How Reasonable Cause Can Defeat IRS Penalties (Case Study)

Reasonable Cause to Abate IRS Penalties (Case Study Example)

Reasonable Cause to Abate IRS Penalties

When a Taxpayer has been penalized by the Internal Revenue Service (such as for failing to file a timely Form 3520 or 8938), they have the opportunity to try to abate the penalties by showing that they acted with reasonable cause. There is no specific IRS form used to submit a reasonable cause submission to the IRS. Rather, the Taxpayer prepares and submits a detailed letter summarizing their facts and circumstances — along with referencing applicable laws and regulations — to support their request for penalty relief.

During the life of a penalty dispute with the IRS, Taxpayers may have multiple chances to prove reasonable cause. The process is usually initiated by protesting the penalty (CP15 Notice). If the CP15 protest is rejected, then the Taxpayer may submit an Appeal or a Collection Due Process Hearing Request.

Golding & Golding first published this article in 2022 as a supplement to our original article from October 2021. It has since been expanded and updated.

Maggie Did Not Report a Foreign Gift or Business

Maggie is a Lawful Permanent Resident who relocated to the United States a few years ago. At the time she relocated to the United States, she did not have any interest in a foreign business, and did not have any ownership or signature authority over any foreign accounts. Therefore, she was not required to report any information about foreign assets to the IRS.

Fast forward a few years, and Maggie’s father, who is getting on in age, decided he wanted to gift her a 25% value of the foreign family business — which is estimated to be worth about $900,000. Maggie was unaware that she was required to report this information because her current CPA told her that, since the gift was not income and the foreign business was not distributing any money, no IRS form was required to be filed at that time.

Later, after speaking with a different CPA, Maggie learned she had missed reporting requirements in the prior year. The CPA submits a late-filed Form 5471 and Form 3520 — and about 18 months later, Maggie gets hit with assessable penalties for failing to file multiple foreign information returns.

The Protest Letter to Prove Reasonable Cause

Since Maggie received a CP15 Notice, she has 30 days to protest the penalty.

To protest the penalty, Maggie should consider submitting a reasonable cause submission package. Maggie’s goal is to apply a ‘totality of the circumstances‘ approach to explain how her failure to report the foreign information was due to reasonable cause and not willful neglect.  Unfortunately, in the current IRS landscape of agents being overworked and underpaid, oftentimes these protest letters are automatically rejected, even if the taxpayer has reasonable cause (but the protest letter is still an important component to the reasonable cause process).

What Goes into a Reasonable Cause Letter?

The reasonable cause letter is not a one-size-fits-all submission.

The purpose of the submission is to explain and persuade the IRS as to why the Taxpayer should have their penalty abated. Before drafting a reasonable cause letter, taxpayers should review the different resources available online to assist them, and taxpayers may want to begin with the Internal Revenue Manual (IRM) — which is typically a good starting point for preparing a reasonable cause submission.

Beware of Hidden Reasonable Cause Tripwires and Landmines

The taxpayer should also refer to the specific code section that forms the basis of their penalty — along with any applicable rules and regulations — before crafting their response.  For example, if a person receives an assessable penalty for Form 8938 (failing to report their foreign accounts and assets on their tax return), because they did not want to violate the other country’s law (so they did not file the Form 8938 with their tax filing), that would not be a strong argument for a reasonable cause penalty abatement.

• • • (g) Reasonable cause exception:

      • • No penalty shall be imposed by this section on any failure which is shown to be due to reasonable cause and not due to willful neglect. The fact that a foreign jurisdiction would impose a civil or criminal penalty on the taxpayer (or any other person) for disclosing the required information is not reasonable cause.

Appeal or CDP Hearing

If the taxpayer’s protest letter seeking a reasonable cause penalty abatement is rejected, then the taxpayer may have the opportunity to pursue an appeal or possibly a collection due process hearing– depending on whether the taxpayer receives a letter 854C or not.

Quiet Disclosure

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Appeal or CDP Hearing

If the taxpayer’s protest letter seeking a reasonable cause penalty abatement is rejected, then the taxpayer may have the opportunity to pursue an appeal or possibly a collection due process hearing– depending on whether the taxpayer receives a letter 854C or not.

Quiet Disclosure

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm