In general, with the exception of the fraud penalty, most IRS penalties will not apply where the taxpayer had reasonable cause and acted in good faith. Any relevant facts may be considered in determining whether the penalty may be avoided based on reasonable cause and good faith. In some instances, usually when it comes to an isolated late-filing penalty or a failure-to-pay penalty, the IRS may apply a one-time courtesy waiver.
The IRS’s internal guidelines provide that reasonable cause is established for individuals “[i]f there was a death, serious illness, or unavoidable absence of the taxpayer or a death or serious illness in the taxpayer’s immediate family (i.e., spouse, sibling, parents, grandparents, children),” if circumstances beyond the taxpayer’s control existed, or where a reasonable mistake is made. See Internal Revenue Manual (“IRM”) 126.96.36.199.2.2.. However, the specific circumstances covered by the IRS’s guidelines are not the only grounds for avoiding a penalty through a showing of reasonable cause.
As Section 3.c. of of IRM 188.8.131.52.2 states,
“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 184.108.40.206.2.2, Ordinary Business Care and Prudence.”
Reliance on a tax professional is a dispositive defense to a penalty. See, e.g., Jorgl Ma-Tran Corp. v. Commissioner, 70-T. C. 158, 173 (1978); Pessin v. Commissioner, 59 T.C. 473, 489 (1972); Garcia v. Commissioner, T.C. Memo. 1998-203, affd. without published opinion 190 F.3d 538 (5th Cir. 1999). This applies in Tax Shelter cases as well, but the IRS will also evaluate whether the taxpayer should have known the advice was too good to be true. As stated in Chapter 7: Reasonable Cause and Good Faith – IRC § 6664 of the IRS’s Audit Technique Guide titled “Accuracy–Related Penalties for Taxpayers Involved In Tax Shelter Transactions,” “[t]he most important factor is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability” along with “the taxpayer’s experience, knowledge, sophistication and education and the taxpayer’s reliance on the advice of a tax advisor.”
Daniel W. Layton, the author of this post, is a former IRS trial attorney and former federal prosecutor in the Tax Division of the U.S. Attorney’s Office in Los Angeles. He is currently a partner in Layton & Lopez Tax Attorneys, LLP, in Newport Beach, Orange County, California. In private practice, he has successfully helped clients obtain abatement or avoidance of the civil tax fraud penalty, negligence or accuracy-related penalties, and penalties applied in tax shelter cases.