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. It’s also noteworthy that penalty abatement applications can also be appealed if initially denied. Thus, you can always get a second set of eyeballs on the issue if it initially doesn’t go your way. 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.” It should be noted up front that “we didn’t have the money” is NOT a reasonable cause criteria. Why is this? Here is the IRS’ logic: when you made the money you should have either paid the taxes at that time (e.g. payroll taxes for a business) or saved the money until it was due (e.g. individual taxpayer who gets a 1099 the next year).
For example, if you are self-employed and receive a check, then you HAD the money, you simply didn’t give the IRS their chunk of it. Same goes with payroll taxes, particularly trust fund taxes (money you withhold from employee paychecks for income tax and Medicare/Social Security). If you had the expectation to pay some amount of wage, then you theoretically HAD the money sitting somewhere to pay that person, and should have withheld it and turned it over to the IRS. If you couldn’t cover the taxes, you shouldn’t have had the employee and should have laid people off or cut back their hours.
There are ways to argue around this, and we have done so very successfully, but there has to be some other circumstance involved. For example, you had the money to pay the tax, but paying the tax instead of something else would have created an “undue hardship.” Examples could include a large medical expense that unpaid would have left a condition untreated, or a court ordered payment that would have resulted in other legal consequences, or a bill such as a large automobile repair which would have left you unable to work and resulted in job loss. These arguments are difficult to make and require significantly more work than standard reasonable cause criteria applications, but they CAN be won.
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 fall into one of these areas:
- 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?
The above questions cover all of the IRS reasonable cause criteria to one extent or another, so finding an answer to your personal or business situation that covers one or more of these questions is the key to a successful penalty abatement application. If you are facing penalties related to back taxes and believe your situation falls into the above, give us a call at 773.239.8850 and we’d be happy to help you.
Until next time…