Taxpayers, individuals, trusts, and corporations alike can expect to pay penalties and interest to the IRS if they do not timely file their returns. Failure to file penalties can accrue quickly and be steep. For example, under IRC Section 6651(a)(1), the failure to file a tax return is 5% per month of the unpaid taxes, with a cap of 25%. The penalty under Section 6677(a) for failure to timely file Form 3520 equals 35% of the gross reportable amount and could equal millions of dollars in some cases.
Once the IRS asserts a penalty, there are generally four criteria it evaluates for whether the taxpayer is entitled to a penalty relief: correction of the error, statutory and regulatory exceptions, administrative waivers, and reasonable cause.
The Effect of Covid-19 on the IRS
The Covid-19 pandemic wreaked havoc on our tax system. The filing deadlines for the 2019 and 2020 tax years were pushed back from the normal April 15 deadline, but it created lot of confusion. IRS resources were stretched beyond thin, and an already underfunded and understaffed IRS was asked to do more by having to distribute the economic impact payments. This took away resources from its day-to-day operations. The pandemic also caused employees not to be physically present to process returns and correspondence. As of the end of the 2021 filing season, the agency had 35.3 million returns awaiting manual processing.
When the IRS is unable to complete its most basic functions, more specialized functions such as processing penalty relief requests take longer. The penalty relief process can be complicated, and if you do not know what you are doing, you could very well be doing it wrong. Even the most seasoned practitioners who deal with the IRS will have to wait on hold for hours and may not even get through to someone. If they do get through, the IRS employee may not be the most knowledgeable on that issue. If you try submitting something formally, you may wait months for the agency to process the request.
Enter IRS Notice 2022-36
IRS Notice 2022-36 provides relief for certain taxpayers from “certain failure to file penalties and certain international return (IIR) penalties” with respect to tax returns for taxable year 2019 and 2020. The relief aims to help taxpayers affected by the pandemic and allow the IRS to focus its resources on processing the backlog of returns and taxpayer correspondence in hopes of returning to normal operations for the 2023 filing season.
Individuals, businesses, trusts, banks, employers, and other businesses required to file various information returns are affected by the notice, as are filers of various international information returns. A list of the exact forms and penalties that qualify can be found in the notice, but some of the forms and penalties include:
- Late-filing penalty under IRC Section 6651(a)(1) for Forms 1040, 1041, and 1120;
- Late-filing penalty for Forms 1065 and 1120-S;
- Penalty for failure to timely file Form 5471, 5472, and 3520; and
- Certain penalties related to late-filing information returns.
The catch is that the forms must be filed by the date specified in the notice, and some must be filed by Sept. 30, 2022. For these returns, taxpayers and their advisers must act quickly to qualify for the relief by filing returns on or before the deadline. Other information returns must have been filed by Aug. 1, 2020, or by Aug. 1, 2021.
When Will this Relief Take Place?
If a taxpayer has already filed their returns for 2019 and 2020 (albeit late), the taxpayer does not need to apply, call the IRS, or take any action, and the penalty relief happens automatically. Penalty relief has already happened for many taxpayers.
For taxpayers who already paid the late filing penalty, they are entitled to a credit or refund. According to the IRS, “nearly 1.6 million taxpayers will automatically receive more than $1.2 billion in refunds or credits.” Again, those taxpayers will get automatic relief.
Possible Underlying Reason for Granting Relief
The IRS is still wading through millions of unprocessed returns from the last two filing seasons. The notice’s penalty relief will allow the agency to process those returns more efficiently for two main reasons. First, it can process the returns without determining separately whether late-filing penalties apply. Second, it will not be weighed down by thousands or even millions of penalty abatement requests that would be submitted for those returns, absent the relief in the notice.
Failure to file penalties generally do not apply if taxpayers can show that the failure to timely file was due to reasonable cause. Under the Internal Revenue Manual, the IRS evaluates a taxpayer’s situation under several different criteria to determine whether a penalty should be relieved due to reasonable cause. One criterion is when a taxpayer may establish reasonable cause if there was a death, serious illness, or unavoidable absence to the taxpayer or the taxpayer’s immediate family. For corporations, estates, and trusts, the IRS will evaluate whether there was a death, serious illness, or unavoidable absence to the taxpayer’s person solely responsible for filing the return.
Millions of people have been diagnosed with Covid-19, and more than 1 million Americans have died. If the person responsible for filing the return was not diagnosed with or didn’t die from Covid-19, the chances are a close family member was. Realistically, taxpayers could file a Form 843 and request an abatement of penalty claiming that their late filing penalties should be abated due to reasonable cause: Covid-19. The IRS would then have to spend resources going through each submission trying to decide which cases were worth relief, which would take up unnecessary resources.
While some taxpayers incurred a late filing penalty because of reasons wholly unrelated to Covid-19, the IRS is better erring on the side of caution. It made the right choice by making the late payment relief automatic.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Richard Gano is a tax attorney at Holtz, Slavett & Drabkin APLC in Beverly Hills, Calif. As a former IRS attorney, he handles all types of tax controversy matters, including audits, litigation, and collection issues before the IRS and state tax agencies.
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