Illness as a Defense to Late Filing Penalties

Will the IRS penalize you if you are unable to file your tax return on time due to the burden of caring for a loved one with COVID?

The IRS has not provided penalty relief for taxpayers impacted by COVID-19.

The existing penalty relief rules may provide a remedy for some taxpayers. These rules do allow the IRS to not impose or to remove penalties when there is an illness or incapacity.

To take advantage of these rules, one generally has to file the late tax return in question, have the IRS assess the late filing penalty, and then ask the IRS to abate the penalty. They may also include a penalty abatement request with their late-filed tax return.

These penalty abatement letters should focus on the facts that have been accepted by the courts. The Brashear v. Commissioner, T.C. Memo. 2020-122, court case provides an opportunity to consider what qualifies.

Facts & Procedural History

The taxpayer-wife was a real estate broker. She operated her brokerage out of her house in California. The taxpayers moved to Washington so the taxpayer-husband could obtain medical care.

After moving to Washington, the taxpayer-wife worked on a project to use grey water in residences. She also worked for Bank of America briefly.

On their tax returns, the taxpayers reported the brokerage activity on Schedule C. The Schedule C included several expenses as deductions, such as travel expenses.

On audit by the IRS, the IRS disallowed the expense deductions. This resulted in a tax due and, since the tax returns were not timely filed, failure to file penalties.

This post focuses only on the failure to file penalties.

Failure to File Penalties

The failure to file penalty is what it sounds like. It is a penalty imposed for filing a tax return late.

The penalty is five percent of the tax required to be shown on the tax return for each month or fraction thereof for which there is a failure to file. The penalty is capped at 25% of the tax, the aggregate.

The penalty is not imposed if the taxpayer had reasonable cause and not due to willful neglect.

There are a number of ways to establish reasonable cause. This includes showing illness or incapacity that prevented the taxpayer from filing timely.

Illness or Incapacity as a Defense

The taxpayers seem to raise the issue of the taxpayer-husband’s medical condition as reasonable cause for the late filing.

Petitioners also claim that their failures to timely file were due to “extreme circumstances”, although they did not elaborate on the nature of those circumstances. We suspect but are not sure, given the confusing nature of petitioner’s testimony, that the circumstances relate to Mr. Thistletop’s medical condition during the relevant period.

The court goes on to note that:

The Court has found reasonable cause for failure to timely file a return where the taxpayer or a member of the taxpayer’s family experiences an illness or incapacity that prevents the taxpayer from filing a tax return. See, e.g., Tabbi v. Commissioner, T.C. Memo. 1995-463. In contrast the Court has not found reasonable cause where the taxpayer does not timely file but is able to continue to conduct his or her business affairs despite the illness or incapacity. See, e.g., Ruggeri v. Commissioner, T.C. Memo. 2008-300, slip op. at 7-8 (and cases cited thereat).

This begs the question as to what illness or incapacity counts as reasonable cause?

What Incapacity or Illness is Sufficient?

The Ruggeri v. Commissioner, Ruggeri v. Commissioner, T.C. Memo. 2008-300 case cited by the court is instructive. In Ruggeri:

the wife had contracted Lyme disease. She had a severe case which left her bedridden at times. Petitioner believed that the disruption in his household, which included three minor children, caused by his wife’s illness would prevent him from filing on time, and so he instructed his employer to “over-withhold” on his earnings in an effort to eliminate any penalties for late filing.

The court did not find reasonable cause in Ruggeri as the husband was able to continue working full time despite his wife’s Lyme disease.

The court cites several other cases that help clarify what incapacity or illness is sufficient:

  • Tabbi v. Commissioner, T.C. Memo. 1995-463 – Reasonable cause found where the taxpayers’ son had heart surgery and the taxpayers spent four months continuously in the hospital with him, and the taxpayers filed their return 2 months after their son’s death.
  • Harris v. Commissioner, T.C. Memo. 1969-49 – Reasonable cause found where the taxpayer’s activities were severely restricted, and the taxpayer was in and out of hospitals because of various severe medical ailments including stroke, paralysis, heart attack, bladder trouble, and breast cancer.
  • Judge v. Commissioner, 88 T.C. 1175, 1189-1191 (1987) – No reasonable cause found where the taxpayer had a long history of delinquent filing of returns and the taxpayer was actively involved in preparing and executing business-related documents despite illness during years at issue.
  • Watts v. Commissioner, T.C. Memo. 1999-416 – Reasonable cause not found where, although the taxpayer’s mother and daughter were both ill and the taxpayer frequently took them to see doctors, the taxpayer also performed extensive architectural services in the taxpayer’s business.
  • Wright v. Commissioner, T.C. Memo. 1998-224 – Reasonable cause not found where the taxpayer had capacity to attend to matters other than filing tax returns despite the trauma of his mother’s disappearance and death.

As the tax court cases show, a significant illness or incapacity is sufficient to establish reasonable cause.

The court may not find reasonable cause if the illness or incapacity is for a family member, if the taxpayer was able to continue working or earning a living.

Presentation Matters

The court may also find there was no reasonable cause if the taxpayer did not squarely raise and prove the issue. This seems to be what happened in the Brasher case.

The court’s opinion provides some suggestions that the taxpayers were not able to work due to the taxpayer-husband’s condition. The taxpayer-wife’s real estate project in California seems to have ended when they moved to Washington for medical treatment. They taxpayer-wife’s income was negligible. She switched jobs. This suggests that she did not continue working full time.

The court does not mention evidence as to what the illness or incapacity was. It did not mention evidence of the severity of the illness or incapacity.

The taxpayers in Brasher did not hire a tax attorney. They represented themselves. This is an example of a situation where a tax attorney can help sharpen the defenses and present evidence in support of the defenses. This effort may have helped the court reach a different holding for the failure to file penalties.

The tax attorney may have also submitted a penalty abatement request in advance of litigation. It is common for the IRS audit function to not impose penalties in situations like this. On appeal, it is also common for the IRS Office of Appeals to not impose penalties in situations like this. The IRS often abates penalties while allowing the taxpayer to proceed to litigate the other matters in the case.

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