Page 2 - Penalties: Reconsidering the Reasonable Cause Defense to Late-Filing Penalties and the Impact of the Service's Clarification of the DIIRSP

PeNALtieS

Tax Administration (“TIGTA”) issued a report finding in having late-filing penalties abated, is attributable to
that the Service is imposing accuracy-related penalties, three reasons.
but not necessarily late-filing penalties, on businesses As to the first reason, the phrases “reasonable cause” and
with assets of more than $10 million (i.e., businesses “not due to willful neglect” are technical legal terms that
covered by the Service’s Large Business and International must be proven by the taxpayer in light of well-settled prin-
Division) less often than it does on businesses with ciples set forth in Treasury Regulations and related case-
assets of $10 million or less (i.e., businesses examined law. Second, the reasonable cause exception to late-filing
by the Small Business/Self-Employed Division). In penalties is distinct from the reasonable cause exception to
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response to TIGTA’s report, the Service’s Director of certain accuracy-related penalties, and certain principles,
Audit Coordination stated that the Service should adopt like the ability to rely on a professional, are transferable
“a single approach to penalty issuance and that large to late-filing penalties in only very limited circumstances.
corporations should be subject to the accuracy-related And third, in addition to establishing reasonable cause,
penalty to the same small extent as businesses.” Thus, taxpayers must satisfy various other conditions before a
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large business and international taxpayers should expect late-filing penalty will be abated. Each of these reasons is
the Service to look to assert (and potentially to assert) discussed in turn.
penalties in cases where penalties historically would not
have been imposed. A. Misunderstanding #1: “Reasonable
Against this background, it is time to reconsider the strate- Cause” is a technical Legal term and the
gies currently being used to secure abatements of late-filing
penalties. Part I of this article examines the types of penalties Legal Nuances Should Be Addressed
that can be imposed for late-filing a return or other docu- 1. Reasonable Cause Generally
ment with the Service and the availability of the reasonable
cause defense with respect to each type of penalty. Part I also Taxpayers tend to overlook that the phrase “reasonable
compares the often-misunderstood standards of “reason- cause” is a legal concept that is specifically and technically
able cause and not due to willful neglect,” which applies to defined in Treasury Regulations and an extensive body of
late-filing penalties, and “reasonable cause and good faith,” caselaw. Treasury Regulations provide that a late filing is
which applies to certain accuracy-related penalties. Finally, due to reasonable cause if the taxpayer exercised ordinary
Part I explains additional administrative requirements that business care and prudence but was still unable to file
the Service imposes before it will grant an abatement on the the required return by its due date. This is an objective
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ground of reasonable cause. Part II of this article discusses standard under which all of the facts and circumstances
recent clarifications by the Service with respect to the DIIRSP. of a late filing must be examined to determine whether
Part II also explains the effect of those clarifications on volun- a reasonably prudent person would have been unable to
tary disclosure submissions generally and the approach to be timely file the required return under the same set of facts
taken with respect to penalty abatement requests. and circumstances as the taxpayer. 11
Reasonable cause is an amorphous concept that is
i. late-filing penalties and the highly dependent upon the facts and circumstances of
a particular late-filing. Various reasons can constitute a
reasonable Cause defense generally reasonable cause for late-filing a return. Courts and the
Service have recognized the following reasons as sufficient
The Code imposes various penalties for late-filing sub- to excuse a late filing:
stantive returns, information returns, and other docu- ■ The death, serious physical injury or mental illness,
ments required to be filed with the Service. The most incapacitation, or unavoidable absence of the taxpayer
common failure-to-file penalties, and the availability of or a member of the taxpayer’s immediate family,
reasonable cause with respect to each, are given below provided that the condition affected the taxpayer to
(see Table 1). such a degree that he or she could not timely file the
Various defenses may be advanced to avoid a late-filing required return; 12
penalty. One of the most frequently cited, but most mis- ■ Destruction by fire, casualty, natural disaster, or other
understood, defenses is that the late-filing is excused on disturbance of the taxpayer’s records or place of busi-
the ground of reasonable cause. The misunderstanding ness, provided that the condition affected the taxpayer
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surrounding the reasonable cause exception to a failure- so greatly that the taxpayer could not timely file the
to-file penalty, and the related difficulties taxpayers face required return; 13

24 JoUrnal of taX praCtiCe & proCedUre Winter 2020