Many taxpayers are unable to timely file their returns or timely pay their obligations. When this happens, the IRS will usually assess penalties against the taxpayer. The penalty for filing the return late is 5% per month, up to 25% of the unpaid obligation. The penalty for paying the tax late is .5 % per month, up to 25% of the unpaid obligation. When the two penalties run together, the late filing penalty will be reduced to 4.5% per month, up to 22.5% of the unpaid obligation. These are stiff penalties.
One common reason taxpayers fail to file their return or file their return late is that they do not have the money to pay the tax and they are afraid of what the IRS will do when it receives a return without full payment. They are concerned that as soon as the return is filed, the IRS will begin pursuing them by levying their bank accounts or their wages. This can happen, but a 25% late filing penalty is a steep price to pay for some additional time to pay the tax. It is usually better for the taxpayer to file the return and, either before or after the IRS contacts them, propose a payment plan or an Offer in Compromise to resolve the obligation. Having filed the return, they have avoided a significant penalty and start their negotiations with a much smaller liability.
Unfortunately, there are many instances when a taxpayer simply cannot file the return or pay the tax on time. Late filings and late payments are often the result of difficult and stressful situations which overwhelm the taxpayer. The IRS recognizes this, and will abate the penalties when the taxpayer can demonstrate that he or she had reasonable cause for failing to timely file the return or pay the obligation.
To prove reasonable cause, the taxpayer must demonstrate that he or she exercised ordinary business care and prudence but was still not able to comply with the filing and payment requirements. The IRS will take into account all the facts and circumstances of the taxpayer’s situation. Internal Revenue Manual (IRM) 22.214.171.124.1.2.
The IRS provides examples of when a taxpayer has reasonable cause in IRM 126.96.36.199. These are only examples. They are instructive, but they are not the only circumstances that amount to reasonable cause. We encourage taxpayers to ask the IRS to abate the penalties in any situation where they believe they had reasonable cause for the late filing or late payment.
The Minnesota Department of Revenue (MDR) has similar penalties and procedures for abating those penalties. Information about the MDR procedures can be found in the MDR Collection Manual. We will address the state’s version of these penalties in our next posting.