Penalties and our responsibilties

I have a client with multiple state returns. I failed to file an extension for one of the states and the client was assessed a late filing penalty. Fortunately, it's not a huge amount and I just offered to pay it and move on.

But this raised a question in my mind. What if the late filing penalty was larger because the client failed to have withholdings or make the required estimated payments?

I know we have E&O insurance for large penalties but are we responsible when the penalty is based on the amount due because clients don't do their part?

Was the state missed because it was a new filing obligation, or was this state historically filed?

ie: new K-1 with multi state filings, etc?

No, I just missed it. It's an individual return. No k1's or anything like that.

We always file on time, so extensions were never an issue. That's probably why I missed it.

Luckily it's not a huge penalty that I rather just pay it than go through the trouble of asking for an abatement.

But it got me wondering what I would have done had the penalty been larger.

So after looking further into this. Maybe it's not my fault.

The state in question is Arizona.

Arizona accepts a Federal filed extension as long as there is no balance due. But it does require an extension if there is a balance due.

I guess my argument is that there was no balance due when I filed the extension because they hadn't gotten me their information. How was I supposed to know they would have a balance due?

Of course, their argument will be, I should have filed it anyway.

So after looking further into this. Maybe it's not my fault.

The state in question is Arizona.

Arizona accepts a Federal filed extension as long as there is no balance due. But it does require an extension if there is a balance due.

I guess my argument is that there was no balance due when I filed the extension because they hadn't gotten me their information. How was I supposed to know they would have a balance due?

Of course, their argument will be, I should have filed it anyway.

But wouldn't the extension expect a payment?

But wouldn't the extension expect a payment?

I don't know.

We file 4868 extensions with $0.00 amount due when clients don't get us their stuff before 4/15.

But some states say: We'll follow the federal extension unless you owe us money. Then you have to request a state extension and pay up.

But some states say: We'll follow the federal extension unless you owe us money. Then you have to request a state extension and pay up.

Does that even make sense?

What's there to penalize if you don't owe? Does it matter at that point?

But wouldn't the extension expect a payment?

I don't know.

We file 4868 extensions with $0.00 amount due when clients don't get us their stuff before 4/15.

Federal yes, but Illinois only requires an extension if you owe and they want a payment.

Vermont I believe client owed $5 tax because of a K-1, he was a non-resident with a multi-states reporting, I think he was under the reporting requirements(?), but got a $50 penalty because did not have an extension for the State.

I know we have E&O insurance for large penalties but are we responsible when the penalty is based on the amount due because clients don't do their part?

Absolutely not. Especially not if the penalty is due to the client's failure to act when you previously advised them to act or to make a payment and all of that is documented in writing.

My income tax compliance engagement letters are very clear that the client is responsible for payment of all penalties and interest associated with their tax returns.

If it is your fault, and the penalty is large, it's best to notify your insurance carrier.

I think our most regular exposure here is P&I for failure to pay estimated tax with an extension. For those reasons, I have become very clear with my clients each March that if they do not provide me adequate information, I am not able to calculate a ballpark extension payment. In those situation I will ask the client how much they want to pay and gently remind them that P&I accrues on any tax due that is not paid with the extension.

Also, I always frame extension payments I calculate as: "this is what I'm calculating based on the documents and assumptions that have been provided, but if you'd like to pay in a little more to build in a cushion and be conservative, you can." Most of my high earners don't bat an eye at paying a few thousand more with the extension to be safe.

I agree and shouldn't have agreed to pay the $50 penalty.

I did advise the client that it is not my fault and I am going to fill out a penalty abatement form after all for them to sign and save me the $50. It's about principle at this point... Lol

For $50, I wouldn't worry about it. Plus, the way you framed it in the OP is that the penalty was due to your inaction, so I probably would have offered to reimburse too if I was in your shoes.

Just set clear boundaries with the client going forward and get out ahead of any P&I by advising in writing. And, make sure the mistake doesn't happen again...maybe evaluate or reevaluate practice management software.

Noted.. thanks ManVsTax.

I do not prepare the 1065, the K-1 was received September 10. New states where K-1s showed reporting. Should i guess at 3/15 of every year and filed extensions in more States that do not recognize the federal extension.

Jon, I would suggest to the client in that situation that the managing members / GPs of the pship are the ones at fault there. They should have a very general idea, by end of year at the latest, of what states they've operated in during the year and could have provided this information to the client before 4/15 if they expect any new state filings.

We are in the Midwest - it is not publicly traded, but it is a large partnership, and we are lucky to get the K-1s by their due date, and answers are a one page guess of federal income/loss on the federal and we received that in early August.

We are in the Midwest - it is not publicly traded, but it is a large partnership, and we are lucky to get the K-1s by their due date, and answers are a one page guess of federal income/loss on the federal and we received that in early August.

Every large partnership with late K-1s that I have dealt with have been able to provide information on state reporting requirements in time for extensions. Some of them are even able to give out estimates in November or December; while the dollar amounts are off, you at least have the states involved.

I agree with ManVsTax; if the partnership can't provide that information to the partner then the fault lies with the partnership.

In this spot, I wouldn't cover the penalty even if it was my fault (in most spots, there are exceptions of course).

The client could have chose to file in February.

And if the client is the one who get's a late K1 - how would any poor extension result be my fault? That's the chance the client takes with an extension.

When I first went on my own, I made a lot of mistakes. Now that I am a journeyman at this, I still make my share. But I have probably paid out less than $1000 for these types of mistakes in the last 10 years.

I have learned to put these things is in my engagement agreement.... and on initial engagement, we again disclaim these things to all clients in writing.

Then, on delivery of the extension with our instructions, we write:

Important notes(!):

1) The extensions are not considered filed unless you send the voucher with payment (or pay online) by the deadline.

2) Since these are only rough estimates based on what we were able to calculate so far, we strongly recommend that you file as soon as practical to reduce monthly compounding of any unexpected penalties and interest.

3) We will not remind you when it is time to file. Most extended calendar year S corporations and partnership tax returns are due on the 15th of September. Extended individual taxes are due on the 15th of October.

4) To file by the extension deadline, please note that our turnaround time could be as much as 6 weeks.

5) Our firm will not reimburse or otherwise compensate clients for late penalties and interest under any circumstance.

I do not reimburse penalties for late filings or extensions. I document my warning to the client and it is on them. I have a client who still has not filed 2019 return (balance due) for some strange reason that she does not want to discuss. I calculated the approx. penalty and interest for her earlier this year and she was not too concerned!