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U.S. IRS Releases Revised Practice Unit on Reasonable and Good Faith — Orbitax Tax News & Alerts

The U.S. IRS has released a revised international practice unit on Reasonable Cause and Good Faith. The general overview of the practice unit and key factors include the following:

General Overview

This Practice Unit supersedes the previously published Practice Unit with the same title published on July 2, 2020. The Practice Unit was updated to provide further detailed information on factors that should be considered when determining if reasonable cause exists.

Taxpayers may assert that the Service's application of penalties is not warranted due to a variety of reasons. This unit addresses the taxpayer's assertion that the return position was based on reasonable cause and that the taxpayer acted in good faith. How the Service evaluates this taxpayer defense depends on the particular penalty that was asserted. In addition to reasonable cause and good faith, certain penalty defenses involve other concepts such as an absence of willful neglect.

The burden is on the taxpayer to provide support to substantiate reasonable cause for penalty relief. Taxpayers are required to exercise ordinary business care and prudence in reporting their proper tax liability. Whether a taxpayer has met the reasonable cause and good faith exception is a facts and circumstances determination that the examiner must make test on a case-by-case basis.

The reasonable cause exception under IRC 6664(c) applies to:

  • Most accuracy related penalties under IRC 6662
  • Civil fraud under IRC 6663.

The reasonable cause exception under IRC 6664(d) applies to the penalty under IRC 6662A for a reportable transaction understatement when the transaction was adequately disclosed. The penalty under IRC 6676 (erroneous claim for a refund or credit) also has a reasonable cause exception.

Reasonable cause exceptions for penalty relief also apply to other IRC penalties such as:

  • IRC 6651 - Failure to File and/or Failure to Pay
  • IRC 6676 - Erroneous Claim for Refund or Credit
  • IRC 6721 - Failure to File Correct Information Reporting Returns
  • IRC 6694 - Understatement of Taxpayer's Liability by Return Preparer.

The reasonable cause exception does not apply to a penalty for an underpayment of tax that is due to transactions lacking economic substance as described in IRC 6662(b)(6), or a gross valuation overstatement from a charitable deduction.

Relevant Key Factors

The most significant factor in determining whether a taxpayer has reasonable cause and acted in good faith is the taxpayer's effort to report the proper tax liability.

For example, if a taxpayer reports amounts from an erroneous information return, but does not know the amounts are incorrect, reasonable cause may apply. Also, an isolated computation or transposition error by the taxpayer may indicate reasonable cause and a good faith effort.

Other factors to consider are the taxpayer's experience, knowledge, education, and reliance on the advice of a tax advisor. When considering the facts and circumstances, the taxpayer's experience, education, and sophistication with respect to the tax laws are relevant in determining whether the taxpayer has reasonable cause. Reliance on advice from a tax professional must be objectively reasonable. The taxpayer must provide the advisor with all the necessary information to evaluate the tax matter. Additionally, the advisor must have knowledge and expertise related to the tax matter.

Make the determination of whether the taxpayer acted with reasonable cause and in good faith on a case-by-case basis after considering all the facts and circumstances. The taxpayer must have exercised the care that a reasonably prudent person would have used under the circumstances.

Click the following link for the International Practice Units page on the IRS website.