EA Part 3 IRS Penalties: Accuracy, Failure-to-File, and Abatement

Why Penalties Matter on Part 3

Penalties appear on Part 3 in two distinct contexts: as collection-related liabilities the IRS asserts against taxpayers, and as preparer penalties that can be asserted against enrolled agents and other practitioners who fail to meet professional standards. Candidates who learn both dimensions will be well prepared for this topic.

Failure-to-File Penalty (FTF)

The failure-to-file penalty under IRC Section 6651(a)(1) applies when a taxpayer does not file a required return by its due date (including extensions).

• Rate: 5% of the unpaid tax per month or fraction of a month the return is late
• Maximum: 25% of the unpaid tax (reached after 5 months)
• Minimum penalty: For returns filed more than 60 days late, the minimum penalty is the lesser of $485 (adjusted annually for inflation) or 100% of the unpaid tax

The failure-to-file penalty is calculated on the unpaid tax at the due date, not the gross tax liability. If no tax is owed (e.g., a refund return), no FTF penalty accrues even if the return is filed late.

Interaction With Failure-to-Pay

When both the FTF and failure-to-pay penalties apply in the same month, the FTF rate is reduced by the FTP rate. If the FTP rate is 0.5%, the effective FTF rate is 4.5% per month, capping at 22.5% — not 25%. The combined maximum (FTF + FTP) is 47.5% of unpaid tax.

Failure-to-Pay Penalty (FTP)

The failure-to-pay penalty under IRC Section 6651(a)(2) applies when tax shown on a filed return is not paid by the due date.

• Rate: 0.5% of the unpaid tax per month or fraction of a month
• Maximum: 25% of the unpaid tax (reached after 50 months)
• Increased rate: After a notice of intent to levy is issued, the rate increases to 1% per month beginning on the date 10 days after the levy notice

Note that an extension of time to file does not extend the time to pay. A taxpayer who gets a 6-month filing extension must still pay at least 90% of the tax due by the original due date to avoid the FTP penalty.

Accuracy-Related Penalty

The accuracy-related penalty under IRC Section 6662 is 20% of the portion of the underpayment attributable to:

• Negligence or disregard of rules or regulations
• Substantial understatement of income tax (more than the greater of 10% of the correct tax or $5,000)
• Substantial valuation misstatement
• Substantial overstatement of pension liabilities
• Substantial estate or gift tax valuation understatement

The accuracy-related penalty does not stack with the fraud penalty — if fraud is established, the fraud penalty applies instead.

Adequate Disclosure Exception

A taxpayer can avoid the substantial understatement portion of the accuracy-related penalty by adequately disclosing the position on the return (on Form 8275 or Form 8275-R) and having a reasonable basis for the position. The disclosure requirement can reduce the penalty exposure for aggressive but non-fraudulent positions.

Fraud Penalty

The civil fraud penalty under IRC Section 6663 is 75% of the portion of the underpayment attributable to fraud. The IRS bears the burden of proving fraud by clear and convincing evidence. Indicators of fraud include:

• Keeping two sets of books
• False invoices or documents
• Failure to report income
• Concealing assets or bank accounts
• Providing false statements to the IRS

When fraud is established, the IRS may also pursue criminal penalties (fines and imprisonment) in addition to the civil fraud penalty. The civil fraud penalty suspends the statute of limitations — there is no time limit for the IRS to assess tax in cases involving fraud.

Trust Fund Recovery Penalty (TFRP)

The trust fund recovery penalty under IRC Section 6672 — sometimes called the 100% penalty — is one of the most severe penalties in the tax code. It applies when a person who is responsible for collecting and remitting employment taxes (payroll taxes) willfully fails to do so.

The penalty equals 100% of the unpaid trust fund taxes — the employee's share of Social Security, Medicare, and withheld income taxes. It is assessed against each "responsible person" individually and can be collected from any or all of them.

Responsible person: Anyone who has the authority and duty to direct payment of employment taxes — typically officers, owners, or others with check-signing authority and control over finances. A passive investor without operational control is generally not a responsible person.

Willfulness: The person knew or should have known about the unpaid taxes and made a deliberate choice not to pay them (including choosing to pay other creditors ahead of the IRS).

Preparer Penalties

Circular 230 is not the only set of rules governing practitioner conduct. The Internal Revenue Code also imposes monetary penalties on return preparers:

• IRC 6694(a): $1,000 penalty (or 50% of income derived from the return) for an unreasonable position — one without substantial authority and not adequately disclosed. Applies when the preparer knew or should have known of the position.
• IRC 6694(b): $5,000 penalty (or 75% of income derived from the return) for a willful or reckless understatement of liability.
• IRC 6695: Penalties for failing to furnish a copy to the taxpayer, failing to sign the return, failing to include a PTIN, or failing to retain a copy or list of returns prepared.

Reasonable Cause Defense

Many penalties can be avoided if the taxpayer demonstrates reasonable cause and good faith. Reasonable cause exists when the taxpayer exercised ordinary business care and prudence in attempting to comply but failed nonetheless. Examples include:

• Death or serious illness of the taxpayer or immediate family
• Unavoidable absence
• Destruction of records by fire or natural disaster
• Reliance on written advice from the IRS

Reliance on a competent tax advisor can constitute reasonable cause if the taxpayer provided accurate information and did not withhold relevant facts.

First Time Penalty Abatement (FTA)

The First Time Penalty Abatement (FTA) is an administrative waiver available to taxpayers who:

1. Have a clean compliance history: No penalties in the 3 tax years prior to the year for which abatement is requested
2. Have filed all required returns (or extensions) for the current and prior 3 years
3. Have paid, or arranged to pay, all tax due

FTA applies to the failure-to-file, failure-to-pay, and failure-to-deposit penalties. It does not apply to the accuracy-related penalty, the fraud penalty, or the trust fund recovery penalty.

FTA is a one-time waiver — it is not available every year. Taxpayers request FTA by calling the IRS or submitting a written request. The IRS does not automatically grant FTA; the taxpayer must ask.

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