Late Payment Penalty

Our accounting firm has a client whose 2017 personal tax return was extended. He paid-in at least 90% of his tax by 4/15/18. He owed another $40k, though, with his return. His return was paper filed on 10/20/18, which is the same day he remitted his balance due payment.

I’m wondering about the “failure to pay” penalty, also known as the “late payment penalty.”

How does it get computed?

I am not wondering about the late filing penalty.

I have no firsthand knowledge of this, but according to the Internal Revenue Manual,

An extension of time to file does not extend the time to pay. However, Treas. Reg. 301.6651-1(c)(3) and (4) provides that reasonable cause will be presumed for the period of the extension in the case of failure to pay income tax if the following criteria are met:

a. In the case of an individual, at least 90 percent of the amount of tax shown on the return must have been paid on or before the due date for payment, and the remainder must be paid with the return.

b. In the case of a corporation, at least 90 percent of the amount of tax shown on the return must have been paid on or before the due date for payment, and the remainder must be paid by the extended return due date.

IRS computers are programmed to automatically apply this waiver of the late payment penalty for reasonable cause if the taxpayer qualifies.

Note:
In the case of an individual, if tax shown on the return is paid after the extended return due date (e.g., with a late filed return), reasonable cause must be shown for the period after the extended due date. If the taxpayer is unable to show that the late payment was due to reasonable cause, the penalty for paying late must be computed from the original return due date, even if 90% of the tax was paid on time and the balance was paid with the late filed return.
[Bold in original, italics added.]

The "90% rule" is a presumption of reasonable cause. It looks like the presumption does not apply if the final payment is after the extended due date. The payment is 7 months late: 3.5% penalty.

You speak of a presumption. Does that presumption work like this, assuming 90% of the tax was paid by 4/15/18:

1. Because you have a valid extension (of time to file), if you pay the remaining balance due on 10/15/18, you are presumed to have reasonable cause for the period 4/15/18 up through the 10/15/18 payment date.

2. Because you have a valid extension (of time to file), if you pay the remaining balance due after 10/15/18, you are not presumed to have reasonable cause for the period 4/15/18 up through 10/15/18, nor are you presumed to have reasonable cause for the period after 10/15/18.

I believe the answer is that you are presumed to have reasonable cause from 4/15/18 through 10/15/18, since you paid with the return. (Again, not speaking from experience.) If you have some other demonstrable reasonable cause covering the period from 10/15/18 to 10/20/18, then that, combined with the presumed reasonable cause from the T. Reg. should be sufficient to have the penalty waived. But if you do not have reasonable cause for 10/15/18 through 10/20/18, you don't have "enough" reasonable cause for the whole 7-month period and the penalty must be applied for the whole period.

I realize that contradicts what I wrote before. I failed to adequately think about what I was saying before I said it. Which I'm sure has never happened before nor will ever happen again.

Your sentence fragment "Which I'm sure has never happened before nor will ever happen again" is quite ambiguous: it doesn't distinguish in any way whether you are talking about yourself only, or about all of us. Almost on purpose, I'm suggesting....

Nicely spotted! Alas, I am less than half as clever as you give me credit for; I meant it only in reference to myself.

That IRM section you cited is a good find, especially the part that says “Note” in bold. And I believe you are attempting to interpret that bolded Note in your Post #4. So, it seems that you are attempting to interpret the IRS’ interpretation.

If your Post #4 interpretation is correct, which it very well may be, we first look to the Regulation to determine reasonable cause during the extension period. If we pay by 10/15/18, this extension period is the only period at play. If we had paid at least 90% by 4/15/18, we’re good to go, because we have maintained reasonable cause throughout that one single period.

Now, if we pay after 10/15/18, your interpretation of the IRS’ interpretation (of the Regulation) is such that a bifurcated timeline is involved. That is, we have (1) the period between 4/15/18 – 10/15/18 and (2) the period starting on 10/16/18 and extended out to the payment date of 10/20/18. So far, so good.

But this is where reasonable minds may differ: The IRS says (assuming your Post #4 interpretation is right) that after our bifurcation is done, we aggregate the two periods and if any one of them (namely, the second period) does not involve “true” reasonable cause, then the entire timeline is tainted, such that the penalty applies from 4/15/18 up through the payment date. It’s hard to fathom why we aggregate after we bifurcate. The Regulation, it seems to me, is pretty clear: reasonable cause is presumed for the extension period if (1) we had paid 90% by 4/15/18 [which the client did] and (2) the remaining balance due is paid with the return [which it was]. Since these two requirements have been met, we have reasonable cause for the (bifurcated) first period and we don’t for the (bifurcated) second period. Accordingly, the penalty should be imposed for the second period only. Again, this assumes that your Post #4 interpretation is correct.

Gosh, this is such a fun topic. What if OP facts are changed in only one regard - the return owing $40k was still filed on 10/20/18, but w/o a payment, which finally gets made months later? Many months later.

I based my (re-)interpretation in Post #4 based on these words: "reasonable cause must be shown for the period after the extended due date."

So it seems to me that if taxpayer was on the way to the mailbox with the tax return and payment on October 15, slipped on the ice and went to the hospital, and mailed the tax return a few days later, reasonable cause applies to the entire period from 4/15 through 10/20.

It doesn't seem at all unusual that having reasonable cause for only part, but not all, of a period of delinquency causes the penalty to be applied for the entire late period. I have had clients who had near-automatic reasonable cause due to, for example, dying, but their return was filed and tax paid long after the DOD. The IRS charged the failure-to-pay penalty based on the original due date, not the date when the reasonable cause "expired". IRC 6651(a)(2) supports this as well, the way the reasonable cause exception is worded makes it an all-or-nothing proposition. ("[In the case of failure] to pay [...], unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added [....]")

Nilodop, in your case, element (ii) of the Reg. is not satisfied -- no presumption of reasonable cause.

The regulation itself says:

(3) If, for a taxable year ending on or after December 31, 1995, an individual taxpayer satisfies the requirement of § 1.6081-4(a) of this chapter (relating to automatic extension of time for filing an individual income tax return), reasonable cause will be presumed, for the period of the extension of time to file, with respect to any underpayment of tax if -
(i) The excess of the amount of tax shown on the individual income tax return over the amount of tax paid on or before the regular due date of the return (by virtue of tax withheld by the employer, estimated tax payments, and any payment with an application for extension of time to file pursuant to § 1.6081-4 of this chapter) is no greater than 10 percent of the amount of tax shown on the individual income tax return; and
(ii) Any balance due shown on the individual income tax return is remitted with the return.

Jeff-Ohio, I agree with your “bifurcation” analysis. I believe that the “Note” in the IRM is an invalid interpretation of the regulation.

Reg. 301.6651-1(c)(3) states that “reasonable cause will be presumed, for the period of the extension of time to file …” if two requirements are met, (i) the taxpayer pays 90% of the tax by the unextended due date, and (ii) pays the balance of tax owed with the return.

The client satisfied these two requirements, and therefore, there should be no failure-to-pay penalty for the 6-month period of the extension.

Does the regulation say that a taxpayer isn't entitled to the presumption of reasonable cause if the return is filed after the extended due date or if the balance of tax is paid after that date? No. Therefore, I think that the "Note" in the IRM goes beyond the regulation and is an invalid interpretation.

The failure-to-pay penalty should only be for the period after 10/15/2018.

It doesn't seem at all unusual that having reasonable cause for only part, but not all, of a period of delinquency causes the penalty to be applied for the entire late period.

These situations also don’t seem unusual or unreasonable either:

1. We have reasonable cause for 6-months, but not for 1-month. Therefore, we should be charged a penalty for 1-month.
2. We have reasonable cause for 6-months, but not for 1-month. Therefore, since we exhibited reasonable cause for the preponderance of the 7-month period, no penalty should be imposed at all.

The IRS charged the failure-to-pay penalty based on the original due date, not the date when the reasonable cause "expired"

That is just what the IRS did, based on their own interpretation, and how they programmed their computers.

IRC 6651(a)(2) supports this as well, the way the reasonable cause exception is worded makes it an all-or-nothing proposition.

You hit the nail on the head here in terms of the question being posed: Is it an all-or-none proposition? A further question would be: If it really is an all-or-none proposition, why can’t we win if we exhibited reasonable cause for the preponderance of the period at issue?

Here’s an expanded version of the Code language:

…unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

The Code says, “such failure” and “the failure” and “such failure continues.” The one failure is paying late. Stated differently, the one failure is not paying on time. So, if we ask ourselves these questions: Do we have one failure for Month A, and then another separate failure for Month B, and then another separate failure for Month C? Or, do we have a single failure, that is continuing in nature, that spans all of these months?...I would have to agree that we have a single, continuous failure.

But…does that fact – the fact that we have one, continuous failure - truly make it an all-or-nothing proposition? And if so, does *not* exhibiting reasonable cause for any part of the overall period cause a full penalty to be assessed, starting on 4/15/18?

The Code doesn’t really imply an “all or none” proposition. The Code merely implies (if not overtly states), that we have a single failure in the case of late payment. But I would agree that if we have a single failure, over a single timeframe, consistency (and logic) would dictate that we test our behavior over that entire timeframe. But I can’t say I agree that the Code calls for an “all or none” decision to be made. The Code simply says…”unless it is shown that such failure is due to reasonable cause.” Remember, the failure is a continuous one – not paying on time. Well, if we are testing one failure over a period of time, it is certainly conceivable that reasonable cause is shown for part of that period (i.e. part of the continuous failure) and reasonable cause isn’t shown for a different part of that period (i.e. a different part of the continuous failure).

But where do we go from here?

Here’s where the IRS would go: Item #1: One failure. Item #2: One period tested. Item #3A: So we draw one “all or none” conclusion. Item #3B: And in coming to that conclusion, the operative principle is that if reasonable cause did not exist at any point in the timeline, the taxpayer loses in full.

Reasonable minds might agree with Item #1 and Item #2…but I’m not so sure about Items #3A and #3B. I find no statutory or regulatory basis for the IRS’ positions with respect to these two Items.

Since we have one failure that spans a certain time period, it sure seems we could have reasonable cause for part of that time period/part of that one failure.

Thank you, Dave829. Ditto to MSchmahl, who understands the issue well.

We are getting into the Reasonable Cause weeds here, more so than I’ve seen anywhere else. MSchmahl is quite right about the issue being one of “all or none.” I think we’d all agree that this is the IRS’ position. But MSchmahl takes it a step further by indicating that the Code Section supports that position. There is at least one case that I know of that agrees with that idea:

https://openjurist.org/979/f2d/1511/san ... -v-sanford

It is a pretty interesting case for a couple of reasons (see the “Specially Concurring” opinion at the bottom), but here’s what the court said:

Neither the Internal Revenue Code nor the Treasury Regulations allow the partial waiver of a § 6651(a)(1) or § 6651(a)(2) penalty for a single tax year. Rather, each penalty for each tax year is fully enforceable against the taxpayer "unless" the taxpayer had reasonable cause not to comply with the Code's requirements that year. Depending on the factual determination of reasonable cause, the penalty for each year will be either fully enforceable or fully unenforceable. The statutory term "unless" does not authorize the partial waiver of a § 6651(a)(1) or § 6651(a)(2) penalty. On the contrary, both statutes command that the penalties for each year be imposed in full, "unless" the taxpayer shows reasonable cause, in which case the penalties for that year will be excused in full.
Because the clear language of §§ 6651(a)(1) and 6651(a)(2) forbids the partial waiver of these penalties, the bankruptcy court may not use its equitable powers7 to reduce the amount of the penalties by partially disallowing them. Reducing the amount of these penalties would supplant Congress' determination of the proper amount of penalty, as set forth in the statutory formulas of §§ 6651(a)(1) and 6651(a)(2). Moreover, reducing, or partially disallowing, the penalties would undermine *1514s 502(b)(1) of the Bankruptcy Code, which provides for allowance of claims according to the applicable substantive legal standards. The bankruptcy court may not use its equitable power against the dictate of § 502, or any other section of the Bankruptcy Code. On the contrary, this equitable power "must and can only be exercised within the confines of the Bankruptcy Code." In re Sublett, 895 F.2d 1381, 1385 (11th Cir.1990) (quoting Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 969, 99 L.Ed.2d 169, 179 (1988)).

Any thoughts on this? Did the court adequately frame and analyze the overall issue properly?

I view the Sanford case as distinguishable on its facts. The opinion states that the bankruptcy judge reduced the IRS’s claim for penalties by two-thirds without publishing relevant factual findings. This means that the bankruptcy judge didn’t explain the reduction in the penalties.

The language you quoted from the Sanford opinion shows that a judge can’t simply allow a partial waiver of a penalty because of circumstances that almost, but don’t entirely, reach reasonable cause.

That’s not the situation here. Here we have a situation involving computation of the penalty. The regulation provides that reasonable cause is presumed “for the period of the extension of time to file” if (i) the taxpayer pays 90% of the tax by the unextended due date, and (ii) pays the balance of tax owed with the return. It’s a computation issue, not a partial waiver because the circumstances almost, but don’t reach, reasonable cause.

That’s not the situation here. Here we have a situation involving computation of the penalty.

Agreed. So the Sanford case isn’t a great one to put up against our theory. But it does display the IRS’ “all or none” position. I have no doubt they’d try to extend that idea into our nuanced situation, however.

Our argument would go something like this:

“We’re not asking for a partial penalty waiver. We’re saying that the penalty wasn’t computed properly. No penalty should have been assessed for the period of time that reasonable cause existed. It was a wrongful assessment to that extent. If the taxing authority that is about to assess the penalty is the same taxing authority that has already presumed reasonable cause, it should know better than to assess a penalty for any period involving reasonable cause. In fact, we aren’t even asserting reasonable cause. The government has already made that call for us, per its own Regulation.”

But…IRS might come back and say, “Our hands our tied. We are required to assess starting on 4/15/18. Only after the full penalty has been assessed can we consider reasonable cause, no matter which party is asserting it. And when we make that determination, it will be an ‘all or nothing’ one, as per the Sanford case.”

To that, we’d probably say: “Sanford isn’t on point. The taxpayer in Sanford didn’t point out the computational aspect of the penalty in detail, and explain how the penalty covers a period of time, and how reasonable cause is tested over that period of time, since the failure is deemed singular and continuous. Given these important details that we are raising here, and that were not part of the Sanford case, the judge’s ‘all or nothing’ ruling in that case, while fine for the Sanford facts, isn’t appropriate in our case.”

Note that the IRS is put in a pickle here somewhat. Normally, one party makes a presumption and a different party has to rebut it. But here, it is the IRS that is making the presumption. Knowing that this presumption exists, for the IRS to assess the penalty anyway would mean they are rebutting a presumption that they themselves made. The presumption is based on 90% paid-in by 4/15/18, the existence of a valid extension and a payment with the return. Those are three facts that haven’t changed, so it’s hard to see how the related presumption would.

I also wondered about the legislative history of the “failure to pay” provision. It came into effect with the TRA of 1969. Once Congress decided to impose this penalty with the 1969 Act, the IRS came out with “TIR-1034” (Technical Information Release…although I can’t find a copy of it). In this temporary guidance, IRS said the penalty wouldn’t be imposed for taxpayers that extended their returns. That TIR was superseded as explained in Rev Rul 75-364, which is here:

Rev. Rul. 75-364, 1975-2 CB 466
Headnote:
Rev. Rul. 75-364
Reference(s):
Rev Rul 75-364. Extension of time for filing returns; failure to pay penalty. The relief from the failure to pay penalty provided by TIR-1034, issued April 6, 1970, is terminated after November 23, 1975, to the extent such relief applied to taxes other than income taxes.
Full Text:
The purpose of this Revenue Ruling is to terminate the relief from the failure to pay penality provided by Technical Information Release No. 1034, issued on April 6, 1970 to the extent that such relief applied to taxes other than income taxes.
The Tax Reform Act of 1969 added to section 6651 of the Internal Revenue Code of 1954 a penalty for failure to pay tax timely, unless the taxpayer could show the failure to pay on time was due to reasonable cause and not willful neglect.
The failure to pay penalty applies only with respect to returns required to be filed (without regard to any extension of time to file) after December 31, 1969, and with respect to a notice and demand for payment of tax made after December 31, 1969.
The Internal Revenue Service announced, in TIR-1034, that taxpayers who received extensions of time for filing their tax returns would not be subject to the penalty for failure to pay tax for the period covered by the extension of time to file, except as provided in TIR-1034.
With respect to income taxes, TIR-1034 was superseded by an amendment to section 1.6081-1(a) of the Income Tax Regulations made by Treasury Decision 7133, 1971-2 C.B. 415. That regulation was further amended by Treasury Decision 7160, 1972-1 C.B. 374, and by Treasury Decision 7260, 1973-1 C.B. 589. Section 1.6081-1(a) now provides, in general, that an extension of time to file an income tax return does NOT operate to extend the time for payment of any tax due on such return.
In order to provide for uniform application of the failure to pay penalty, TIR-1034 is hereby revoked in its entirety. This revocation terminates the relief from such penalty provided by TIR-1034 with respect to all taxes other than income taxes.
Pursuant to the authority contained in section 7805(b) of the Code, the principles of this Revenue Ruling will not be applied prior to November 24, 1975.
…of note is TD 7160 (Regulations) which came out on 2/2/1972. One thing it says is:

Par. 3. Paragraph (c) of § 301.6651-1 is amended by revising subparagraph (1) and by adding at the end thereof a new subparagraph (3)

The “new subparagraph (3)” is this:

( 3 ) If for a taxable year ending on or after December 31, 1971, an individual taxpayer satisfies the requirements of § 1.6081-4(a) (relating to an automatic extension of time for filing an individual income tax return), reasonable cause shall be presumed, for the period of the extension of time to file, with respect to any underpayment of tax if--
• ( i ) The excess of the amount of tax shown on Form 1040 over, the amount of tax paid on or before the regular due date of the return by virtue of taxes withheld by the employer, payments pursuant to the declaration of estimated tax and the payment in full of estimated tax liability pursuant to § 1.6081-4, is no greater than 10 percent of the amount of tax shown on the individual's Form 1040, and
• ( ii ) Any balance due shown on the Form 1040 is remitted with the return.

So, this is when the provision we are discussing came into being. The Regulation also says this:

Because of the need for immediate guidance with respect to the provisions contained in this Treasury decision, and because it does not appear that the changes are adverse to persons concerned, it is found unnecessary and impracticable to issue this Treasury decision with notice and public procedure thereon under 5 U.S.C. 553(b), or subject to the effective date limitation of 5 U.S.C. 553(d).

True enough…the changes are not adverse to persons concerned…It’d be hard for the IRS to argue against such a long-standing Regulation, which doesn’t distinguish between a timely filed return and a late one. To boot, the reasonable cause provision in question, as it pertains to corporations, has different language – language that calls for the payment of the remaining balance due to be paid by the extended due date in order to invoke reasonable cause (because of a valid extension) during the extension period.

Absent spin, it would be real hard to argue that the provision that applies to individuals (remaining balance due payment must accompany the return [whenever it is filed]) should be interpreted the same way as the corporation provision (which specifically says the remaining balance due payment must be made by the extended due date of the corporate return). If the IRS really believes the provisions should be interpreted identically, then they should have changed the portion of the Reg that pertains to individuals.

I read the quote from the Rev Rul right up to "The purpose of this Revenue Ruling is to terminate the relief from the failure to pay penality…."
Terminating the relief from the failure to spell things correctly is almost too many double negatives.

[Is "penality" from the Rev Rul? I'm assuming so...]

failure to pay penality…."
spell things correctly is almost too many double negatives.

"Penality" is a word, and it is spelled correctly. What's the problem?

There's no pablum.

Penality and penalty have their root in penal, which always reminds me I'm overdue for a prostrate examination.

A prostrate exam is one we get lying down, right?