What Does “Reasonable Cause” Mean to the IRS?

At some point in your life, it is possible you will have a disagreement with the Internal Revenue Service (IRS). The more complex your financial profile, the greater the likelihood that you and the IRS may not see eye-to-eye.

Let’s assume you signed a business or personal income tax return that understates your tax liability. In addition to paying the tax due, you may be on the line for interest on the amount due and a possible penalty on top of that. Tax penalties rarely come cheap, so you might be interested in a work-around. One popular appeal is the concept of “reasonable cause.”

When preparing your return or directing the preparation of your return, maybe a mistake was made. A number was transposed, income accidentally under-reported, or left out altogether. Given the nature of the error, and the circumstances around it, you might think it was a reasonable mistake given the facts involved.

A taxpayer’s definition of “reasonable cause” usually does not line up with the definition provided by the IRS. Although results may vary, the IRS maintains a pretty strict rubric on what constitutes reasonable cause. Just a few points about the process of penalty relief for reasonable cause include:

• For cases in which failure to file is a concern, the IRS takes into account all facts or circumstances that may have impeded your ability to file. For example, this year the IRS extended the deadline for filing personal income tax returns due to the COVID pandemic, and has extended FBAR filing deadlines for those who reside, or whose business records reside, in an identified disaster area.
• Proving an honest error can be difficult because you must at the same time disprove willful neglect. As a business person, or someone with a diverse investment folio, the IRS expects a level of business acumen which naturally includes understanding of the timely filing of accurate income tax and compliance reports. The IRS does take into account education, background, access to advisors, and efforts made by a taxpayer to understand their tax landscape. If review of your returns reveals persistent, consistent errors over several years, it may be hard to support a claim that you often and always exercise ordinary business care.
• While reliance on a tax preparer could be a convenient out, it will likely not prove a fruitful argument if the type of advisor does not have experience equal to the complexity of your tax situation. The IRS expects an individual of higher wealth will retain a preparer familiar with the scenarios of that income level.

Proving reasonable cause can be a challenge. The IRS does not offer halfway gestures like excusing the interest on a penalty leveled due to an error. Neither the interest nor the penalty can be excused unless the account is fully paid, or there is a finding that the penalty should be reduced or removed. If notified of an error by the IRS, do the reasonable thing and speak with your tax attorney sooner than later.

If involved in an IRS criminal tax investigation or tax controversy, talk to our tax lawyers

Whether you have questions about your offshore tax structures, or you become aware of a payroll tax issue—we can help. At Robert J. Fedor, Esq., LLC we work with clients throughout the US and internationally who face allegations of tax crime, or fear charges could be underway. When you have tax questions, we have answers. Contact us today or call 800-579-0997.