Many small and medium-size not-for-profit organizations are mostly run by volunteers, and the staff of these charities may forget or inadvertently fail to timely file Form 990, Return of Organization Exempt From Income Tax, Form 990-EZ, Short Form Return of Organization Exempt From Income Tax, or even Form 990-N, Annual Electronic Filing Requirement for Small Exempt Organizations, which is a postcard-size information return that is electronically filed. IRS penalties for late filing can be hefty, not the least of which is the loss of exempt status after failing to file for three consecutive years. It can be devastating to receive penalty letters from the IRS telling the not-for-profit to pay thousands of dollars in penalties or pulling the organization’s exemption.
Sec. 6652(c)(1) imposes a penalty on any tax-exempt organization for failure to file a tax return or failure to include complete or correct information on the tax return. For organizations with gross receipts less than $1 million, the penalty is $20 for each day during which the failure continues, with a maximum penalty of the lesser of $10,000 or 5% of the organization’s gross receipts for the year. If gross receipts are more than $1 million, the penalty is $100 for each day the return is late with a maximum penalty of $50,000 (Sec. 6652(c)(1)(A), flush language).
It is important to note that (1) the statute provides the formula for the penalty calculation; (2) the IRS has no discretion to decide how much of a penalty to impose; (3) the statute does not allow for imposition of a partial penalty; and (4) the penalty is either fully enforceable or fully unenforceable (see Service Employees International Union, 598 F.3d 111 (9th Cir. 2010)).
CRITERIA FOR PENALTY RELIEF
Generally, relief from penalties falls into four categories: (1) reasonable cause; (2) statutory exceptions; (3) administrative waivers; and (4) correction of service error. The first three categories are discussed in this article. IRS Appeals may recommend the abatement or nonassertion of a penalty based on these four criteria as well as “hazards of litigation” (Internal Revenue Manual (IRM) §126.96.36.199).
No penalty is imposed if the taxpayer shows that the failure to file the tax return is due to reasonable cause (Sec. 6652(c)(4)) and not willful neglect (Regs. Sec. 301.6652-1(f)). Neither reasonable cause nor willful neglect is defined in the Internal Revenue Code. Regulations provide that if the taxpayer exercised ordinary business care and prudence and was unable to file the tax return within the prescribed time, then the delay is due to reasonable cause (Regs. Sec. 301.6651-1(c)(1)). Court cases interpret the term “willful neglect” to mean “a conscious, intentional failure or reckless indifference” (Boyle, 469 U.S. 241 (1985)).
FACTORS THE IRS CONSIDERS IN DETERMINING REASONABLE CAUSE
The IRS considers the following factors, along with other criteria, in determining reasonable cause (see IRM §188.8.131.52.2):
- What happened, and when did it happen?
- What facts and circumstances prevented the taxpayer from filing a tax return, paying tax, and/or otherwise complying with the law?
- How did the facts and circumstances result in the taxpayer’s not complying?
- How did the taxpayer handle the remainder of his or her affairs during this time?
- Once the facts and circumstances changed, what attempt did the taxpayer make to comply?
These criteria apply to all taxpayers, not just tax-exempt organizations.
ESTABLISHING REASONABLE CAUSE
A taxpayer, including a tax-exempt organization, must meet the ordinary business care and prudence standard to establish reasonable cause. Any evidence that a taxpayer exercised ordinary business care and prudence but nevertheless failed to comply with the tax law may be considered for penalty relief. In determining if the taxpayer exercised ordinary business care and prudence, the IRS considers the taxpayer’s reasons and reviews the dates and explanations to ensure they correspond with events on which the penalties are based. The IRS also examines the taxpayer’s compliance history for the three preceding tax years for payment patterns and overall compliance and looks at the length of time between the event cited as a reason for the noncompliance and subsequent compliance. Finally, the IRS considers whether there were circumstances beyond the taxpayer’s control and whether the taxpayer continued to attempt to meet the requirements, even though late (IRM §§184.108.40.206.2, 220.127.116.11.2.1, and 18.104.22.168.2.2).
PROCEDURE FOR CLAIMING REASONABLE CAUSE
Regs. Sec. 301.6652-1(f) provides that a request for abatement of penalties based on reasonable cause must be made in the form of a written statement, containing a declaration by the appropriate person in the organization that the statement is made under penalties of perjury, setting forth all the facts alleged as reasonable cause. This statement should be made as an attachment to Form 990 and should include supporting documentation and address:
- The reason the penalty was charged (either a late filed return, an incomplete return, or both);
- The circumstances that prevented the organization from complying with the timely filing requirement, including circumstances that led to failure to request an extension if the organization failed to get an extension;
- Why the failure was not due to willful neglect;
- How the organization exercised ordinary business care and prudence; and
- The steps being taken to prevent the problem in the future.
The taxpayer should attach documents that support any material aspect of the reasonable-cause claim to the statement. The burden of proof is on the taxpayer to establish both reasonable cause and lack of willful neglect (Boyle, 469 U.S. 241 (1985)). The elements that must be present to constitute reasonable cause for a late filing is a question of law, but whether these elements are present in a given situation is a question of fact (Conklin Bros. of Santa Rosa, Inc., 986 F.2d 315, 317 (9th Cir. 1993)).
SOME ADDITIONAL TIPS
Whether attaching a statement with Form 990 or writing a letter in response to the notice, the taxpayer should indicate that the organization took corrective measures as soon as the mistake was brought to its attention and state that the organization intends to comply with the law at all times. If the organization is otherwise current with all its filings, that should be mentioned as well. This strengthens the argument that the organization intended to comply, that failure to file was not due to willful neglect, and that the organization has taken affirmative action to stay on track with timely filings.
In addition, organizations should make sure their accounting records are accurate because, if assessed, penalties are based on gross receipts. Incorrect gross receipts may result in incorrect penalties, may require amended tax returns, and can trigger audits.
A practitioner who represents a not-for-profit that received a penalty notice should obtain a Form 2848, Power of Attorney and Declaration of Representative, from the organization so that the practitioner can contact the IRS to have a hold placed on the account until he or she has time to prepare a response to the notice.
EXAMPLES OF REASONABLE CAUSE
Generally, circumstances beyond a taxpayer’s control can give rise to reasonable cause for all taxpayers, including not-for-profit organizations. Examples include death, serious illness, or unavoidable absence; fire, casualty, natural disaster, or other disturbance; mistakes; and wrong advice or reliance on incorrect advice and ignorance of the law (IRM §§22.214.171.124.2.2.1–126.96.36.199.2.2.7).
Although the IRS considers casualty to be reasonable cause, in the case of American Friends, the argument that loss or destruction of records during relocation constituted reasonable cause was not accepted because the organization’s bookkeeper had failed to make efforts to salvage waterlogged boxes containing financial records. Instead she had simply thrown them out. By doing so, the taxpayer had shown little regard for maintenance of records (American Friends of Yeshivat Ohr Yerushalayim, Inc., 04-CV-1798 (CPS) (E.D.N.Y. 6/9/09)).
In another case, due to his age, health, and lack of experience, the responsible person was unable to cope with the emergency situation created by the unexpected illness of his attorney shortly before the tax return was due. The taxpayer therefore had reasonable cause for filing late, the court held (Brown, 630 F. Supp. 57 (M.D. Tenn. 1985)).
To make a reasonable-cause determination, all the factors have to be evaluated based on the facts and circumstances of each case (Rohrabaugh, 610 F.2d 211 (7th Cir. 1979)). Such an approach is necessary because it is “not the purpose of the law to penalize … innocent errors made despite the exercise of reasonable care” (Spies, 317 U.S. 492, 496 (1943)).
OTHER TYPES OF PENALTY RELIEF
Examples of statutory exceptions that may provide relief for exempt organizations include timely mailing being treated as timely filing and paying (Sec. 7502) and penalty relief based on erroneous written or oral advice from the IRS (Sec. 6404(f)). The IRS may also grant an administrative waiver (other than an FTA) from a penalty when it has delayed printing or mailing forms, publishing guidance, and in certain other cases.
Most not-for-profit organizations rely on donations, and paying penalties can use up funds that are not easily replaced. Besides this, an organization that fails to file the required information returns for three consecutive tax years automatically loses its tax-exempt status. It is better to have a system in place to keep track of important deadlines, follow up on a timely basis with persons responsible for filing tax returns, and take steps to ensure there is no breakdown in communication between management and the attorney, CPA, or volunteer responsible for filing the return. Most of all, practitioners and tax-exempt organizations should take their responsibility for tax compliance matters seriously.
Many tax-exempt organizations have small staffs or are run by volunteers who may not have the expertise to comply with the Form 990 filing requirements.
The penalties for failing to file Form 990 can be severe and quickly deplete the budgets of many smaller not-for-profit organizations.
Relief from these penalties is available, however.
An organization can obtain relief if it shows that it had reasonable cause for its failure to comply with the Form 990 filing requirements.