, you will need to complete Form 656-L.
3: Effective Tax Administration: This is the most difficult type of OIC. Only 2-3% of these are accepted a year.
In this situation, you are basically saying to the government, "It is not in your best interest to collect against me." A taxpayer must establish that collecting on the tax liability would cause economic hardship. This program allows the IRS to accept an amount that is less than the reasonable collection potential in a situation where accepting a lesser amount would be fair and equitable.
"Abatement" means a removal of certain penalties if certain criteria are met. There are 2 common types of abatement available: First-Time Penalty Abatement and Reasonable Cause. Let's dive into these 2 programs and decipher which of these you may be eligible for.
1: First-Time Penalty Abatement:
This program is based on prior experience and is designed to reward you if you consistently file and pay your taxes on time (after all, we are entitled to one mistake).
First-time penalty abatement allows the IRS to remove certain penalties from your account based solely on your clean compliance history. This type of penalty abatement is intended to help taxpayers who have an isolated compliance issue. To qualify, you must have had no penalties added to or removed from your account for the previous three years (except for the estimated tax penalty), must have filed all required returns, and must be current with all required tax payments.
2: Reasonable Cause:
According to the IRS, "Reasonable Cause is based on all the facts and circumstances in your situation. We will consider any reason which establishes that you used all ordinary business care and prudence to meet your Federal tax obligations but were nevertheless unable to do so." Essentially, this means an "extraordinary circumstance" must have occurred to be eligible for the Reasonable Cause Penalty Abatement, such as: severe medical emergency, victim of a crime, fire, casualty, natural disaster or any unavoidable absence of the taxpayer.
The IRS will also look to see if you paid all your other bills such as car payments, mortgage, etc. They believe if you are able to pay your other bills, you have the money to pay them back as well.
*The IRS notes, a "lack of funds" is not reasonable cause for failure to file or failure to pay on time. However, the reasons for the lack of funds may meet reasonable cause criteria for the failure-to-pay penalty.
You don't have to do this alone. There are resources available to you to help you pick the best solution that fits your needs. Get a second opinion with one of our tax attorneys! Call us at 1.800.290.8160