Many unfortunate taxpayers find themselves in the position of owing a tax debt that consists of a small tax liability and a large assessment of tax penalties and interest. In many of these cases the penalties and interest can be substantially larger than the original tax debt.
This situation often forces taxpayers to seek the protection of bankruptcy or forces taxpayers to live with the uncertainty of having a large and growing debt until the collections period expires. A common remedy that many taxpayers fail to take advantage of is to request that the IRS abate the penalties and interest. This post will provide a very basic overview of the penalty and interest abatement rules.
Penalty & Interest Abatement Rules
Congress has expressly provided the IRS with the authority to abate some tax penalties and interest. As a general rule, the IRS does not abate penalties where abutment would be unfair to other tax compliant taxpayers or provide a taxpayer with a competitive business advantage over other tax compliant taxpayers. Section 6404(a) provides that the IRS may abate tax and any related liability if a taxpayer can demonstrate that the liability is: excessive, assessed after the expiration of the applicable limitations period, or illegally assessed. There are numerous administrative and judicial opinions that flesh out these terms.
Section 6404(b) specifies that taxpayers do not have the right to request abatement of income, estate or gift taxes. Pursuant to Section 6601(e), interest is generally treated as a tax; therefore, interest is subject to the 6404(b) limitation. Section 6601 does not treat penalties as a tax; therefore, penalties are not subject to the 6404(b) limitation. Moreover, this limitation does not expressly limit taxpayers right to request abatement of employment or other taxes.
Taxpayers Do Not Qualify?
If taxpayers cannot qualify under these principles then they must pursue abatement under the other provisions of Section 6404. Most of these cases fall under Section 6404(e). This section addresses abatement of interest that is attributable in whole or in part to an unreasonable error or delay by an IRS officer of employee in performing a ministerial or managerial act. Each of these terms are defined in the Regulations and expanded upon in various administrative and judicial opinions. As a side note, some courts have unfortunately and mistakenly held that the IRS does not have the authority to abate employment taxes under this provision (such as the Tax Court and the Ninth Circuit in Miller v. Commissioner).
Even if taxpayers cannot request abatement or the IRS does not have the authority to abate, there are circumstances where the IRS must abate interest and time-sensitive penalties. Section 6404(g) and Revenue Procedure 2005-28 provide that interest and certain penalties must be suspended if the IRS fails to provide a taxpayer with timely notice of the amount and basis for a tax liability. Suspension of interest under this provision is mandatory. Timely notice is defined as within 18 months of the later of the due date of the return or the date the return was filed. The IRS does not permit taxpayers to request abatement for periods where this mandatory suspension provision applies; however, taxpayers can notify the IRS of improperly assessments under Section 6404(g).
A last consideration that taxpayers must address is how best to protect their right to appeal any adverse and arbitrary IRS decision not to abate penalties and interest. The law provides a number of rules to preserve the right to appeal. Failure to do so substantially increases the chances that abatement and/or suspension requests will fall on deaf ears. In the right circumstances requests to abate penalties and interest can be a viable alternative to bankruptcy or living with a large and growing tax debt.