12/15/2021

The Increasing Importance Of IRS Penalties: Taxes Are Not The Only Way That Government Is Funded

Sherry[1] was looking tired – but she couldn’t sleep. Over her career, Sherry had worked hard to build her business from nothing to over 50 employees. Because Sherry was focused on growing her business, she hired a local bookkeeper to handle payroll for her business. This included preparing and filing the returns needed to report the payroll and payroll taxes for Sherry’s employees to the IRS.

However, Sherry’s bookkeeper was not as knowledgeable as she needed to be. That bookkeeper had filed some of those returns late – for just one year. Even though the IRS did not inform Sherry of the late filings for three years after they occurred, it now was demanding penalties of over $100,000 because the returns were late. A penalty of this size, given the other COVID-19 challenges that Sherry’s business was facing, was putting the future of Sherry’s business at risk. Even though Sherry had called the IRS a number of times to try to reach a sensible result, she either could not get through at all or could not reach anyone with any authority to help.

Sherry was at her wits end – how do you fight the government when you can’t even reach anyone to talk?

Federal Tax Penalties Are Growing In Scope And Size

Unfortunately, we are seeing situations like Sherry’s more and more often. There has been a growing trend, over the last several years, to pay for an increasing amount of government spending using increased penalties for noncompliance. In some ways, IRS penalties are the new federal taxes.

One example of this increase in penalties was from the Small Business Jobs Act of 2010. That act increased – very significantly - the penalties for failure to timely file information returns, including Forms W-2 and W-3, with the IRS. The first-tier penalty (if a return was filed within 30 days of its due date) increased from $15 to $30, and the calendar year maximum for companies with multiple information returns increased from $75,000 to $250,000. The second-tier penalty (if a return was filed more than 30 days late, but before August 1 of the calendar year in which the filing date occurs) increased from $30 to $60, and the calendar year maximum increased from $150,000 to $500,000. The third-tier penalty (returns filed after August 1) increased from $50 to $100, and the calendar year maximum increased from $250,000 to $1,500,000. For small business filers, the calendar year maximum increased from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The minimum penalty for each failure due to intentional disregard increased from $100 to $250.

Another example of the increase in penalties occurred beginning in 2016, when penalties became tied to inflation. So, the penalty amounts may now increase each year.

While each member of Congress has his or her own motivations for passing such penalties, we know that there is no organized lobby to advocate in Congress for people who are required to pay penalties when they miss a filing deadline. So, there is often little push back when representatives, who want revenue for a given program, find that revenue by increasing penalties.

That leaves us with the situation we have now, in which companies of all sizes are facing increasingly stiff penalties for tax mistakes that many people would not consider serious. Accordingly, we have seen a significant number of new IRS penalty disputes in the last several months.

Reaching The IRS By Phone Is Very Difficult

While there are increasingly significant penalties, reaching the IRS to discuss those penalties has become much more difficult. This is partly because people have been calling the IRS to discuss all sorts of things, including receipt of their stimulus payments or advance child tax credits. For example, on March 15 of this year, the IRS received 8.6 million calls – about 1,500 per second. From January 1 to September 18 of this year, the IRS received approximately 200 million calls and could answer just 9% of them. You can bet that those lucky 9% were usually on hold for a significant period of time before their calls were answered.

In fact, this backlog has allowed one enterprising company to create a new business model. That company floods the IRS lines with computerized calls and sells the slots near the front of the line to those willing to pay (often tax professionals).

Furthermore, even if you reach someone at the IRS, only a few IRS employees are authorized to reduce penalties. Our experience has been that you will not reach one of those people on the phone.

So, What Do You Do If You Get A Penalty Notice?

Given that Congress is increasing penalties and counting on that penalty revenue to pay for spending, the IRS will not automatically waive penalties upon a taxpayer’s request. The IRS has received the message that Congress usually wants the IRS to collect the penalties when applicable.

This leaves business owners in a quandary: “what should we do when we receive a penalty notice from the IRS?”

While each penalty is different, there are some common things that taxpayers should do if they have been informed that the IRS is looking to assess a penalty. These include the following:

• Be Aware Of Procedural Steps. Most letters and notices from the IRS can seem threatening. That is how the IRS collects. However, some notices must be answered in a timely and specific fashion, or the taxpayer may lose the opportunity to present their position before the IRS Appeals Office. The Appeals Office is an independent part of the IRS that can provide taxpayers with a cost-effective forum to present their position (short of a formal court appeal).
• Document The Times You Got It Right With The IRS. One thing the IRS looks at in reviewing penalties is whether the taxpayer has a habit of missing returns or filing returns late. So, you’ll want to show the IRS all the times that you got it right. Don’t assume that an IRS agent will find this out on their own (or that they have time to research your case).
• Properly Present Your Case From The Beginning. The IRS has specific rules about when it will grant penalty abatement. This generally involves showing a reasonable cause to the IRS. We suggest that this position be laid out in the earliest reply to the IRS. We’ve seen a number of instances in which taxpayers replied to the IRS on their own and did not present their position effectively. Remember that IRS employees see lots of correspondence daily. Those employees will not make a change without a convincing reason to do so.
• Bring In The Taxpayer Advocate When Appropriate. The IRS has a Taxpayer Advocate Service that can be contacted to help present a taxpayer’s case to the IRS, including the IRS Appeals Office. It is critical to know when to bring in the Taxpayer Advocate and how to present your case to the Taxpayer Advocate so the Advocate will help to resolve your case favorably. The Taxpayer Advocate can have sway within the IRS, so its help can be a valuable tool.
• Get A Knowledgeable Professional If It All Seems Too Confusing. For significant penalties, the expertise of a tax professional, who is familiar with IRS penalties, can be extremely valuable. If a taxpayer is not sure about the next steps, we suggest that they ask for help – sooner rather than later. It is a lot easier to avoid mistakes with the IRS upfront than to fix mistakes after they have already happened.

If you would like to discuss the process for resolving an IRS penalty in more detail, or you have a situation that you think may need representation before the IRS, don’t hesitate to contact a member of McGrath North’s tax team. We stand ready to assist and have the expertise and experience to help.