IRS and Civil Tax Penalties Where is the Love?

By Jeffrey M. Gad and Drew LaGrande
Akerman Senterfitt, Tampa


The Federal Government is seemingly caught in the perfect storm. Unemployment is high, tax revenues are low and spending is out of control. You can almost feel the collective angst at the Department of Treasury every time Congress goes on another drunken spending spree leaving someone, someday, to pay the tab. As the Treasury grapples with an escalating deficit and diminishing revenues, growing evidence suggests the Internal Revenue Service may be more aggressive when imposing civil tax penalties and far less willing to work with taxpayers on abatement of such penalties.

National Taxpayer Advocate, Nina Olson, noted during a luncheon in May 2008 before the ABA Section of Taxation that "I think we are back to a time of penalty creep". She added that "we are seeing a penalty enacted for any kind of abuse du jour . . . with overlapping penalties, irrational penalties, penalties that are counterproductive, penalties that are so narrowly designed . . . and you have lost the core structure of what penalties are supposed to do."

In December 2008, the National Taxpayer Advocate published its Annual Report to Congress ("Report"). The Report, which included findings of research conducted on the IRS's penalty structure, addressed many of the concerns raised earlier in the year by Ms. Olson. The Report indicates the number of civil penalties in the Internal Revenue Code has grown from about 14 in 1954 to approximately 130 today and suggests that some penalties are obscure or unduly harsh.

The Report highlighted the challenging array of laws faced by small business taxpayers, in particular, including "a patchwork set of rules" that "can keep businesses and the IRS battling each other for years with no obvious 'correct' answer." By way of example, the data contained in the Report indicates that the number of assessed Trust Fund Recovery Penalties rose from 52,233 cases in 2000 to 179,000 cases in 2006. At the same time, the amount of penalties abated dropped from 41.4% in 2000 to just 24.6% in 2006 (The 2006 figures are subject to change during the period of assessment).

Individual taxpayers are also feeling the pinch. The IRS imposes failure to file penalties on taxpayers when they are unable to pay their liabilities in full by the due date. However, the Report finds that the IRS often miscalculates penalties and interest due to system limitations and human error, inflicting further pain on taxpayers. The study cited in the Report found that miscalculations and errors could potentially effect two million taxpayers, including situations where the penalty systemically charged taxpayers in excess of the 25% rate which is in direct violation of the IRC Section 6651. These miscalculation errors can be further compounded by the restrictiveness of the "reasonable cause" penalty abatement.

As tax dollars continue to dwindle, there is a growing likelihood that taxpayers who are unable to pay their taxes on time and in full will face serious challenges when dealing with the IRS. Higher unemployment rates and a stagnating recession suggests that more taxpayers may find themselves caught up in this escalating perfect storm.