Attached is a sample reasonable cause letter in support of a client’s request that all penalties and interest arising out of his unintentional failure to file and pay Form 941 withholding taxes be waived.
This is a heavily redacted version and should not be relied upon in any way, shape, or form in dealing with the IRS.
I. General Facts
Mr. X is the former president of XYZ Industries, a corporation established under the laws of Caifornia. While the corporation is still in existence, it ceased doing business back in 2011. Mr. X has been retired ever since.
XYZ Industries’ Form 941 tax woes go back to 2008. In 2008, the IRS assessed tax, interest, and penalties against XYZ Industries in the amount of $ 200,000 for failing to file and pay Form 941 employer withholding taxes.
The tax periods in question included those ending in:
Substitute returns were prepared on May 1, 2007 and the IRS assessed additional tax for several of the periods listed above. Two tax liens were later filed: the first on February 1, 2008 in the amount of $ 200,000 and the second on May 1, 2008 in the amount of $ 20,000. These liens were released on March 1, 2009 and on April 1, 2009, respectively.
On July 1, 2008, Mr. X received “Letter 1153,” in which the IRS proposed to assess a trust fund recovery penalty against him in the amount of $ 75,000 for failing to withhold the “trust fund” portion of XYZ Industry’s Form 941 liability (See Appendix I). On August 7, 2008, Mr. X met in person with Revenue Officer, John Doe to discuss a complete and final resolution to this matter. He was not represented by a tax practitioner. At the meeting, Mr. X was asked to sign Form 2751. Believing that Form 2751 represented a full and final settlement of XYZ’s Form 941 liability, Mr. X signed it. In doing so, Mr. X acknowledged that he was the “responsible party” and agreed to the assessment and collection of the trust fund recovery penalty (See Appendix II, Form 2751).
Beginning on July 1, 2008 and ending on June 1, 2010, Mr. X paid the trust fund recovery penalty in full through an aggressive IRS Installment Agreement consisting of six equal installments of $ 5,000 and eight equal installments of $ 6,000 for a total amount of $ 78,000 (See Appendix III).
Much to Mr. X’s surprise, no sooner did he get done paying the trust fund recovery penalty than he began receiving notices from the IRS notifying him of delinquent Form 941 tax liability. It was not until he inquired that he learned – for the first time – that the trust fund recovery penalty did not represent a full and final resolution of XYZ’s Form 941 tax woes.
Shocked but nonetheless wanting to “get it right” with the IRS, Mr. X attempted in good faith to negotiate an offer in compromise with the IRS that would satisfy the remaining balance. He completed Form 656 and beginning on May 2, 2010 made a total of eleven payments in equal installments of $ 2,000.00 for a total of $ 22,000.
Any hope of reaching an offer in compromise was shattered on December 1, 2010 when Mr. X received a terse letter from the IRS roundly rejecting his offer in compromise. This letter, written by Jane Smith, listed the grounds for which the IRS was rejecting Mr. X’s offer. Specifically, it assumed that Mr. X’s economic condition was such that he should have been able to make monthly installment payments at a rate that was almost five times more than what Mr. X proposed. Such a payment plan would have left Mr. X with nothing more than the shirt on his back. On or about August 1, 2015, the reality of these disparaging circumstances hit Mr. X like a ton of bricks. He received a torrent of notices from the IRS informing him that XYZ Industry’s 941 taxes were overdue (for most of the periods listed above) and demanding payment.
With compounding interest, this figure has ballooned to a staggering $ 200,000, an amount that Mr. X will never be able to pay off in this lifetime.
Throughout this process, Mr. X has made valiant attempts to reach a settlement agreement with the IRS that would resolve XYZ’s 941 tax liability once and for all. Sadly, this matter continues to linger, hanging over the head of a now elderly and infirm eighty year-old man like the sword of Damocles.
Mr. X is now eighty-two years old and his health is rapidly declining. He suffers from a myriad of medical conditions that affect his quality of life.
Mr. X’s personal circumstances represent a sympathetic case and the civil penalty structure imposes penalties that are grossly disproportionate for a person in his position. The outcome of strapping Mr. X with such harsh penalties would be draconian. Very simply, he risks having his entire retirement wiped out in one fell swoop – sealing his fate as a ward of the state who will require Medicaid in order to meet the escalating costs of health care. This is likely unintended and unwanted by the IRS.
It is in the best interests of both Mr. X and the IRS that a nuanced approach to the assertion of penalties be taken and that his reasonable cause arguments be given full consideration. Complete forgiveness of penalties and interest for the period from ____ to ____ due to reasonable cause is warranted.
II. Mr. X has Reasonable Cause for Not Filing and Turning Over Form 941 Withholding Taxes. Therefore, complete Non-assertion of penalties due to reasonable cause is warranted
a. Mr. X was unaware of his Form 941 Obligations.
Mr. X was born overseas and moved to the United States later in his life. He is a simple and humble man who came to the United States with nothing more than the shirt on his back. Those who know him best say that he is so thoughtful and caring that he would give a perfect stranger “the shirt off his back.”
Mr. X’s story is nothing short of inspirational. Through hard work and perseverance, he pulled himself up by the bootstraps in the face of enormous adversity to achieve an unprecedented level of success that many only dream about.
A hallmark of reasonable cause is that a taxpayer exercised ordinary care and prudence. See IRM 22.214.171.124.2.2. Lack of awareness of a filing obligation may be consistent with ordinary business care. IRM 126.96.36.199.2.2.6 (2) (e) states that reasonable cause may be established if the taxpayer shows ignorance of the law where “there were recent changes in the tax forms or law which a taxpayer could not reasonably be expected to know.”
Reasonable cause is also consistent with IRM 188.8.131.52.2.2.6 (4) (b) when a taxpayer establishes that “[she] was unaware of a requirement and could not reasonably be expected to know of the requirement.”
While savvy as a business person, the same cannot be said about Mr. X’s understanding of U.S. corporate tax compliance. Very simply, Mr. X was utterly naïve as to what forms he had to complete on behalf of XYZ, not the least of which was Form 941. Considered by many to be one of the more complicated IRS forms, Form 941 has been known to elude even U.S. citizens who fastidiously attempt to comply with their fiduciary obligations as officers of a company.
Therefore, it is not hard to imagine the havoc that Form 941 compliance wreaked on an Immigrant such as Mr. X who was born, raised, and spent the better part of his life outside of the U.S. where no such requirement existed, let alone an equivalent form. Therefore, it is unreasonable to expect Mr. X to have known of the Form 941 requirement.
b. Good faith: Immediate compliance upon becoming aware of Form 941 reporting obligations
IRM 184.108.40.206.3.1 (3) states that:
“Treas. Reg. 1.6664-4, Reasonable Cause and Good Faith Exception to § 6662 penalties, may serve as useful guidance in determining the factors to consider.”
It cannot be emphasized enough that Mr. X firmly believed that Form 2751 represented a full and final settlement of XYZ’s Form 941 liability. And he had strong grounds for believing so. First, nothing was said at the meeting to disabuse him of this notion. On the contrary, Mr. X’s belief that XYZ’s Form 941 liability had been resolved once and for all was confirmed by Ms. Doe verbally. Mr. X relied upon these representations to his detriment.
From the very moment that Mr. X learned that he should have been filing Form 941s on behalf of XYZ, he took swift action.
Learning for the first time that one’s company should have been withholding social security, Medicare, and income taxes from its employees’ wages is alone enough to put a “responsible person” in a state of shock, and perhaps even cause such a person to turn a blind eye to what might otherwise be an “inconvenient truth.” But what can make an already dire situation that much worse is when it happens during a deep recession and at a time when the company’s future is as uncertain as the price of a barrel of crude oil.
Such was the case for Mr. X back in 2006. To say that XYZ had fallen on difficult times and that its future was uncertain would be a complete understatement. In order to ease an immediate cash flow problem, Mr. X was forced to take out a personal line of credit as well as a personal loan in order to keep the company afloat.
The actions that Mr. X took in the face of such adversity are a true testament to his character as a person and to his desire to “get it right” with the IRS. Despite being faced with a never-ending “parade of horribles,” Mr. X rose to the occasion and did what he has done for his entire life: the honorable thing. He signed Form 2751 and accepted responsibility for the assessment and collection of the trust fund recovery penalty. Two years later, Mr. X paid off the trust fund recovery penalty without so much as missing a payment.
In sum, Mr. X satisfied his end of the bargain.
c. Mr. X is in poor health
As discussed above, Mr. X is eighty years-old old and his health is rapidly declining. He suffers from a myriad of medical conditions that affect his quality of life. These conditions have left a once spry and active man weak and feeble – a shell of the person he once was. Mr. X’s life is now dominated by frequent visits to his doctor and daily dosages of a myriad of prescription drugs, some of which require manual injection. While stable, each day presents a formidable challenge.
Mr. X has shown clear evidence of non-willful behavior. He had no prior knowledge of the Form 941 reporting requirements, which are known to evade even native U.S. citizens who scrupulously abide by the U.S. corporate tax code. These are complex reporting requirements which are documented as being so.
Mr. X exercised multiple instances of good faith in trying to meet these reporting obligations. On the heels of receiving Form 2750 from the IRS, he immediately negotiated what he believed was a full and final settlement of XYZ’s Form 941 liability. In doing so, Mr. X acknowledged that he was the “responsible party” and agreed to the assessment and collection of the trust fund recovery penalty (See Appendix II).
Two years later, Mr. X paid the trust fund recovery penalty in full through an aggressive IRS Installment Agreement never missing a payment.
Mr. X’s approach to taxation and regulatory filing requirements in the U.S. is clear: he wishes to comply. This is demonstrated by the fact that Mr. X acted swiftly to come into compliance with his Form 941 tax obligations as soon as he became aware of the discrepancies.
Mr. X’s facts point to a strong history of compliance, an understandable lack of awareness, a date at which awareness occurred, and immediate compliance efforts in the wake of that awareness.
This experience has made Mr. X acutely aware of the complexities of the Form 941 reporting regime and of the absolute necessity to engage the services of a professional tax preparer to prepare his returns.
For these reasons, it is in the best interests of both Mr. X and the IRS that a nuanced approach to the assertion of penalties and interest be taken and that his reasonable cause arguments be given full consideration. Complete forgiveness of penalties and interest due to reasonable cause for the period from ____ to ____ is warranted.
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1 comment on “Sample Reasonable Cause Letter”
I was an IRS Revenue Officer for 35 years even looking at the facts and circumstances in the most favorable light for Mr. X I am shaking my head at any attempt to get relief here.
The case cited in this article involves the kind of tax where the taxpayer has the highest fiduciary responsibility to be in compliance. IRS has a very low bar to jump over to find a responsible person liable for the Trust Fund Recovery Penalty coupled with his excuse that is at best, lame. The taxpayer/corporation failed to pay over tax withheld from their employees and also failed to file returns. What did Mr. X think he was supposed to do with the withheld funds? Where did they go? You don’t say but it appears he used the IRS as the corporation’s “involuntary banker” so aside from penalties assessed against the corporation, he was found liable for a penalty that has no reasonable cause escape. IRS has a litany of potential reasonable causes ranging from illness, death an inability to get records along with a catch all of “the taxpayer exercised ordinary business care and prudence.” Mr. X did not exercise ordinary business care and prudence! If he didn’t understand the rules he had an obligation to hire someone who did.
In the context of liability for the Trust Fund Recovery Penalty Mr. X has shown no evidence that he did not act willfully because the withheld taxes were dissipated on something else. Willfull failure to pay over withholding tax does not suggest evil intentions and what was paid is irrelevant. Paying a subsequent payroll with funds that could have been used to cover the withholding from a previous one is a willful act. If the money had been sitting in the bank when he was asked to sign the IRS Form 2751 liability for that penalty would be a non-issue.
Before a case gets to the point where IRS determines the amount of tax due on Form 941 the taxpayer has had multiple opportunities to respond to IRS requests. Mr. X had plenty of opportunity to show good faith by complying but sat on his hands.
Mr. X’s approach to taxation and regulatory filing requirements in the U.S. is clear: he didn’t know what he was doing and did nothing to learn. This is demonstrated by the fact that Mr. X didn’t thought the liability was being satisfied when presented with IRS Form 2751. He either didn’t read with the Letter 1153 said or didn’t bother to ask. The ostrich defense fails.
Mr. X’s facts point to a strong history of non-compliance, an inexcusable lack of awareness and dissipation of funds withheld from employee’s wage which generated significant penalties to the taxpayer/corporation and personal liability on his part because immediate compliance efforts in the wake of that awareness was too little too late.
Post assessment payment ability is irrelevant. Routine penalties charged on delinquent employment tax liabilities are for late filing, late payment and failure to make timely deposits of withheld tax. Lack of knowlege If there were funds to pay net wages, there is the assumption that there were funds to cover the withholding. Complete forgiveness of penalties and interest due to reasonable cause for the periods involved is out of the question. Whoever wrote the letter knows nothing about forgiveness of interest because it is unforgivable except in cases where there is a delay cause by IRS failure to perform a ministerial act.
As penalty abatement cases go, this one is DOA.
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