Tax Court Permits Penalty Relief for Taxpayer’s Failure to Pay Due to Circumstances Beyond Control

July 12, 2011

The U.S. Tax Court recently expanded the list of potential reasons for which a taxpayer may be relieved from penalties for failing to timely pay employment taxes. Obtaining relief from potential penalties is often a key issue in resolving disputes with the IRS over unpaid taxes.

Treasury regulations authorize penalty abatement if the taxpayer is unable to pay taxes due to financial circumstances beyond his or her control; however, the regulation has seldom been applied to support abatement for late payment of employment taxes. The Internal Revenue Manual—the guide book for IRS employees—supports this, stating that penalty abatement is rarely allowed on employment tax deposits.

In Custom Stairs & Trim Ltd. V. Commissioner, T.C. Memo 2011-155, the taxpayer’s business suffered severe damage from Hurricane Ivan in 2004 and then in 2008 was affected by the general economic downturn. The taxpayer had previously been consistent in filing and paying employment taxes on time, but after Hurricane Ivan they became frequently late. Penalties mounted as the IRS applied recent payments to penalties and interest that accrued from earlier periods, causing the taxpayer to be delinquent on the current period.

Despite the IRS’s disapproval of Custom Stairs favoring other creditors over them, the Tax Court held that the company, “exercised ordinary business care and prudence in cutting benefits and payroll, selectively and prudently paying business expenses, and attempting to sell its real property to provide for the timely payment of its tax liabilities.”

Furthermore, the Tax Court disagreed with the IRS’s suggestion that businesses in financial circumstances such as Custom Stairs should fold, citing East Wind Indus., Inc. v. United States, 196 F. 3d 499, 507-508 (3d Cir. 1999) which states, “Both the economy and the federal fisc are negatively impacted by such an approach—the amount of money flowing into the economy and the fisc is reduced as a result of increased unemployment, idle buildings and plants, and decreased sales of goods and services.”

On the basis of the court’s ruling in Custom Stairs, Penalty relief for late payment of taxes may be granted if the taxpayer can establish that he or she exercised prudent business care in providing for tax compliance responsibilities but due to financial circumstances beyond their control were unable to pay taxes on time.

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