The year 2020 has seen some very unusual circumstances and events—the Australian wildfires, the COVD-19 pandemic, the presence of murder hornets, a contentious presidential election—and the year is not over yet! Throughout this year, taxpayers may have missed estimated tax payments or underpaid their estimated taxes. This can have consequences come tax filing season next year. The year 2021 (which everyone hopes will be better than 2020) may already have certain types of tax penalties waiting for taxpayers.
Section 6654 Penalties, Generally
The Internal Revenue Service (“IRS”) may assess failure-to-pay-proper-estimated-tax penalties based on I.R.C. Section 6654. According to I.R.C. Section 6654(a):
(a) Except as otherwise provided in this section, in the case of any underpayment of estimated tax by an individual, there shall be added to the tax under chapter 1, the tax under chapter 2, and the tax under chapter 2A for the taxable year an amount determined by applying—
(1) the underpayment rate established under section 6621,
(2) to the amount of the underpayment,
(3) for the period of the underpayment.
Consequently, Section 6654(a) authorizes the imposition of an addition to tax for failure to make timely and sufficient payments of estimated tax. The addition to tax under section 6654 is calculated by reference to four required installment payments of the taxpayer’s estimated income tax.[1] The amount of the underpayment is the excess of the required installment,[2] over the amount (if any) of the installment paid on or before the due date for the installment.[3]
Limited Exceptions
Nevertheless, a taxpayer who wishes to avoid a failure-to-pay-proper-estimated-tax penalty may make a showing of all facts to establish a waiver:[4]
(A) In general No addition to tax shall be imposed under subsection (a) with respect to any underpayment to the extent the Secretary determines that by reason of casualty, disaster, or other unusual circumstances the imposition of such addition to tax would be against equity and good conscience.
(B) Newly retired or disabled individuals No addition to tax shall be imposed under subsection (a) with respect to any underpayment if the Secretary determines that—
(i) the taxpayer—
(I) retired after having attained age 62, or
(II) became disabled, in the taxable year for which estimated payments were required to be made or in the taxable year preceding such taxable year, and
(ii) such underpayment was due to reasonable cause and not to willful neglect.[5]
Unlike failure-to-file and failure-to-pay penalties under Section 6651, which can be avoided by establishing “reasonable cause” and not “willful neglect,” Section 6654 has a more limited “waiver in certain cases.”[6] In fact, the Tax Court has previously held that Section 6654 provides no exception for reasonable cause or lack of willful neglect, except in very limited circumstances.[7]
A. Casualty, Disaster, or Other Unusual Circumstances
Section 6654(e)(3)(A) waives the imposition of penalties under Section 6654 if a taxpayer underpays his or her estimated tax payments due to casualty, disaster, or other unusual circumstances, and the imposition of such penalties would be against equity and good conscience. While the taxpayer must establish his or her case and ultimately bears the burden of proof,[8] the Commissioner ultimately must make the determination.
“Casualty,” “disaster,” and “other unusual circumstances” are fairly nebulous terms. One would hope in bleak circumstances like those many are experiencing in 2020 that “other unusual circumstances” would serve as a veritable umbrella from IRS penalties. Unfortunately, previous cases have made clear that certain arguments, such as ignorance of the law, financial inability to pay, financial disasters, and/or past compliance with tax laws, do not qualify as “disasters” or “other unusual circumstances” within the purview of Section 6654(e)(3)(A).[9]
B. Retirement or Disability and Reasonable Cause
Section 6654(e)(3)(B) also waives the imposition of penalties under Section 6654 if a taxpayer retires or becomes disabled during the taxable year and underpays due to reasonable cause and not willful neglect. Interestingly, a taxpayer can only argue reasonable cause as a defense if he or she can satisfy the disjunctive requirement of either retiring or becoming disabled during the taxable year at issue.
A taxpayer must be able to show that he or she retired during the tax year at issue. Unfortunately, the IRS does not reward early retirees. A taxpayer only satisfies the first requirement if he or she is at least 62 during the taxable year. Issues can arise if a taxpayer cannot show the IRS a definitive retirement date (a la semi-retirement) much like the taxpayer in Adams v. Commissioner.[10]
In the alternative, the taxpayer must present evidence of being disabled during the taxable year. While a taxpayer may offer a tongue-in-cheek disability of “advanced age,” the IRS will not willingly accept such an argument.[11] Additionally, the Tax Court has not recognized a disability where the taxpayer suffered from bilateral tendinitis, carpal tunnel syndrome, and depression but continued to run her own startup business.[12] The Tax Court, however, has recognized significant psychiatric disorders and mental incapacitation as disabilities for purposes of Section 6654(e)(3)(B).[13]
Once the taxpayer satisfies the requirement of retirement or disability, he or she may present a reasonable cause defense. And, as United States v. Boyle makes clear, “[w]hether the elements that constitute ‘reasonable cause’ are present in a given situation is a question of fact . . . .”[14] Many taxpayers may attempt to argue “reasonable cause” on the basis of reliance on a tax professional. This, of course, assumes on the facts and circumstances, particularly the good faith of the taxpayer.[15]
Conclusion
As the IRS and Tax Court have made clear, taxpayers do not have a broad “reasonable cause” defense at their disposable with respect to Section 6654 penalties. Taxpayers must meet one of the specific exceptions outlined in Section 6654(e). To do this, taxpayers must have evidentiary support to overcome this burden. A taxpayer may think he’s retired or that his circumstances are unusual, but the IRS may disagree. Here’s to 2021—hopefully, your circumstances are just right to defend against potential Section 6654 penalties.
Expert Penalty Defense Attorneys
Need assistance with IRS penalty defense? Each individual civil penalty has different penalty defenses. It is important to raise the proper penalty defenses with the IRS at the appropriate time. Freeman Law can help you navigate these complex issues. We handle all types of cases including civil, failure-to-file and failure-to-pay, accuracy-related, fraud, tax shelters, international tax, employment tax, and trust fund recovery penalties. Schedule a consultation or call (214) 984-3000 to discuss your tax concerns.
[1] Nitschke v. Comm’r, T.C. Memo 2016-78, 2016 WL 1701343 at *3 (2016).
[2] Generally, the required installment is 25 percent of the required annual payment. I.R.C. § 6654(d)(1)(A). The required annual payment is the lesser of 90 precent of the tax shown on the return for the taxable year, or 100 percent of the tax shown on the return of the individual for the preceding taxable year. I.R.C. § 6654(d)(1)(B). However, if the adjusted gross income on the return of the individual for the preceding taxable year exceeds $150,000, then, in calculating the required annual payment, the percentage of tax shown on the return for the preceding taxable year is 110 percent, not 100 percent. SeeI.R.C. § 6654(d)(1)(C)(i).
[3] I.R.C. § 6654(b).
[4] In addition to the waiver under subsection (e), a taxpayer may also avoid the penalty by (1) establishing that the tax due for a particular tax year is less than $1,000, or (2) showing there was no tax liability for the preceding taxable year. See I.R.C. § 6654(e)(1)-(2).
[5] I.R.C. § 6654(e)(3)(A)-(B).
[6] See ATL & Sons Holdings, Inc. v. Comm’r, 152 T.C.138, 150 (2019)
[7] See Mendes v. Comm’r, 121 T.C. 308, 323 (2003).
[8] See Higbee v. Comm’r, 116 T.C. 438, 446 (2001).
[9] See Christman v. United States, 110 Fed.Cl. 1, 9 (2013); Nasir v. Comm’r, 102 T.C.M. (CCH) 558, 2011 WL 6029936, at *5-*7 (2011); Alba v. United States, No. 80–764C(2), 1980 WL 1742, at *2 (E.D. Mo. 1980).
[10] 105 T.C.M. (CCH) 1029, 2013 WL 135103, at *16 (2013).
[11] Id.
[12] See Thomas v. Comm’r, 90 T.C.M. (CCH) 477, 2005 WL 2860497, at *4 (2005).
[13] See Jones v. Comm’r, No. 4274-09S, 2010 WL 3664064, at *4 (2010); see also Meyer v. Comm’r, T.C. Memo. 2003-12.
[14] 469 U.S. 241, 249, n.8 (1985).
[15] See Cavallaro v. Comm’r, T.C. Memo 2014-189, P64 (2014); see also I.R.M. 20.1.1.3.2.2.5.5.
