Employees at the Greenwood, Ind., office of the Internal Revenue Service were more than a little surprised a few weeks ago when a disgruntled man pointed a gun at a revenue officer saying, "You can't do this. You can't take my money like this."No one was injured and the man was arrested, but it leads one to wonder about a system that brings out such a violent response from someone who clearly wasn't satisfied with his tax situation.
IRS spokesperson Pat Brummer was at the scene of the Greenwood incident.
"That's not really a good way to negotiate," she quipped. "We obviously don't want people to talk to us that way. We want them to talk to us face to face. People need to know they can sit down and talk; there are many avenues to negotiate."
While accountants may attempt negotiation with the IRS on a regular basis, many taxpayers may be surprised to learn that the IRS is open to negotiation. In particular, the IRS has the ability to be flexible in the area of penalty reduction or abatement for late filing of tax returns and for underpayment of taxes.
The IRS's operation handbook, the Internal Revenue Manual, sets out general rules for negotiating penalty abatement. The ability to grant relief from penalties falls into four categories: reasonable cause, statutory exceptions, administrative waivers and correction of service error. Taxpayers and preparers find that there is flexibility in the area of reasonable cause when it comes to negotiating a settlement for a penalty.
"Reasonable cause is something that really is a facts-and-circumstances test," said Marvin Michelman, director of tax controversy services at Deloitte Tax. "You have to look at everything involved, what caused the problem, how quickly did someone act to remediate it."
The IRM states, "Reasonable cause relief is generally granted when the taxpayer exercises ordinary business care and prudence in determining their tax obligations, but is then unable to comply with those same obligations."
"You have to look at all the facts and find that one fact that demonstrates why the penalty should be abated," said Michelman. He also recommended writing a "very fact-specific letter, explaining all the steps you have taken."
For example, if a taxpayer blames a computer crash for a belatedly filed tax return, Michelman explained that the taxpayer should be able to present records showing when the crash was discovered, that it was worked on, what information was stored on the computer, and how the crash prevented the taxpayer from meeting the deadline.
Turnover in personnel can cause problems that result in late payment or late filing penalties. "In small businesses, we see a lot of heads of business or heads of bookkeeping who had an illness or there was an illness in the family, and there was no way for the business to file on time. The IRS reacts favorably [in terms of penalty abatement] to illnesses in the family of the person responsible for the books," said Dan Wilds, director at the PricewaterhouseCoopers national tax service in Washington.
"Turnover is a big deal" in small businesses as well, said Ruth Perez, also with the PwC national tax service. But turnover alone isn't enough to warrant an abatement. "The small business would have to say that even though an accountant quit, we immediately started looking for someone else. It's not that we dropped the ball and we have no one responsible for tax any more," explained Perez.
When it comes to late payments, past history is extremely important. "The IRS does look at compliance history," said Perez. She explained that the service will look back over several years to see if there have been late payments in the past.
"The same penalty, previously assessed or abated, may indicate that the taxpayer is not exercising ordinary business care," according the manual. Even if this is the first time that a taxpayer has made a late payment, that alone is not sufficient cause to abate the penalty. The IRM states that the compliance history will be weighed with other reasons that the taxpayer gives for the late payment.
Norman Neubauer, manager of tax training for Kansas City-based H&R Block, pointed out that a penalty for late filing is one penalty that shouldn't be incurred in the first place. "Even if you don't pay the tax on time, if you file the return on or before the due date there is no penalty for filing late, so Tip No. 1 is just not to incur the penalty in the first place."
Eric Smith, a spokesperson for the IRS, agreed. "A lot of people still remember the old rules where you could not get an extension without estimating the tax and submitting a payment with the extension request," he said. "You still have to estimate the tax due and make a reasonable estimate, but in order to get the extension you no longer have to make a payment with the extension request."
The IRS offered five suggestions for including information in an explanation letter:
1. What happened and when did it happen?
2. During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return, paying a tax or otherwise complying with the law?
3. How did the facts and circumstances prevent the taxpayer from complying?
4. How did the taxpayer handle the remainder of their affairs during this time?
5. Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
Smith pointed out that ignorance of the law is not ordinarily considered an excuse worthy of abatement.
"The other thing is maintaining a clean history," Michelman said. "If this is the first time you've ever been penalized, that shows you've really tried to comply. There was this one footfall, but you were working hard to avoid it. When the IRS looks at your record, they will be able to see that you've never had a problem."
