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The Treasury Inspector General for Tax Administration (TIGTA) has reported that the IRS failed to inform about 1.45 million taxpayers that they qualified for relief from penalties totaling close to $181 million under a little known program—“First-Time Abate” relief.

The failure to file penalty is usually 5% of the unpaid taxes for each month or part of a month that a tax return is late. This penalty will not exceed 25% of the unpaid taxes. If a taxpayer files his tax return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100% of the unpaid tax.

If a taxpayer doesn’t pay all taxes owed by the due date, he will generally have to pay a failure to pay penalty of one-half of one percent of the unpaid taxes for each month or part of a month after the due date that the taxes aren’t paid. This penalty can be as much as 25% of the unpaid taxes. The failure to pay penalty will continue to accrue after the initial assessment if the taxpayer fails to pay the total tax due when the tax return was due.

Beginning in 2001, IRS began granting penalty relief under an Administrative Waiver known as the First-Time Abate. Under its First-Time Abate relief, to reward past tax compliance and promote future tax compliance, IRS waives these two penalties for taxpayers who have demonstrated full compliance over the prior three years. However, the relief is provided only if the taxpayers request penalty relief. IRS doesn’t widely publicize the opportunity to request this waiver.

IRS can also abate both the failure to file and failure to pay penalties where taxpayers show that they exercised ordinary care and prudence, and failure to file or pay was due to reasonable cause and not due to willful neglect.

Failure to communicate. TIGTA reports that taxpayers with compliant tax histories are not offered and do not receive the waiver. For the 2010 tax year, TIGTA estimated that approximately 250,000 taxpayers with failure to file penalties and 1.2 million taxpayers with failure to pay penalties did not receive penalty relief even though they qualified under First-Time Abate waiver criteria. TIGTA estimated that the unabated penalties totaled more than $181 million.

In addition, TIGTA found that the First-Time Abate waiver was not used to its full potential as a compliance tool because it was granted before taxpayers demonstrated full compliance by paying their current tax liability.

Recommendations. To make better use the First-Time Abate waiver as a compliance tool, TIGTA recommended that IRS ensure that taxpayers are aware of their potential to receive the waiver based on their past compliance history, and that IRS make the grant of the waiver contingent upon taxpayers paying their current tax liability.

TIGTA also recommended that a process be developed to address the negative impact to taxpayers who qualify for abatement of the failure to file and failure to pay penalties based on reasonable cause, but are given First-Time Abate waivers instead. This may preclude these taxpayers from being granted the First-Time Abate waiver in future years, and may reduce the portion of their penalties abated.

Illustration : Taxpayer, who had a clean compliance history, asked to have his failure to file penalty abated in tax year 2010 for reasonable cause (serious illness). IRS would first consider the First-Time Abate waiver and Taxpayer would be granted penalty relief under First-Time Abate criteria. The following year, Taxpayer was late paying his tax year 2011 taxes, but did not have reasonable cause. He will be assessed a failure to pay penalty, which can’t be waived because he had been granted a First-Time Abate waiver for the prior tax year. Had the failure to file penalty for tax year 2010 been excused on the basis of reasonable cause, he would have qualified for a First-Time Abate waiver for the failure to pay penalty for tax year 2011. (Audit Report No. 2012-40-113)

IRS reaction. In response to the TIGTA report, IRS officials agreed with the recommendations and are taking appropriate corrective actions. IRS plans to study how best to use the First-Time Abate waiver as a compliance tool.