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Welcome to the 41st episode of How Tax Works. I'm Matt Forman. In this episode, I'll discuss what to do if you owe money to the IRS or state revenue agency. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make. Before we get started, let's talk through some administrative stuff. New episodes every two weeks. We're in December now. We're closing on the year. Next episode is going to talk about an offer and compromise. If you have any questions, comments, or constructive criticism, email me at my FRB email address, which you can find via your favorite search engine. I don't. I have one more webinar coming up on the 18th. If my memory serves you right, talking about QSBS. If you Google Advanced Tax Series, you will find it Advanced Tax Series Foreman, you know, Matt Foreman or frb. You can sign up. It's free. You know, there's cpe, there's cle, there's ce, there's even cfp ce. So you can go for it. So now you know what to do if you owe money to the IRS or state revenue agency. There are a lot of ways to go with this. I'm going to talk about three things, right? There are payment plans. There's penalty abatement. There's what's called other collection alternatives, which is offering compromise. I am going to talk about offering compromise in the next episode. I tried to get it all into one episode and I sort of lazily timed it out and I was at like 36 minutes and I was like, ah, we'll just put a little more robust. Drop a couple extra things in here and we will talk. We'll make it into two. The penalty stuff is much more interesting, candidly, than anything else. In this episode, I'm going to generally assume a few things. First, the returns are filed. Second, the audit, if any, is complete. And third, under the law, you owe the tax. You may not necessarily agree that you owe the tax, but there's really not a whole lot you can do. Okay, this may be post litigation. This just may be. You filed the return and you know the OW that you owe the tax, so there's no point in litigating it. Right? And that's it. So generally interest is statutory and cannot be abated Cannot. One word. It's not, it's not able to be abated. Penalties can be abated. Generally, you know, there's certain ones that can't, certain ones that have certain things for certain reasons, etc. If you abate the penalties, you will decrease the interest too. If you decrease taxes, you will then decrease, generally decrease your penalties which will also decrease the interest. If you're the state of New Jersey, if you're doing the state of New Jersey, you have to tell them to decrease the interest. When you abate penalties, they don't automatically do that. IRS does that. Every other state I've dealt with does that. New Jersey doesn't seem to understand how that works and they give you a hard time about it, which is awesome. But statutorily they're required to do it because otherwise they're making you pay too much money and that's incorrect. Interest and penalties are generally imposed on tax due and interest and penalties are added to tax. So then interest and penalties will accrue on interest and penalties. So that's a really important point that I always do it. There are certain penalties and that are like a flat fee penalty. Like if you don't file a 5471, for example, if you don't know what one is, Google it or don't worry about it. There's a $10,000 penalty for each one not filed or filed incorrectly. So it's really important to kind of get that one in. But what happens is once that penalty is assessed, then interest and more penalties will continue to accrue on that interest and penalty. And the tax due penalties, again, federal level 6, 7%, they tend to be 1 or 2% higher for states and, and they can really add up. And quickly. If you were to do, you know, owe $10,000 after like five years, you know you're going to owe $20,000 with interest and penalties. So the numbers really go up. So putting yourself in a payment plan or otherwise resolving it, even if you're paying interest while you're paying it off, you're only paying interest, you're not paying interest and penalties and interest and penalty rates tend to be the same. Penalties can be higher, but for most taxpayers the rates are the same. Some penalties, as I said, not due and tax due. At the end of the audit, auditors will offer to abate to settle. I'm going to go on a rant about New York State here. New York State. Does this thing ever had me talk about this. It irks me. New York is Authorized to impose penalties. They, as a default, impose penalties, which is not correct, violates their own statute. However, they do it as a mechanism to encourage settlement. And basically, if you agree to the amount due, they will abate penalties. Conversely, if you were to litigate the amount of, generally, the court then abates penalties no matter what. So it's really just a timing thing, and it's a way to get things done a little faster. I disagree with it because it's wrong. It's not what the statute says. It says that penalties may be imposed. That is not mandatory, but they do that that way. That's. That's, you know, as. As a noted philosopher once said, welcome to New York. Interest. Interest, as I said earlier, cannot be abated. You sort of can abate it through alternative methods, such as an offer and compromise, but. Or if you abate penalties, interest, as I said, accrued on penalties so that it will then also come down. So you can't abate it, but you can decrease it and you can sort of abate it. We'll talk about that later. Payment plans, Right. So let's talk about some payment plans. So post audit or appeal, you know, you're going to set up by an auditor. So if you have an audit or you've appealed it, what happens is the auditor, appeals officer, or someone, like an office of counsel, for example, in New York State, they'll actually be like, you know, this is the amount. You'll come to a resolution, like, hey, can you put me into a payment plan? And they'll say, sure, sure. You know, you send in a form, we'll talk about it, you'll negotiate a little bit, and then you can just basically pay it off. They'll do it for you. It's pretty easy to do. It's very straightforward in that situation. And payment plans are much, much, much, much, much easier when you're dealing with someone directly. I've had clients, you know, they owe 100, $200,000 then of an audit locally, can't really play it. They can pay it within 12 months. Can we do a payment plan? Sure, sure, no problem. You know, $100,000, basically. All right, you know, 10 grand a month. It'll take you about 11 months to pay it. We'll set that up perfect. You know, that. That's easy enough. If there's no revenue officer or appeals officer or audit, you know, auditor involved, you must formally request a payment plan. The IRS form is the 9465. If it's under $50,000, you can just Call the practitioner priority line, for example, and agree they don't really need financials because it's a lower number. This is pretty easy to do, up to about a million. You can call the practitioner priority line and you get manager approval. You must generally submit financials, although you can actually submit a significant portion of it verbally. You know, they make $38,000 a month. Their expense, their house mortgage is this. You know, they might look at other stuff depending on the amounts. Amounts are approximate million or more. The IRS used to have, like, firm standards where you needed to be, and then they decided to make it squishy. I'm not a huge fan of that, but it is what it is. But anyway, a million dollars or more, you must have a revenue officer assigned. The irs, as I've said earlier, you know, on this is having a moment. It's struggling a bit. And I have a client, for example, rose over $1 million and we're trying to put him in a payment plan and then request penalty abatement. Can't request penalty abatement until you're in a payment plan. And it has been at least four, possibly now six months. And things are just kind of ticking along. And when I request penalty abatement, I'm going to point out that this took forever. Not thrilled. And they should abate based on that. If the IRS takes too long, you can actually request interest abatement based on the IRS delay, which I plan on doing candidly. Financials. So let's go through what financials do need to provide. Right? Bank and other financial accounts, significant assets, houses, cars, art, jewelry. Talk about your cash flow, income, less expenses. I'm going to talk about this a lot more in the next episode about offers and compromise. So I'm not going to go into a huge amount of detail here. Expect some sort of down payment if it's $100,000 or more. I know I said, you know, $100,000 or pay over a month. They might say, look, we want 20,000 the first month, 10 for the next 10 or 8 for the next 12, whatever it is. And that's really important. So you agree to a payment plan, right? You can. Then once you're in a payment plan or you've paid in full, you can request penalty abatement. Revenue officer will often review, especially in a appeals setting or an audit setting. They have pretty good latitude, which is, which is really nice and helpful to help you resolve everything and abate penalties. They, they, they do somewhat frustratingly, but truthfully, they do use it as A mechanism to incentivize resolving the issue and ending the audit. It is what it is. All right, let's get some music in here and we're going to talk about come back and talk about penalty.
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All right, we're back. So penalty Bateman. Right, right. What penalties exist? Right? There can be penalties for a lot of stuff. And I'm just going to rip through a list because I think it's actually helpful to talk about what can be there because different penalties exist for different reasons. Right. So there's failure to file a timely return, failure to pay tax timely, failure to pay additional tax after the notice of demand, negligence or disregard of law or regulation, civil fraud, failure to deposit taxes, valuation misstatements or understatements, substantial understatement return reporting penalties such as failure to file correct information returns, failure to furnish correct payee statements and failure to comply with other information reporting requests. There's trust fund recovery, aiding and embedding and understatement of tax liability. And then there's tax, there's penalties imposed on tax return return preparers. You know, some of them are things where it's like 162ordinary necessary business expense deductions. And there are preparers who I'll just say are a little more willing to allow their clients to be aggressive than some other providers so that you can get penalties imposed for. I'm a major proponent of doing that. I think that's a good idea. And then you impose penalties on preparers. It's really important to do that. I think it would clean up a lot of problems. People say, oh, you shouldn't be, you know, an enforcement for the IRS or the state. And I disagree. I think the job is to get it right. You know, I don't think it's necessary to be overly aggressive. But also same time, I think it's important to explain to clients that they can get audited and the IRS will often or state will be less impressed on these ones. And I can get in trouble for this. I don't file returns. But if I were a return preparer or someone giving advice and I am, you know, I could be returned preparer. I have a, I have a ptin, I have a caf. I have all that stuff. I can get in trouble for that. There's other civil penalties such as penalties for intentional delay, a frivolous tax filing or submission or, or failure to file a return. And then as always, there's, you know, I talk about civil fraud. There are criminal tax penalties just in case going to Jail is insufficient to convince you that it was a bad idea. They will also include penalties. A lot of people who go to jail or prison, you know, people go for longer for tax purposes. So the BP Roses or Dale Strawberries of the world, they had penalties heaped on their things. You know, both of them went to jail for the same basic reason, which is they took cash for services such as signing autographs, most notably, and then they didn't pay taxes on it. So that's problematic. And there were penalties put on. Their advisors may have gotten penalties too, I don't know. So let's talk about the first time abatement or fta. First time abatement is really, really friendly. Certain penalties are abated under IRM. Get ready for the citation century 20.1.1.3.3.2.1 also discussed in PMTA 2018 2. There'll be a test on that later. We'll say it three times fast. And the PMTA says the IRS's authority to do this. No one ever complains that the IRS has authority to do this because it's one of the better ones. It's for certain penalties. Failure to file, failure to pay, and failure to deposit only. And they're abated if there's no penalty for the same within three years for the same reason. So I think that that's really important to note that, you know, this is automatic. This is no reasonable cause, no reason. I just filed late. It happened. No penalty. Boom, gone. Move on. The first time abatement is considered before reasonable cause for the IRM. Also discussed in CCA 2014017 Reasons for Penalty abatement. So it's really important to note that you have to have a reason. If you don't have first time abatement, you have to have a reason why the penalty should be abated. Called reasonable cause. Right. Many penalties can just not be imposed. Can be not imposed. Right. If the auditor agrees, can be a settlement tool, as I discussed. You can also abate it if there is a reasonable cause. There's a number of code sections that talk about this and have different examples. The ones that primarily deal with it are 6651. Internal record code, obviously 6651, 6652, 6686 and of course everyone's favorite 6664. That one's A. That one's a banger. That those are really important. You can also abate if there are statutory exceptions such as reliance written advice from the irs. That's when I talk about a bunch, you know, because if there's unclear guidance or we thought we were complying, you know, or you get some sort of response from the IRS, whether it's an email or a letter. Right? That's 6404F Treasury Reg. 301.64043. And it's also in the IRM. So let's talk about reasonable cause abatement. Reasonable cause abatement is really powerful. It is very broad. The IRS has a lot of discretion in it. I'm of the opinion that they should be more broad. I'm of the opinion that if the IRS is viewed, and this is state agencies generally, as willing to abate penalties, I think more people would come forward and pay their taxes. That's how I view the situation. I may very well be in the minority there. But I'm the opinion that you should incentivize people to come forward and pay taxes and you can do you get reasonable cause for abatement. You. If the underpayment is one, due to reasonable cause and two, not due to willful neglect, you must affirmatively show both. Okay, that's really important. People like, oh, it wasn't willful. I'm like, yeah, but there also has to be reasonable cause. So reasonable cause also requires no willful neglect. Now, the. No willful neglect is actually the easier one to show, I found because at least for my client base, something happened. Right. And whether it's reasonable cause or not, the lack of willful neglect is pretty easy. So what is reasonable cause? Willful neglect is pretty obvious. What is reasonable cause? Well, we're going to get some more music in here, and then I'm going to knock through what is reasonable cause, which is actually a little longer than I want to go without a commercial break. But, you know, we'll do that and just be back. Thank you.
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Foreign.
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We're back. Let's talk about reasonable cause. Okay. Reasonable cause is ordinary business care and prudence. Okay. Treasure Egg 301.66511 C Atlas Therapy 199 Northern District of Alaska. I don't have another. Oh, it's a 1999 case in the Northern District of Alaska. I. I didn't know Alaska had more than one district. Doesn't seem to have the population for it, but I guess Alaska is such a big state. It's, you know, slightly, slightly bigger than Rhode island or Delaware, so probably makes sense in that case. In Atlas Therapy, the CFO just didn't file there was no reasonable cause. Right. Case law on hired providers. An attorney or a CPA can create reasonable cause. All right, so if you have hired an outside provider but an inside provider such as a cfo, or if you have an internal person who does it, that's generally not reasonable cause, which is really interesting. Ordinary business care is hiring someone to do it. If they just don't do it, you still exercise real care, reasonable care. However, if an internal person does it, not reasonable care, there is no actual definition of reasonable cause in the Internal Revenue Code or the regulations. The Internal Revenue Manual actually says that this is on purpose. I think it is. I do. I really do. I think that's true. And they give examples. Okay? They're examples in case law. There's a lot of them. I'm going to go through a lot of reasonable cause examples after I give this string site and I'm going to include some citations within it. But there's a bunch of stuff you want to look at if you're doing examples of reasonable cause. Here's where I start. Every time I have stuff written on it so I don't have to go back and read the cases, although I often do. There's IRS Policy Statement 32 Williams 16 Tax Court 893 Carmahan. If my handwriting is Carnahan, I don't know. TC Memo 1994, 163 Jones, TC Memo 1998, 542 Carlson 126 Fed. Third 915. That's a seven circuit case. And then there's a list of things in the Internal Revenue Manual that are not reasonable costs. 20.1.1.3.2.2. I'll say that again. 21.1.3.2. That has ones that are not reasonable costs. I want to point this out. IRM is extremely low, extremely low on how much you can rely on it. Okay? It is sub, sub regulatory guidance. If you disagree and you have good facts, go for it. Connect four. Right. All right, so let's go through some things that are a reasonable cause. One, tax or a disability. I'm sorry, I couldn't do it. I was in a coma for six months. Absolutely. Number two. Yes. Death, serious illness or unavoidable absence. And this is the taxpayer or an immediate family member. Look, if the other person has the authority or shared. If another person has the authority or shared responsibility act, such as a cfo, CEO or controller, a spouse with a sick family member, look at the other spouse. Can the other spouse file that return you know, just because. Oh, you know, so and so normally does it, that that's often not sufficient. It may be sufficient. There's some discretion here. It depends. Sometimes a sick family member requires both spouses. Right. And that's an issue being incarcerated. There's case law on this. Being incarcerated is not reasonable. Cause I, once a year will speak with someone who went to prison for a couple years. No comment on that. And they will be like, well, how can I owe? I couldn't file a return because I was in prison. And I was like, you earned income when you were in prison? And they were like, yeah, because I have these other investments or whatever happened. And I was like, well, you still have to file a return. Like, well, how could I? I was in prison. And I'm like, you earned income? I don't know. What do you want? And they're like, well, that's not reasonable. And I'm like, look, there's case law, all right? You know, George versus Commissioner TC Memo 2019, dash 128. And this is not the only case, is this. This is what fascinates me. This is not the only case on point. There's other ones. Fire, casualty, natural disaster or other disturbance, rare. If it's a federally declared disaster area, because the federal government then extends, they'll give you the three months. So they're not going to give you reasonable cause on it. However, if your house burns down, generally, yeah, that can be big. Or if instead of, you know, there's. You're in a federally disaster area, but yours is just much worse. Right. Most of the area just had a fire, problematic. But your house burned down. And then there's a flood only on your property. And then two meteors hit. Right? Yeah, yeah. I mean, that's. That's probably reasonable. Cause I think the IRS will give that one to you. Inability to obtain records is, believe it or not, can be reasonable cost. What they're looking for is a partnership dispute that just takes a couple years to resolve and then everything's done. So it generally, yes, you can do it. It is a very high bar. You must be able to show you you really tried. I will run into this again about once a year. I got a partnership fight. We didn't file returns for two years. I didn't file my return for two years because of my income. And I didn't know what to do. And by the time it got resolved, it was two years later. What can we do? I'm like, yeah, you'll get penalties abated. You'll Pay interest because interest is statutory and you didn't pay the tax for a while. So that's a thing. And an offer requires a party to withhold records. Having a lawsuit is extremely helpful, but not necessarily. And you must demonstrate that you tried to get the record. One of my favorite, I don't know is lack of funds. Lack of funds is not a reason to abate penalties in general. It's only one. If paying would result in undue hardship. And people say, well, look, how can lack of funds not result in undue hardship? And the answer is if you had other assets similar. I'm going to talk about this in the offer and compromise a lot, but if you own a yacht and the yachts just cost so much to operate, that's not a reason to not pay the irs. Okay? It's just not. I know we often, you know, all of us think about that. Geez, you know, it's just terrible. You know, what about my yacht? Right. So that's an issue in terms of lack of funds generally requires some level of insolvency, such as bankruptcy, though it doesn't actually require bankruptcy. The key is why the taxpayer couldn't pay. You have to avoid lavish and unnecessary expenditures. QED Inc. What a name. 55 Federal Court of Claims 140. And then I have 0.4. So I'm not sure what exactly that is, but there's a case that talks about it that, you know, and what they always are are people who owe money to the IRS but are going on vacations to Turks and Caicos twice a year. And like, I just didn't have money, you know, my lifetime lifestyle's so expensive. The kid needed a yacht. Right? And I make fun of yachts because, you know, boats just, man, they are money pits. Right? Ignorance of the law. No, it can be a factor in conjunction with other factors. Reliance on IRS guidance helps. One disagreement I have with that, and it's an example of when ignorance of the law does count, is if you've ever filed a 3520, it is a situation where a non resident alien, so not a US person gives a gift to a US person. There is no tax, but there is in fact a penalty imposed. And the penalty is huge. I think it's like 40% or 35% or something like that of the gift amount. So they get huge and there's an exclusion up to like $250,000. So every so often I do run into these. You have a situation where someone gets a gift. You know, examples I've run into a pretty common college graduation gift right from, from an uncle. They want to give it to their, their favorite niece. So excited. I'm going to give you a million dollars. You can use it to buy an apartment. You know, that's your down payment, et cetera, et cetera. And that's really exciting. Until they file a tax return, they forget to file the 3520 because they didn't know they have to file one. It's kind of a weird fact pattern. That one's one where ignorance of the law is actually really helpful because you're like, Jesus. And I've written these where I say this is a quirky penalty, right? There's no tax and they knew there's no tax. They didn't know there was a penalty. They didn't know there's a filing requirement. I've actually had very good luck on those. I, I have every time. Although admittingly a bunch of them have actually been more recent since Farhi and Farhee because it has the issue with 5471, which is the same penalty imposition mechanism for Form 3520. As a result, I actually think that maybe why they did the last one. We'll see. That was. That was a good one to have tax law changes and IRS form revisions. Sometimes it changes in a way that's like 2024 and 2025. The law is the same, the form is different. You're like, oh, should I have done that differently? That's actually a reason. Or they changed it and you're like, well, now I'm not going to put that in because even though it's the same fact, it sounds now like it's not taxable. That that's actually a reason not to do it to. You still owe the tax, but you may be able to get penalty payment. Helpful, still interest, but taxpayer or subordinate made a mistake or forgot. Generally. No, you possibly can if you can show you still ordinary and prudent business care. Simply having a CFO who doesn't do it is insufficient. But it can be a factor, right? One of the big ones is reliance on competent tax advisors. Competent tax advisors, competent. Okay. Hiring someone who is incompetent is not helpful. Attorney, CPA, enrolled agent, they want licenses and this sort of one. Competent. Not just generally, but also on this specific issue, they got it wrong. Simply having a license is insufficient. Showing the advisor was given. You must be able to show that the advisor was given sufficient information and facts to do it. If the advisor is like, I Was never told these three facts. That becomes problematic. And if you're doing one. Reliance on competent tax advisor. You need an affidavit from your competent, ostensibly competent tax advisor. There's a key case. Boyle 469 US 241. There are a lot of cases on this. Unsurprisingly, malpractice carriers very much litigate this on behalf of underlying clients. Reliance on an internal computer system. You must show you used it. You used it correctly. A good case on this is Dealer's Auto Auction TC Memo 2025 38. Recent one too, which is nice. Reliance on IRS advice. You need all. There are a lot, a lot of things I'm going to list here. Okay. Purely attributable to the erroneous advice furnished to the taxpayer by an officer or employee of the Internal Revenue Service. The officer or employee of the Internal Revenue Service acted in their capacity. The advice was in writing. The advice was reasonably relied on by the taxpayer. It cannot be contrary to the law or regulations. And you must have actually relied on on it. Not just reasonably. You actually have. The invites must be in response to specific written request by the taxpayer. And the taxpayer provided the IRS with adequate and accurate information. Terminal Revenue Code. Let's get some sites in here. IRC 6404F is in Falcon and Treasury Reg. 301.6404. 3A, lowercase. A substantial compliance right. If you substantially comply with the code and the regs. And that'll work. Block 12, TC 366. It is a 1949 case. A year that all of us remember. Well, so that's an older one, but the concept's still there. What about oral advice from the irs? You notice I skipped ahead a little bit. That's fine. What about oral advice from the Internal Revenue Service? The IRS cannot. They're permitted. They must. The taxpayer must exercise ordinary business care and prudence in relying on advice. There is more in IRM 24.2. This is where I really tried to knock this one out. But as you can tell from the time, we are way past where I usually end. Or maybe we're not. We're probably right around there. So this. This is the end. That was the 41st episode of How Tax Works. Hope you enjoyed it. Hope you learned something. Possibly more importantly, possibly less importantly. I'll be back in two weeks with the 42nd episode Jackie Robinson episode. I'm going to talk about offers and compromise. I'm sure he was thrilled about that. And now for the best song of all time.
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Sam.