What is a Penalty Abatement and What Can be Abated?

What is a penalty?

For starters, it’s important to understand what a penalty is. A penalty is essentially a fee assessed to a taxpayer to punish the taxpayer for failing to meet certain requirements in its tax obligations. The most common penalties relate to not filing a tax return on time or within the extended time, and not paying the tax due on time. There is generally not an extension to pay, only to file.   Taxing Authorities will also add interest to a tax liability. This interest will accrue on the total liability; including the principal, penalties and previous interest.

What is a penalty abatement?

A penalty abatement is the release of penalties filed for what the IRS calls “reasonable cause,” which is essentially a good excuse for failing to meet a given obligation. A penalty abatement request can be submitted after a penalty has been assessed, and is generally most successful when using the proper forms and supporting documentation in addition to a well-researched brief containing case-law and statute interpretations supporting the argument that the taxpayer has “reasonable cause.” If a penalty abatement request is filed after the penalties have already been paid, this effectively becomes a penalty refund request, and follows the same rules but the IRS will generally not issue refunds more than three years after the penalty has been paid.

What can be abated using this process?

If the Taxing Authority agrees that the taxpayer had reasonable cause for not meeting its obligations, a penalty abatement will be authorized, and the tax liability will be adjusted, or a refund check will be issued if there is no liability. In addition to the penalties that can be abated, any interest that accrues on the penalties (but none that accrues on the principal) will be abated as well. This can often result in drastic reductions in the liability owed. While the IRS does not typically abate interest (except interest on abated penalties), a taxpayer can submit Form 843 and request an abatement of interest in instances of unreasonable error or delay in performing a managerial or ministerial act by the IRS.

What if I have paid some or all of the penalties already?

If you have been in an installment agreement or otherwise been paying towards your liability, you have probably noticed that a sizeable portion of your payments have been applied to penalties and interest instead of the principal, and you may be worried that only the remaining penalties are eligible to be abated. This is actually not the case. If a penalty is abated, the whole value of that penalty is waived from the liability, and the amounts previously applied to the penalty are re-applied to either interest or principal. Even more, if a penalty has been fully paid off before being abated, those payments will go fully towards the principal on that period first, then to any other periods of liability, or refunded if no other periods of liability exist.