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Reasonable Cause

September 2009 - Recently, I have received requests from taxpayers to have certain penalties waived for what they believe is reasonable cause. The important thing to remember is that these requests are considered based on the individual facts and circumstances surrounding each case. Taxpayers most often request waivers of penalties based upon reasonable cause for the following penalties:

  • Late payment of tax.
  • Failure to file a return.
  • Accuracy related penalty.
  • Failure to furnish information.
  • File after notice of demand.

In order to establish reasonable cause for the late payment of tax, the taxpayer must show that his failure to pay the proper amount of tax by the original due date occurred despite the exercise of ordinary business care and prudence. (Appeal of Roger W. Sleight (83-SBE-244) October 26, 1983.) 

In a recent decision, the Board determined  that a taxpayer did not show reasonable cause in a case where the taxpayer paid his tax late because of a dispute he had with his partnership over the amount of income reported on a Schedule K-1. The Board ruled the taxpayer had not explained with adequate precision the nature and extent of the steps that he allegedly took to gather the information he considered necessary to confirm the correctness of the income reported on the K-1. The Board also reasoned that the taxpayer failed to obtain by independent inquiry the information he needed from the partnership to calculate accurately the tax that he owed before the due date of his return. As a result, the Board concluded that the taxpayer failed to exercise ordinary business care and prudence when he paid his tax after the due date.

In order to establish reasonable cause for failing to file a return on or before the due date, the taxpayer must show that his failure was due to reasonable cause and not due to willful neglect. To establish reasonable case, the taxpayer “must show that the failure to file a timely return occurred despite the exercise of ordinary business care and prudence, or that cause existed as would prompt an ordinary intelligent and prudent businessman to have so acted under similar circumstances.” (Appeal of Howard G and Mary Tons (79-SBE-027)  January 9, 1979.) The burden is on taxpayers to prove that reasonable cause exists to support abatement of the penalty for filing a late tax return.

We may impose the accuracy related penalty (ARP) on any portion of an underpayment of tax that should be shown on the return. (Revenue &Taxation Code Section (R&TC) Section 19164) The penalty is equal to 20 percent (or 40 percent for amnesty eligible year) of the underpayment of tax. R&TC Section 19164 imposes a 20 percent ARP on any portion of an underpayment attributable to one or more of the following:

  • Negligence or disregardof rules or regulations.
  • Substantial understatement of income tax.
  • Substantial valuation misstatement.
  • Substantial overstatement of pension liabilities.

A 40 percent penalty may be assessed for gross valuation misstatements.

The reasonable cause and good faith defense applies to negligence or disregard of rules or regulations, substantial understatement of income tax, substantial valuation misstatement, and gross valuation misstatement. However, under certain circumstances the defense does not apply to an underpayment attributable to a substantial or gross valuation understatement regarding charitable deduction property. Internal Revenue Code (IRC) Section 6664 (c) (1) provides that no penalty under IRC Section 6662 will be imposed if the taxpayer can show that there was reasonable cause and that the taxpayer acted in good faith with respect to the underpayment. Treasury Regulation Section 1.6664-4 provides guidance on what constitutes reasonable cause and good faith and whether those standards are met for purposes of eliminating the ARP. The determination of reasonable cause is made on a case-by-case basis, taking into account all facts and circumstances.

Failure to furnish information or file after notice and demand penalty can only be abated by showing reasonable cause and not willful neglect. To establish reasonable cause, a taxpayer must show that the failure to reply to the notice and demand or request for information occurred despite the exercise of ordinary business care and prudence such that an ordinarily intelligent and prudent business­person would have acted similarly under the circum­stances.

Examples1

Reasonable Cause

Credible and competent proof of illness or other personal difficulty completely prevented taxpayer from complying.

Relied on tax professional with competency in the subject of tax law, and tax professional’s advice is based on taxpayer’s full disclosure of relevant facts and documents.

Proof that the notice and demand/request for information was not mailed to taxpayer’s last known address.

Not Reasonable Cause

Ignorance of the law.

Reliance on agent to respond on taxpayer’s behalf.

Lost, lacking, inaccurate, or difficult to obtain information.

Complexity of tax law.

Pressures of business affairs or work.

Claim taxpayer did not receive notice.

 

This is intended to be a broad overview for purpose of general discussion and is not a complete analysis of how reasonable cause is determined or denied for the penalties listed.

For more information, go to ftb.ca.gov and search for reasonable cause.

Steve Sims, EA
Taxpayers' Rights Advocate



1The determination of reasonable cause is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Nothing herein constitutes tax or legal advice.

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