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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

First Time Penalty Abatement: What It Is and Why You Should Care

First Time Penalty Abatement: What It Is and Why You Should Care

Most tax practitioners are familiar with reasonable cause as the basis for penalty abatement. But many often overlook another important reason for penalty abatement: the so-called First Time Abatement.

This exemption is available when an eligible taxpayer has been exempt from penalties within the past three years and has filed and paid all required returns or a valid extension or payment agreement. No other reason or justification is required. It is a get out of jail card for the taxpayer who is historically tax compliant.

While the First Time Abatement exemption, perhaps surprisingly, went unnoticed by tax professionals, the Treasury Inspector General for Tax Administration (TIGTA) pointed this out late last year. Following an audit of the use of the First Time Abatement relief, the treasury inspector general for tax administration estimated that annual tax penalties of more than $181 million had not diminished for nearly a decade, despite the requirements of the First Time Abatement exemption. Indeed, the treasury inspector general for tax administration's findings went further: it concluded that "the First Time Abatement exemption [in fact] is not granted to the majority [more than 90%] of taxpayers who are eligible for the waiver". 

The reasons seem quite simple. The IRS doesn't advertise First Time Abatement relief too much, a circumstance that can be somewhat strategic. First Time Abatement facilitation is also not automatic. A taxpayer must affirmatively request a reduction before being granted the First Time Abatement relief. As a result, First Time Abatement relief has been grossly underutilized so far.


Brief Background

Our tax system is based on the principle of voluntary compliance. In other words, to operate effectively, it relies heavily on taxpayers to self-impose and pay taxes. Consistent with this principle, the Code's sanctions framework is not intended to generate revenue per se but rather promote compliance with tax laws. This distinction is important. And that goes a long way to explaining the rationale behind the First Time Abatement: to reward a taxpayer's compliance history and, therefore, promote future compliance. At least that's the idea.

The First Time Abatement relief is available for two of the most common and frequently mentioned penalties: the non-filing and non-paying penalties referred to in §6651.


IRC §6651(a)(1) sets a late fee for not filing a return by the due date or extending the due date of the return. Usually, this penalty for non-appearance is 5% of the amount.

Unpaid tax for part of a month or each month during which the declaration is unpaid. In the absenteeism of fraud, the maximum penalty cannot, in general, exceed 25% of the unpaid tax.

IRC §6651(a)(2) establishes a late penalty for a taxpayer who does not pay the amount of tax stated in return by the due date. This non-payment of the fine is generally 0.5% of the unpaid tax for part of a month or each month in which the tax remains unpaid. Like the non-payment of the fine, the fine maximum has a maximum tax of 25% unpaid tax.

Even when penalties are initially assessed, there are several possible ways to improve and reduce them. For example, taxpayers can avoid these penalties when they fail to show up or pay on time due to just cause and not willful misconduct like §6654(e) - the provision of exceptions to the estimated tax fine where the tax is less than $1,000 - to the more obscure ones, such as §7508, which prohibits the imposition of fines on taxpayers in combat zones.

In addition to these relevant statutory provisions, the IRS may grant administrative exemptions. And in 2001, the IRS implemented a major administrative waiver program known as the First Time Abate Waiver, which it administered through Reasonable Cause Assistant, an interactive decision-support software designed to manage and facilitate the reduction of fines.

Under the First Time Abatement exemption program, the IRS grants tax exemptions to taxpayers who have complied within the last three years. In a note published on April 17, 2013, the Revenue Agency indicated that this condition required the taxpayer to know the reporting and collection obligations for those years to be in good standing with their liability obligations if they have a valid extension declaration of all payments in installments. 

Those entitled to the benefit may benefit from the First Time Abatement exemption from penalties for non-appearance and non-payment. For corporations, including S Corps and Partnerships, the First Time Abatement waiver program extends to these penalties and non-reporting penalties unless the penalty is imposed for circumventing the EFTPS.

However, the First Time Abatement exemption has certain limitations. It applies to a single fiscal year and cannot be used to obtain exemptions for several fiscal years. And there are other caveats: the program exemption does not apply to penalties based on non-compliance event-based requirements, including those of Form 706. It also does not apply to accuracy-related penalties.


 What the treasury inspector general for tax administration audit found.

The treasury inspector general for tax administration summarized its findings on using the First Time Abatement exemption in one sentence: "The First Time Abatement exemption is not granted to the majority of taxpayers eligible for the exemption." The treasury inspector general for tax administration audit found that First Time Abatement relief was not extended to an estimated 90% of taxpayers eligible for failure to file exemption and 92% of taxpayers eligible for failure to pay waiver relief. Again, these figures indicate that the First Time Abatement exemption is grossly underused.


How does this affect me? If you don't ask, you won't get

The main reason for the lack of First Time Abatement exemptions? The First Time Abatement is only considered if a taxpayer requests the exemption and the taxpayers have simply not requested it. That is, if you don't ask, you won't receive. The blame, however, is not entirely on the taxpayers' shoulders. According to the treasury inspector general for tax administration, the lack of orders is largely due to the IRS not publishing the exemption from the First Time Abatement exemption. For instance, IRS Form 1040 and its instructions do not state that the exemption is available. The First Time Abatement exemption program is conspicuously absent from the IRS' public website. 


Conclusion

Under the right circumstances, a First Time Abatement exemption can be a great tool in a tax practitioner's toolbox and a historically underutilized tool. It gives taxpayers who have had a clean record in the past three years a one-time permit (well, technically, every three years) so they don't get penalized. But there are a few subtle factors to consider when claiming a First Time Abatement exemption, particularly when the taxpayer may also qualify for a reasonable cause exemption. With this in mind, taxpayers and tax professionals should at least add the First Time Abatement exemption to their arsenal and assess its case-by-case applicability basis.


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Jim McClaflin, EA, NTPI Fellow, CTRC
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