The IRS has updated its practice unit discussing when reasonable cause and good faith exist and what factors should be examined. The overview is as follows:
This Practice Unit supersedes the previously published Practice Unit with the same title published on July 2, 2020. The Practice Unit was updated to provide further detailed information on factors that should be considered when determining if reasonable cause exists.
Taxpayers may assert that the Service’s application of penalties is not warranted due to a variety of reasons. This unit addresses the taxpayer’s assertion that the return position was based on reasonable cause and that the taxpayer acted in good faith. How the Service evaluates this taxpayer defense depends on the particular penalty that was asserted. In addition to reasonable cause and good faith, certain penalty defenses involve other concepts such as an absence of willful neglect.
The burden is on the taxpayer to provide support to substantiate reasonable cause for penalty relief. Taxpayers are required to exercise ordinary business care and prudence in reporting their proper tax liability. Whether a taxpayer has met the reasonable cause and good faith exception is a facts and circumstances determination that the examiner must make test on a case-by-case basis .
The reasonable cause exception under IRC 6664(c) applies to: § Most accuracy related penalties under IRC 6662
§ Civil fraud under IRC 6663.
The reasonable cause exception under IRC 6664(d) applies to the penalty under IRC 6662A for a reportable transaction understatement when the transaction was adequately disclosed. The penalty under IRC 6676 (erroneous claim for a refund or credit) also has a reasonable cause exception.
Reasonable cause exceptions for penalty relief also apply to other IRC penalties such as:
§ IRC 6651 – Failure to File and/or Failure to Pay
§ IRC 6676 – Erroneous Claim for Refund or Credit
§ IRC 6721 – Failure to File Correct Information Reporting Returns
§ IRC 6694 – Understatement of Taxpayer’s Liability by Return Preparer.
The reasonable cause exception does not apply to a penalty for an underpayment of tax that is due to transactions lacking economic substance as described in IRC 6662(b)(6), or a gross valuation overstatement from a charitable deduction.
Posted by Lewis J. Saret, Co-General Editor, Wealth Strategies Journal.