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For entrepreneurs, it’s understandable why there are often big-time mistakes with taxes. But of course, the IRS likes to make these problems even worse — such a with interest and penalties. And yes, over time these can certainly add up. The interest and penalties can even exceed the tax owed, which does seem horribly wrong.
So what can you do? Well, first of all, the IRS can reduce or eliminate penalties if you show “reasonable cause” (this process is called abatement). But as should be no surprise, determining reasonable clause is fairly subjective. But here are some typical examples:
Destruction of your home or business, such as by fire or natural disaster
You relied on a tax professional who ultimately provided bad advice
The IRS gave inaccurate information (this is why it is important to keep all correspondence)
A customer sent out wrong information, such as with a 1099-MISC
You did not pay the tax bill because of a harsh financial situation
To request an abatement of your penalty, you need to write a concise letter that sets forth the reasonable cause. You will then attach this to Form 843, Claim for Refund and Request for Abatement. Of course, you should include copies of any documents that support your position, such as a statement from you doctor, an insurance claim and so on.
Now if the IRS rejects your abatement proposal, then there are some actions you can take. One is to file a protest with the agency (you can do this either by phone or mail). Or, you may seek other type of relief, such as an offer-in-compromise (but this can be tough to get).
Something else: The IRS has a little-talked about policy called “First Time Abate.” This means you can wipe out your penalties — for late filings or late tax payments — if you did not have penalties for the prior three tax years, are current with all filings and have paid all taxes due.
OK then, what about reducing the interest that the IRS charges? Unfortunately, your chances for getting relief is fairly slim. Keep in mind that interest is required by law and the IRS essentially assumes that your nonpayment of taxes is a loan.
Yet there is some wiggle room. Consider that the IRS will reduce or eliminate interest if:
The IRS made an error.
You settled with the IRS, which reduced or eliminated your tax or you received an abatement of a penalty. As a result, there is no interest on the changed amounts.
The IRS sent you a refund check by accident! If so, the agency will charge interest. No doubt, in this situation you can request a refund for this.
If the IRS takes too long with an issue, you can seek a reduction in the interest payment.
You filed a tax return late but live in a federally-declared disaster area.
You file for bankruptcy, which discharges your IRS debt, or negotiate an offer in compromise (the interest on the reduced amounts will be refunded).
Even if these do not apply, you can definitely save lots of tax dollars by getting an abatement for your penalties — that is, if there is reasonable clause or you meet the requirements for a first-time abatement.