In the course of filing enforcement, the IRS assesses various interest and penalties on taxpayers. When you receive a notice from the IRS, there should be a section on the notice that breaks out the balance owed.
Below, we've outlined some of the penalties and interest you might find on a Form 1040 Individual Income Tax Return, and at the bottom, we've included a downloadable template letter you might use to request First Time Abatement from the IRS.
Penalties
Failure to Pay Penalty (§6651(a)(2)) Assessed if you have not paid in the full balance of your tax return by the original due date of the return (April 15th, generally). This is the primary cause you'll hear extensions described as "an extension of time to file, not an extension of time to pay." This penalty (currently 0.5% of the balance due) is assessed for each whole month passed the due date of the return.
Estimated Tax Penalty (§6654) The IRS requires taxpayers to pay in their estimated payments to cover the current year tax balance. For most taxpayers with W2 withholding, this penalty might come into effect if you're not withholding enough from your wages. For self-employed taxpayers, or taxpayers who have substantial income outside of wages and are required to pay in quarterly estimates, you will be assessed a penalty if your estimated payments are not sufficient to cover either 1) 100% of the prior year's tax balance (110% for high income earners), or 2) 90% of the current year's taxes due. These percentages are called the Safe Harbor.
Failure to File Penalty (§6651(a)(1)) If you do not file a tax return, you can have a substantial penalty assessed. This penalty is the most punitive - 5% of the unreported tax due per month, up to 25% - and originates when you do not file your tax return on time. This is the reason extensions matter, and also why you want to file your tax return by the due date even if you cannot pay your tax balance by the due date. The Failure to Pay penalty is 1/10th the Failure to File penalty.
Accuracy Related Penalty (§6662) Assessed if there is an error on your tax return that they determine is related to negligence or a substantial overstatement or understatement of one or more of the items on your tax return. This penalty is 20% of the calculated underpayment of tax, and is not the same as the Fraud Related Penalty (where you outright tried to defraud the goverment, a 75% penalty).
Interest
Underpayment Interest (§6601) The IRS will assess interest due on unpaid balances of taxes owed at a daily rate until the balance is paid in full.
Underpayment Interest on Penalties (§6601(e)(2)) The IRS will assess interest on penalties once assessed until the entire balance is paid in full. When you are disputing penalties with the IRS, we always want to verify they not only waived the penalties, but also waived any interest on the removed penalties.
Balances due on notices are usually calculated to 21 days in the future from the date of the notice. If you respond and pay within the timeframe outlined, you will not be assessed further penalties/interest. While a waiver of penalties may affect the interest calculation, in general, interest on taxes due is not waived.
First Time Abatement
The IRS is permitted to grant an administrative request for First Time Abatement based on a clean compliance history for the past three years. In order to request and be granted this abatement, you would want to show the IRS that you 1) have timely filed all other tax returns prior to this event, 2) paid all outstanding balances due preceding this event, and 3) have not been assessed penalties on other tax years for the three years prior to this event.
The IRS will consider this abatement by looking under the tax records of the taxpayer(s) on the account. Note that they may abate the penalties for the Failure to Pay and Failure to File penalties, but waivers are not generally granted for other penalties. Our approach is that it doesn't hurt to ask.
Paying While Disputing
Clients always ask if we recommend they pay the notice or do nothing. If you have the cash available, it is generally advisable to pay the full balance assessed and then request a waiver of penalties (and get a subsequent refund). If you go this route, you will now need to also file Form 843 to get a refund of paid penalties.
If you do not have the cash available, or you have a strong case that the penalties and interest will be waived, you may decide to not pay the balance assessed. Please note on your original notice how much of the balance due is taxes (which will still be owed) and how much is penalties or interest (which may or may not successfully be waived). You should at least attempt to pay in the amount owed for taxes, to keep future interest from accruing during the many months it may take to argue your case.
NOTE: The IRS has started to pre-emptively remove penalties from some tax notices in anticipation of the FTA (and given the backlog due to the COVID-19 Pandemic). Your notice will indicate if this action has already been taken or not. If not, it doesn't automatically mean that you are ineligible. You are still within your rights to request a review.
We are happy to assist our clients with any correspondence with the IRS or state agencies. But some notices are easily cleared up and sending your own letter could save you some money on prep fees.
Enter your email to have a templated request letter sent to your inbox. Correspondence with the agencies requires patience and good documentation, but eventually they will take action. Best of luck to you!
