Taxpayers have asked me many times whether or not they can get penalties and interest abated as a result of an IRS audit. The interest cannot be abated, but the penalties might be able to be.
Typically, if the taxpayer does their own taxes and makes a mistake, then any penalties that are incurred for their mistakes are very unlikely to be abated unless you catch the IRS in a good mood. That’s because the 20% accuracy penalty has a built in negligence feature that allows the IRS to penalize the taxpayer for making a simple mistake. The failure to file and failure to pay penalties for not filing on time or paying the tax are also automatic unless the return wasn’t filed on time due to hardship such as medical emergency, Act of God etc. Even then, it takes a skilled tax professional to ensure that those cases are treated favorably to the taxpayer. The substantial understatement penalty is for failure to report income received.
But what happens when the taxpayer uses a CPA or other service to prepare their taxes and someone else makes the mistake on the tax return? This has been decided by the US Tax Court as follows:
A taxpayer may demonstrate reasonable cause and good faith by showing reliance on the advice of a tax professional, such as an accountant or a lawyer, regarding a particular item’s tax treatment. Id. para. (c)(1). To rely in good faith on the advice of a professional, the taxpayer must show that: (1) the adviser “was a competent professional who had sufficient expertise to justify reliance”; (2) “the taxpayer provided necessary and accurate information to the adviser”; and (3) “the taxpayer actually relied in good faith on the adviser’s judgment.” Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
The burden is on the taxpayer to prove that the penalties should be abated. The less educated the taxpayer and more egregious the errors made by the tax preparer, the easier it is to get the penalties abated. It is a subjective test based solely on the facts of the case as to whether or not the taxpayer gets his or her penalties abated. A good rule of thumb is to always ask questions about your return before you sign it. If you aren’t satisfied with what your preparer says or if something seems too good to be true, get another preparer. If the preparer solely gets paid because of your refund, WATCH OUT! It’s likely that they got creative with your return to make sure they got paid.