Can Reasonable Cause Avoid or Remove Tax Penalties? (2024)

Reasonable Cause May Provide IRS Penalty Waivers

Reasonable Cause Not Willful Neglect to Avoid IRS Penalties: It would be literally impossible to try to find a standard more nebulous and precarious for Taxpayers seeking to avoid IRS penalties than the phrase “Reasonable Cause and Not Willful Neglect.” In an all-to-common IRS situation, a Taxpayer gets hit with significant fines and penalties for what seems like a relatively harmless mistake or error. Especially in the realm of international tax and international information reporting penalties — where noncompliance penalties reach into the hundreds of thousands of dollars, if not millions of dollars — getting the matter resolved with the Internal Revenue Service is a Taxpayers’s top priority. Unfortunately, Taxpayers are often dismayed to learn that their main chance in abating or avoiding an IRS penalty boils down to their ability to show reasonable cause — a standard which is not properly defined by the IRS. Not only is it completely unfair for Taxpayers to get hit with an IRS assessable penalty in the first place (aka penalties which Taxpayers cannot dispute before they are issued) — but then in order to abate the penalty, the Taxpayer then has the incredibly difficult task of proving “reasonable cause and not willful neglect.” While there is no exact standard or bright line test, let’s go through the basics of reasonable cause and the uphill battle Taxpayers face.

Example of an International Reporting Penalty

International information reporting penalties come in all shapes and sizes. One of the most common penalties is the penalty for not reporting a gift received from a foreign person. Here is a common example: Frank is a lawful permanent resident in the United States who has nonresident alien family members outside of the United States. Frank just graduated from school and his family wants to help him purchase a home in the United States — so Frank’s mom gifts him $1,000,000. Frank purchases the home and later after tax filing was complete — for one reason or another — learns that this gift should have been reported to the Internal Revenue Service. He files a Delinquent form 3520 and since more than five months have passed, he gets hit with an assessable penalty of $250,000 as the IRS rejects that reasonable cause existed. The penalty notice arrives on a form CP15 Notice and Frank has 30 days to protest the penalty and show the noncompliance was due to reasonable cause.

6039F Form 3520 Penalties

Form 3520 penalties are founded in Internal Revenue Code section 6039 F (Notice of Large Gifts received from Foreign Persons). Here is what the code section provides as to penalties and reasonable cause:

• • • (2)Reasonable cause exception Paragraph (1) shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.

Internal Revenue Manual Reasonable Cause Explained

Since reasonable cause is not definitively “defined” in the code, but is rather based on a totality of the circ*mstance — it is important to get a baseline understanding of what the IRS looks for when evaluating Taxpayer reasonable cause. One good place to start is the Internal Revenue Manual. While the Internal Revenue Manual is not binding, it does provide good insight into what reasonable cause is:

IRM Reasonable Cause 20.1.1.3.2 (11-21-2017)

• • • Reasonable cause is based on all the facts and circ*mstances in each situation and allows the IRS to provide relief from a penalty that would otherwise apply. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining his or her tax obligations but was nevertheless unable to comply with those obligations.

    • In the interest of equitable treatment of the taxpayer and effective tax administration, the non-assertion or abatement of certain civil penalties based on reasonable cause or other relief provisions provided in this IRM must be made in a consistent manner and should conform with the considerations specified in the IRC, Treasury Regulations (Treas. Regs.), policy statements, and IRM Part 20.1, Penalty Handbook.

    • Reasonable cause relief is not available for all penalties; however, other exceptions may apply.

    • For those penalties where reasonable cause can be considered, any reason which establishes that the taxpayer exercised ordinary business care and prudence, but nevertheless was unable to comply with a prescribed duty within the prescribed time, will be considered.

    • If a reasonable cause provision applies only to a specific IRC section, that reasonable cause provision will be discussed in the IRM 20.1, Penalty Handbook, section relating to that specific IRC section. See IRM 20.1.1.1.2, Authority, and Exhibit 20.1.1-1, Penalty Relief Application Chart.

      See Also

      What Is Good Faith Defense?

    • When considering the information provided in the following subsections, remember that an acceptable explanation is not limited to those given in IRM 20.1. Penalty relief may be warranted based on an “other acceptable explanation,” provided the taxpayer exercised ordinary business care and prudence but was nevertheless unable to comply within the prescribed time. See IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence.

    • The wording used to describe reasonable cause provisions varies. Some IRC penalty sections also require evidence that the taxpayer acted in good faith or that the taxpayer’s failure to comply with the law was not due to willful neglect. See specific IRM 20.1, Penalty Handbook, sections for the rules that apply to a specific IRC penalty section. See IRM 20.1.1.1.2, Authority.

    • Taxpayers have reasonable cause when their conduct justifies the non-assertion or abatement of a penalty. Each case must be judged individually based on the facts and circ*mstances at hand. Consider the following in conjunction with specific criteria identified in the remainder of this subsection:

      • What happened and when did it happen?
      • During the period of time the taxpayer was non-compliant, what facts and circ*mstances prevented the taxpayer from filing a return, paying a tax, and/or otherwise complying with the law?
      • How did the facts and circ*mstances result in the taxpayer not complying?
      • How did the taxpayer handle the remainder of his or her affairs during this time?
      • Once the facts and circ*mstances changed, what attempt did the taxpayer make to comply?

    • Reasonable cause does not exist if, after the facts and circ*mstances that explain the taxpayer’s noncompliant behavior cease to exist, the taxpayer fails to comply with the tax obligation within a reasonable period of time.

Example if a Reasonable Cause Regulation 26 CFR 301.6689-1

• • • The penalty set forth in this section shall not apply if it is established to the satisfaction of the IRS that the failure to file the notification within the prescribed time was due to reasonable cause and not due to willful neglect. An affirmative showing of reasonable cause must be made in the form of a written statement that sets forth all the facts alleged as reasonable cause for the failure to file the notification on time and that contains a declaration by the taxpayer that the statement is made under the penalties of perjury. This statement must be filed with the Internal Revenue Service Center in which the notification was required to be filed. The taxpayer must file this statement with the notice required under section 905(c) or 404A(g)(2). If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the notification within the prescribed time, then the delay will be considered to be due to reasonable cause and not willful neglect.

US v Boyle

In the Supreme Court case of US V Boyle, the court lays out the concept of reasonable cause with late filings as follows:

Taxpayer’s Position

• • • Respondent paid the penalty and filed a claim for a refund. He conceded that the assessment for interest was proper, but contended that the penalty was unjustified because his failure to file the return on time was “due to reasonable cause,” i.e., reliance on his attorney.

    • Respondent brought suit in the United States District Court, which concluded that the claim was controlled by the Court of Appeals’ holding in Rohrabaugh v. United States, 611 F.2d 211 (CA7 1979). In Rohrabaugh, the United States Court of Appeals for the Seventh Circuit held that reliance upon counsel constitutes “reasonable cause” under § 6651(a)(1) when:

      • (1) the taxpayer is unfamiliar with the tax law;

      • (2) the taxpayer makes full disclosure of all relevant facts to the attorney that he relies upon, and maintains contact with the attorney from time to time during the administration of the estate; and

      • (3) the taxpayer has otherwise exercised ordinary business care and prudence. 611 F.2d, at 215, 219.

    • The District Court held that, under Rohrabaugh, respondent had established “reasonable cause” for the late filing of his tax return; accordingly, it granted summary judgment for respondent and ordered refund of the penalty. A divided panel of the Seventh Circuit, with three opinions, affirmed. 710 F.2d 1251 (1983).

But there was No Reliance on Counsel inBoyle

• • • This case is not one in which a taxpayer has relied on the erroneous advice of counsel concerning a question of law. Courts have frequently held that “reasonable cause” is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken. See, e.g., United States v. Kroll, 547 F.2d 393, 395-396 (CA7 1977); Commissioner v. American Assn. of Engineers Employment, Inc., 204 F.2d 19, 21 (CA7 1953); Burton Swartz Land Corp. v. Commissioner, 198 F.2d 558, 560 (CA5 1952); Haywood Lumber & Mining Co. v. Commissioner, 178 F.2d, at 771; Orient Investment & Finance Co. v. Commissioner, 83 U.S.App.D.C., at 75, 166 F.2d, at 603; Hatfried, Inc. v. Commissioner, 162 F.2d, at 633-635; Girard Investment Co. v. Commissioner, 122 F.2d, at 848; Dayton Bronze Bearing Co. v. Gilligan, 281 Fed. 709, 712 (CA6 1922).

    • This Court also has implied that, in such a situation, reliance on the opinion of a tax adviser may constitute reasonable cause for failure to file a return. See Commissioner v. Lane-Wells Co., 321 U.S. 219, 64 S.Ct. 511, 88 L.Ed. 684 (1944) (remanding for determination whether failure to file return was due to reasonable cause, when taxpayer was advised that filing was not required).

    • When an accountant or attorneyadvisesa taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.

    • Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney.

    • To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. SeeHaywood Lumber, supra,at 771. “Ordinary business care and prudence” do not demand such actions.

Boyle Court Denies Reasonable Cause

• • • By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute.

    • Among the first duties of the representative of a decedent’s estate is to identify and assemble the assets of the decedent and to ascertain tax obligations. Although it is common practice for an executor to engage a professional to prepare and file an estate tax return, a person experienced in business matters can perform that task personally.

    • It is not unknown for an executor to prepare tax returns, take inventories, and carry out other significant steps in the probate of an estate. It is even not uncommon for an executor to conduct probate proceedings without counsel.

    • It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not “reasonable cause” for a late filing under § 6651(a)(1). The judgment of the Court of Appeals is reversed.

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