What to Do About an IRS Negligence Penalty

One of the more common IRS assessments is the accuracy-related penalty for negligence or disregard of the rules. This penalty arises when the IRS determines a taxpayer has underpaid their taxes not through fraud, but through a failure to exercise the proper care when preparing their return. It is a civil penalty designed to encourage accurate tax reporting, and taxpayers have established avenues to contest the assessment if they believe it was applied in error.

Defining the Negligence Penalty

The negligence penalty is a component of the accuracy-related penalties outlined in Internal Revenue Code Section 6662. The penalty targets “negligence or disregard of rules or regulations.” The IRS defines negligence as any failure to make a reasonable attempt to comply with tax law, which is a broad standard that looks at whether a taxpayer acted with the care a reasonably prudent person would exercise.

Disregard involves a higher level of culpability and is defined as any careless, reckless, or intentional ignoring of tax rules and regulations. In this context, “intentional” refers to knowingly ignoring a rule without a fraudulent intent to evade tax. The IRS does not need to prove you intended to cheat, only that you failed to follow established tax laws.

Several specific actions can trigger a negligence penalty. A frequent cause is the failure to report all income, especially when documented on an information return like a Form 1099 or W-2. Another common trigger is claiming deductions or credits that a taxpayer is not entitled to. The IRS also considers a failure to keep adequate books and records to substantiate items on a tax return as a form of negligence.

The penalty is not automatic and is determined on a case-by-case basis, often during an IRS audit. An auditor will review the return and records to determine if the errors rise to the level of negligence. The penalty may only apply to the portion of the underpayment caused by the negligent actions, not to mistakes deemed justifiable.

Calculating the Penalty Amount

The calculation for the negligence penalty is straightforward. The penalty amounts to 20% of the portion of the tax underpayment that the IRS attributes to negligence. This 20% is not applied to your total tax liability or the entire underpaid tax, but is targeted at the deficiency from the negligent act.

To illustrate, consider a taxpayer who underpaid their federal income tax by $8,000. Upon review, the IRS determines that $5,000 of this underpayment was due to a simple mathematical error. However, the remaining $3,000 of the underpayment resulted from the taxpayer claiming a business expense deduction for personal travel, an action considered a disregard of tax rules.

In this scenario, the negligence penalty would be calculated only on the $3,000 portion of the underpayment. The penalty would be 20% of $3,000, which equals $600. The taxpayer would be liable for the original $8,000 underpayment, the $600 penalty, and any applicable interest that has accrued.

Establishing Reasonable Cause for Abatement

Tax law provides an exception under Internal Revenue Code Section 6664 that allows for the penalty to be waived, or abated, if the taxpayer can demonstrate “reasonable cause” for the underpayment and that they acted in good faith. This requires a taxpayer to show they exercised ordinary business care and prudence in their efforts to comply with the tax law but were unable to do so.

The determination of reasonable cause is based on all the facts and circumstances of a specific case. The IRS considers factors such as the taxpayer’s experience, knowledge, and education. For example, a taxpayer with limited financial knowledge facing a complex tax issue may have a stronger case for reasonable cause than an experienced accountant making a similar error.

Certain specific situations are often considered valid grounds for establishing reasonable cause. These can include death or serious illness of the taxpayer or an immediate family member, which prevented them from managing their tax affairs. Unavoidable absence or the destruction of financial records due to a casualty are also accepted reasons. Another basis is reliance on erroneous advice from a tax professional, provided the advisor was supplied with all necessary and accurate information.

To build a successful reasonable cause argument, documentation is needed. If illness is the reason, medical records or a doctor’s note can be persuasive. In the case of a disaster, a fire department report or insurance claim can substantiate the loss of records. If relying on professional advice, a letter from the tax advisor explaining the advice is needed.

How to Request Penalty Removal

The formal process of requesting penalty removal begins by filing Form 843, Claim for Refund and Request for Abatement. This form serves as the official request to the IRS to remove the penalty. You must file a separate Form 843 for each tax period for which you are requesting abatement.

When completing Form 843, you must provide your identifying information, such as your name, address, and Social Security number. You will need to specify the tax period, the type of tax, and the penalty amount. You should also list the penalty’s Internal Revenue Code section, which is found on the IRS notice.

The explanation section of the form requires a clear statement explaining your reasonable cause argument for why the penalty should be removed. It is advisable to attach a separate cover letter that outlines the timeline of events and references your supporting documents. This package should be mailed to the IRS service center address indicated on the penalty notice.

After mailing the request, the IRS review process can take several months. If your request is approved, the penalty will be abated. If it is denied, the IRS will provide an explanation, and you will have the right to appeal the decision to the IRS Independent Office of Appeals.