The failure to pay penalty is one of the most commonly assessed penalties. The penalty does not apply and can be abated or removed if the taxpayer can establish that the failure to pay is due to reasonable cause and not to willful neglect.
But how do you establish reasonable cause? In C1 Design Group, LLC v. United States, 1:15-cv-146-CWD (D. Ohio 2016), the court considered the taxpayer’s proof of cash on hand to establish reasonable cause for abating the failure to pay penalty.
Reasonable Cause for Failure to Pay
In the C1 Design Group court case, the IRS filed a motion for summary judgment arguing that the taxpayer could not establish that its failures to timely pay were due to reasonable cause. The court considered several prior court cases to determine whether the facts could establish reasonable cause. The court summarized these cases as follows:
- Van Camp & Bennion, P.S. v. United States, 70 F. App’x 937 (9th Cir. 2003)
The taxpayer corporation failed to timely pay its employment taxes due to a shareholder’s illness, which resulted in the taxpayer’s decrease in income—the income that was reported, the taxpayer alleged, was necessary to pay expenses to keep the business open. The United States Court of Appeals for the Ninth Circuit affirmed the district court’s finding on summary judgment that the taxpayer did not prove it exercised ordinary business care and prudence in providing for its tax liability. In support of its decision, the district court found: (1) the taxpayer was receiving large monthly deposits that were sufficient to meet its tax obligations; (2) during the relevant tax years it paid its president over $100,000 per year; and (3) the taxpayer’s tax obligation was given “very low priority in comparison to the other expenses associated with the operation of the [business].
- Fran Corp v. United States, 164 F.3d 814, 815 (2d Cir. 1999)
The taxpayer failed to make timely employment tax payments, and alleged that its payments were late because it had not been paid on two of its largest contracts. The Second Circuit affirmed the district court’s finding that the taxpayer did not prove it exercised ordinary business care and prudence during its period of financial difficulty, because the taxpayer lavishly spent its money on rent, auto leases and repairs, and entertainment in lieu of using the money to timely pay the IRS.
- E. Wind Indus., Inc. v. United States, 196 F.3d 499, 505 (3d Cir. 1999)
[T]he Third Circuit found, contrary to the district court’s conclusion when considering the same undisputed facts, that the taxpayer could prove it exercised ordinary business care and prudence based on: (1) all income received by East Wind on government contracts was used to pay either the IRS or employee wages; (2) East Wind “did not pay suppliers, rent, health and welfare premiums, employees’ union dues, and workers’ compensation insurance premiums;” (3) utility companies were not paid until the companies threatened to shut off service; (4) East Wind did not pay any of its suppliers from 1982-96, which was over $7 million owed; (5) [the president] secured a mortgage on his personal residence and sold personal assets to obtain cash to pay creditors; (6) East Wind’s bookkeeper provided a $65,000 loan of her personal funds to the business; and (7) [the president] sought legal and financial advice as to the bribery scheme and cash flow issues.
In considering the facts in C1 Design Group in light of these cases, it concluded that the taxpayer may be able to establish reasonable cause. So the IRS’s motion for summary judgment failed for this reason.
Proof of Cash on Hand
The IRS also argued that the taxpayer could not establish reasonable cause because it did not provide proof of the cash it had on hand at the time the taxes were not paid. That the argument was raised by the IRS for the first time in court shows that the IRS did not have the necessary evidence to refuse to abate the penalty in the first place. This suggests that the IRS simply denied the taxpayer’s abatement claim without any real consideration.
The court, which is not in the Ninth Circuit, cited the Ninth Circuit’s Van Camp & Bennion case cited above and other Ninth Circuit cases that followed Van Camp & Bennion for the proposition that the taxpayer has to provide this proof. It concluded that “the case law to require[s] the taxpayer to produce evidence of the cash it had on hand when its excise taxes were due toward meeting its burden of establishing reasonable cause.”
The court allowed the taxpayer to admit evidence of its cash on hand. The court accepted the taxpayer’s financial statements and the inference from the IRS’s arguments (that the taxpayer had cash on had to pay other creditors) to establish that the taxpayer had sufficient cash on hand. The court concluded that this evidence was enough to survive summary judgment.