IRS RESPONSE TO RECOMMENDATION: Since the IRS administers over 200 civil penalties, it is most effective to focus stakeholder input and internal review on discrete issues. We are continuously improving our programs to ensure penalties are applied fairly and consistently.

For example, we are currently engaged in a Servicewide effort to improve the Reasonable Cause Assistant tool that assists Taxpayer Services and Collection in determining whether a taxpayer’s late return, payment, or deposit were due to reasonable cause, and not due to willful neglect. The planned improvements are informed by stakeholder feedback received from focus groups conducted at the 2024 Nationwide Tax Forums and a direct result of a cross-functional team with knowledge of the real day-to-day situations that taxpayers share with IRS employees who are using the tool. Together, this feedback is helping to drive needed and taxpayer-favorable updates to reasonable cause categories and factors to consider regarding penalties already assessed.

As another example, the IRS completes bi-annual Civil Penalty Accuracy Reviews each year that validate the proper computation of penalties. On average, we find an accuracy rate of 98%, with any errors immediately resolved at discovery. We are currently exploring the creation of a Review & Recovery team to expand these reviews to a much larger scale, thereby enabling improved identification of systemic penalty issues and the ability to resolve issues on a one-to-many level.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The purpose of civil tax penalties should be to encourage compliance. TAS supports the IRS’s efforts to improve the administration of certain penalties such as its planned improvements to the Reasonable Cause Assistant tool and its bi-annual reviews to validate the proper computation of penalties. However, the IRS’s focus on discrete issues does not address the overriding policy concerns of the current penalty regime. While verifying that the IRS accurately computed certain penalties is important (“we find an accuracy rate of 98%”), it does not take into consideration the rationale behind the penalties and whether the imposition of the penalties furthers their intended purpose, and the 98% accuracy rate does not include the percentage of penalties abated or not sustained. Moreover, the correct computation of certain International Information Return (IIR) penalties does not consider whether the penalties are excessive in relation to the offense or underlying tax liability, or whether the purpose is punitive rather than to enhance compliance.

The focus of the federal civil tax penalty regime has shifted away from utilizing civil penalties only to enhance compliance. The IRS needs to refocus its policy on administering penalties in a manner solely for the purpose of encouraging compliance. The effective way to do this would be to create a task force to study the current penalty regime and make recommendations to ensure that the IRS properly applies penalties for the purpose of improving tax compliance. TAS strongly urges the IRS to reconsider its refusal to do so.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

IRS RESPONSE TO RECOMMENDATION: The IRS already has a considerable number of programs and procedures that facilitate resolution of a taxpayer’s non-criminal compliance issues while encouraging voluntary disclosure and future compliance. While the IRS does not have a discrete program to address every emerging issue, the existing programs allow taxpayers to resolve any issue when the noncompliance does not rise to the level of criminal fraud.

Before establishing a new civil disclosure or settlement program, whether for a longstanding or emerging issue, such as digital assets, or other areas of noncompliance, the IRS would need to consider whether the scope of the issue and level of noncompliance merit the creation of a new program specific process. Additionally, the time and resources needed to establish and administer any such program can be substantial. Rather than creating new programs, the IRS would want to consider whether alternative approaches such as improved outreach and communications strategies could help taxpayers learn about the best paths to compliance.

CORRECTIVE ACTION: N/A

TAS RESPONSE: TAS appreciates the IRS’s commitment to finding ways to resolve emerging noncompliance issues through alternative approaches and recognizes there are challenges to addressing these issues, including time and resource constraints. TAS supports the IRS’s focus on improved outreach and communication strategies as a first step in attempting to resolve areas of noncompliance

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

IRS RESPONSE TO RECOMMENDATION: The requested review is unnecessary, since IRS notices, including these penalty notices, are reviewed every year and our current process conveys the required information to taxpayers.

When a penalty is systemically assessed at filing, the taxpayer receives a CP notice, which provides the name of the penalty and IRC section and the penalty computation. IRS’s Master File computes the penalty and has all the data needed to pass the computation to the notice programs. These CP notices constitute the vast majority of penalty notices that are issued. Based on the volume of penalties applied systemically each year, notices are as specific as they can be while maintaining the efficiency of a systemic program.

Notices associated with manually assessed penalties include the name of the penalty and IRC section. However, since the penalty is computed outside of Master File, the examiner provides the penalty computation to the taxpayer prior to, or together with, the penalty notice. In general, taxpayers have already received notices showing the penalty computations from an examiner prior to having a penalty assessed and have been afforded the opportunity to work directly with the examiner to ask questions and gain a full understanding of the penalty computation. Additionally, many of these manual penalty notices include the total penalty amount along with the base rate of the penalty, making it very easy to back into the number of violations that were assessed.

CORRECTIVE ACTION: N/A

TAS RESPONSE: TAS disagrees that IRS review of penalty notices is unnecessary. The statutory requirement of I.R.C. § 6751(a) is clear – the IRS “shall” include certain information, including a computation of the penalty, with each notice of penalty that it sends to taxpayers. Practitioners report that the IRS frequently fails to include a penalty computation in penalty notices it issues to taxpayers, especially in the case of immediately assessable penalties including IIRs. Further, requiring taxpayers to “back into” the penalty is unacceptable, places undue burden on taxpayers, violates the rights to be informed and to pay no more than the correct amount of tax, and does not meet the clear requirements of the law.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

IRS RESPONSE TO RECOMMENDATION: The IRS already considers whether a taxpayer had reasonable cause based on their particular circumstance prior to manually assessing a late-filing penalty, including in field examinations. Where a penalty is assessed systemically at filing, the taxpayer has an opportunity to raise a reasonable cause defense and, if reasonable cause is denied, seek review by Appeals. Accordingly, the current process balances up-front consideration of reasonable cause where it is feasible to do so with leveraging systemic tools where they yield the greatest efficiencies.

More specifically, and as the National Taxpayer Advocate acknowledges in the report, the IRS has already stopped the assessment of Part IV penalties on Form 3520 at filing and updated procedures to review reasonable cause statements attached to Form 3520 and Form 3520-A prior to assessing penalties at filing. Currently these forms are paper-filed, and the consideration of a penalty at filing is largely a manual process, which made it both possible and more efficient to change procedures and look at reasonable cause prior to assessment.

In addition, penalties for most types of international information return (IIR) filings – including Forms 8938, 8865, 926, 8858, 8621, 8854, and 8992, FBARs, and Form 5471 filings attached to Form 1040 – are only assessed through a field examination in which taxpayers are given a chance to work directly with an examiner, who is familiar with the taxpayer’s particular circumstances and who considers reasonable cause prior to assessing a penalty.

The only IIR penalties that are systemically assessed at filing via programming apply to a Form 5471 or Form 5472 attached to an original late-filed Form 1120 or Form 1065. With higher volume returns like these, systemic assessment results in more consistent treatment of taxpayers, rather than just penalizing those selected for audit. It also serves as a stronger incentive for timely compliance knowing a penalty will be assessed regardless of whether a field exam occurs. Information reported on these forms is valuable to understand the accuracy of the taxpayer’s income tax return and helps IRS efforts to minimize the international tax gap. Pivoting to a manual process for these penalties, so the IRS could consider reasonable cause prior to assessment, would significantly delay return processing and, importantly, delay the payment of any refunds owed to taxpayers on their related Form 1120 or 1065.

CORRECTIVE ACTION: N/A

TAS RESPONSE: TAS is pleased that the IRS stopped the assessment of Part IV penalties on Form 3520 at filing and updated procedures to review reasonable cause statements attached to Form 3520 and Form 3520-A prior to assessing penalties at filing. While the changes the IRS has made with respect to Forms 3520 and 3520-A are beneficial for taxpayers, the IRS should expand its elimination of automatic assessments to all late filed IIRs and provide taxpayers the ability to raise a reasonable cause defense with the opportunity for an administrative review with Appeals prior to any assessment.

TAS has expressed its concerns with the IRS’s approach to IIR penalties on many prior occasions. These penalties are systemically assessed, without any prior review or opportunity to establish reasonable cause or other defenses. They are often erroneously classified as assessable and therefore must be paid before judicial review, which deprives taxpayers of review in the U.S. Tax Court and causes financial hardship. They are disproportionate in comparison with any potential underlying tax and fall particularly hard on lower-income taxpayers and small businesses.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

IRS RESPONSE TO RECOMMENDATION: The IRS is charged with enforcing penalty provisions with respect to the high volumes of returns received each year. When an income tax or employment tax return is filed late and with a balance due, the IRS has all the information needed to assess the late filing and/or late payment penalty. For efficiency, the IRS assesses these penalties systemically. Taxpayers receive a notice and may respond with a reasonable cause statement, which the IRS considers.
If reasonable cause is denied, the taxpayer has the right to seek review by Appeals. In this way, the current process appropriately balances the need for efficient and effective enforcement of penalties in support of voluntary compliance with affording taxpayers the opportunity to assert penalty defenses. The reasonable cause analysis itself is not something that can be handled systemically at filing, since it is dependent on a consideration of the taxpayer’s particular facts and circumstances. However, where reasonable cause can be considered first, such as in a field examination, the taxpayer is provided an opportunity to submit a reasonable cause statement prior to penalty assessment.

We will continue to weigh the merits of potential improvements, such as the suggested checkbox, that could be helpful in terms of identifying whether a reasonable cause statement has been attached to an original, late-filed return.

CORRECTIVE ACTION: N/A

TAS RESPONSE: TAS understands that there are current systemic limitations which would need to be addressed in order to implement the recommendation. TAS supports continued consideration by the IRS of potential improvements to systemic penalty assessments including the checkbox.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

IRS RESPONSE TO RECOMMENDATION: First Time Abate (FTA) is an administrative waiver meant to reward those taxpayers with a history of filing, paying, and/or making deposits on time, in service of the purpose behind penalty administration of enhancing voluntary compliance. FTA’s criteria around a timely compliance history do not apply to event-based information returns that a taxpayer may or may not be required to file in any given year, but which, in years they are required, are key to the IRS’s ability to verify accurate reporting of income. Accordingly, FTA has not historically applied to any penalties other than the failure to file, failure to pay, and failure to deposit penalties, which are the most common systemically assessed penalties for individual and business returns.

With respect to estimated tax penalties specifically, each penalty is intended to collect the lost interest from amounts the taxpayer did not pay timely to the IRS throughout the year as the law requires. It is computed in the same manner as interest, except it is not compounded daily. Accordingly, waiver of this penalty is not appropriate other than in cases where the late estimated payment is due to reasonable cause. In addition, the assessment of an estimated tax penalty in the prior three years does not preclude a taxpayer from benefitting from FTA in the current year. Finally, a safe harbor already exists that limits the application of the estimated tax penalty. Specifically, the penalty is not assessed if less than $1,000 (IRC 6654) or $500 (IRC 6655) in tax is due (after withholding/credits) or the balance due is less than a specified percentage of the current or prior year tax shown on the return.

CORRECTIVE ACTION: N/A

TAS RESPONSE: While the estimated tax penalty is intended to function as an interest provision, taxpayers often have difficulty estimating how much tax they will owe. As a result, millions of taxpayers do not satisfy the requirements of I.R.C. §§ 6654 and 6655 and are liable for penalties each year. For example, in fiscal year 2023, over 14 million estimated tax penalties totaling around $7 billion were assessed against individuals, estates and trusts. However, only 179,109 estimated tax penalties totaling around $105 million were abated for individuals, estates, and trusts. Although the reasonable cause exception to the estimated tax penalty applies under limited circumstances, expanding FTA to estimated tax penalties would potentially benefit many taxpayers and eliminate the burden of filing a request for abatement.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A