Approximately 1.45 million taxpayers who qualified for relief from tax penalties totaling close to $181 million never heard from the Internal Revenue Service that they were entitled to it and never received it, according to a new government report.

J. Russell George

The report, from the Treasury Inspector General for Tax Administration, noted that the Tax Code imposes penalties on taxpayers with a filing requirement who fail to file a tax return or fail to timely pay the full tax shown on any tax return. The IRS waives those penalties for taxpayers who have demonstrated full compliance over the prior three years, but only if the taxpayers request penalty relief. The IRS does not widely publicize the opportunity to request this waiver, known as a First-Time Abate.

The reason for granting the First-Time Abate is to reward past tax compliance and promote future tax compliance. However, most taxpayers with compliant tax histories are not offered and do not receive the waiver, TIGTA found. For tax year 2010, TIGTA estimated that approximately 250,000 taxpayers with failure-to-file penalties and 1.2 million taxpayers with failure-to-pay penalties did not receive penalty relief even though they qualified under First-Time Abate waiver criteria. TIGTA estimated the unabated penalties totaled more than $181 million.

“Penalty waivers should not be granted only to taxpayers or preparers with knowledge of IRS processes,” said TIGTA Inspector General J. Russell George in a statement. “If the IRS does not administer these and other penalties fairly and accurately, taxpayers’ confidence in the tax system will be jeopardized.”

In addition, TIGTA found that the First-Time Abate waiver is not used to its full potential as a compliance tool because when it is granted, it is granted before taxpayers demonstrate full compliance by paying their current tax liability.

TIGTA suggested that the First-Time Abate waiver would be better used as a compliance tool if the IRS ensured that taxpayers were aware of the potential to receive the waiver based on their past compliance history, while making receipt of the waiver contingent upon taxpayers paying their current tax liabilities.

In response to the report, IRS officials agreed with the recommendations and said they are taking appropriate corrective actions. The IRS plans to study how best to use the First-Time Abate waiver as a compliance tool. It also intends to review the current process for application of an FTA waiver prior to reasonable cause and its impact on taxpayers who qualify for reasonable cause, but instead are given an FTA waiver.

“Our policy on FTA was initially developed to both reduce burden on taxpayers with a history of compliance as well as conserve IRS resources,” wrote Faris R. Fink, commissioner of the IRS’s Small Business/Self-Employed Division in response to the report. “We, therefore, designed our process to first consider FTA so further detailed information and analysis would not be required as it is when making a reasonable cause determination. We will continue to review our policies for the application of FTA and Reasonable Cause to determine the best ways to assist taxpayers with their federal tax payment obligations. This includes ensuring appropriate communication to taxpayers.”

However, Fink took issue with TIGTA’s estimates of the costs of implementing the proposed changes, noting that while the IRS agrees the measure is accurately calculated, it does not take into account other aspects of penalty abatement, such as implementation costs or “lost opportunity costs.”