Understanding IRS Reasonable Cause Criteria
Often times, when someone owes taxes that they haven’t paid for a few years, they are surprised when they find out how much the IRS says they owe. This is because the IRS inevitably tacks on several of the dozens of penalties they are allowed to charge. However it’s the late filing, the late payment and the penalty for not making Federal Tax Deposits (when combined) that can add a whopping 65% to your total IRS bill. The good news is that if your tax debt is more than two years old, you’ve maxed out all these penalties!
The IRS does actually have a compassionate side, and it’s typically found in the penalty abatement process. The thing to keep in mind is that the IRS has very strict guidelines for granting penalty abatements, and these guidelines are referred to as “reasonable cause criteria.”
The primary IRS penalty abatement reasonable cause criteria center on natural disasters, loss or destruction of vital business records, bad advice from the IRS or an accounting professional, criminal activity, medical issues, substance abuse problems, and other serious circumstances. Thus, you are more likely to have your penalties abated if the circumstances cause you to answer “yes” to any of the following questions:
- Were any business records lost or destroyed?
- Were there any circumstances that led to a substantial drop in collecting on accounts receivable?
- Was there any transition in the business that lead to the failure to pay taxes?
- Was there a death or serious illness that directly affected the business or personal wages?
- Was there any embezzlement of funds, theft of valuable property, or identity theft?
- Were there any alcohol or drug abuse issues that affected the business or wage earning capability?
- Was there a natural disaster that impacted you or your business?
- Did you rely on the advice of a CPA or IRS employee in making tax decisions?
- Were there any circumstances that created substantial financial hardship, to the point where your business was close to going bankrupt?
Specific Internal Revenue Manual (IRM) References
The sections of the IRM outlined below will help you see what the IRS will consider and how they evaluate each circumstances. Please note that this list is not exhaustive and that the IRS will consider the facts and circumstances on a case by case basis. The other thing to note is that if your initial request is denied, it might be approved via submitting an appeal.
- Ordinary Business Care and Prudence IRM 22.214.171.124.2.2
- Death, Serious Illness, or Unavoidable Absence IRM 126.96.36.199.2.2.1
- Fire, Casualty, Natural Disaster, or Other Disturbance-Reasonable Cause IRM 188.8.131.52.2.2.2
- Unable to Obtain Records IRM 184.108.40.206.2.2.3
- Mistake Was Made IRM 220.127.116.11.2.2.4
- Erroneous Advice or Reliance IRM 18.104.22.168.2.2.5
- Ignorance of the Law IRM 22.214.171.124.2.2.6
In our next post, we’ll talk about how you can create your reasonable cause letter to the IRS and what it should contain.