Why Companies Should Always Contest IRS Tax Reporting Penalties

Wendy Walker
October 3, 2019

Michael Chittenden and Michael Lloyd, or Mike & Mike, specialize in helping companies deal with all sorts of tax issues, including tax reporting. They will speak at GCS Intelligent Reporting in San Antonio about seeking abatement of IRS penalties. Sovos sat down with both to discuss why companies should generally challenge IRS tax reporting penalties.   

Michael Chittenden specializes in tax and employee benefits, the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. 

Michael Lloyd practices in the areas of tax and employee benefits with a focus on information reporting and withholding on cross-border payments (e.g., Forms 1042 and 1042-S) and Foreign Account Tax Compliance Act (FATCA), backup withholding, employment taxation, the treatment of fringe benefits, cross-border compensation, domestic information reporting (e.g., Forms W-2, 1099, 1095 series returns), penalty abatement, and general tax planning and controversy matters.

Sovos: Why is the process of abating penalties so difficult? 

Michael Lloyd: We do a lot of penalty work in a variety of areas. Taxpayers frequently are denied penalty relief at early stages before relief is ultimately granted. Penalties arise in different contexts. For information return penalties, a Notice 972CG is often issued and proposes–rather than assesses–an information return penalty. Assessment is the act of recording a liability on a taxpayer account. The Notice 972CG prompts the filer to send a response to the IRS to explain why the proposed penalties should not be assessed. Taxpayers may be initially denied after they send their first submission, but they should then often protest such a denial. 

Sovos: What are some best practices for responding to penalty notices? 

Michael Lloyd: The government often shoots first and asks questions later, so to speak. When responding to a notice proposing penalties or a notice that assesses penalties, you should view every stage of the process as a full opportunity to fully make your case to the IRS. Your first submission should not be a one-page request that includes little detail or substance. It should be a detailed, introspective submission that demonstrates the taxpayer’s focus on compliance.

The document should include a full discussion of the taxpayer’s history of compliance and a robust review of the taxpayer’s compliance activities. This goes not only for federal information returns but all aspects of federal, state, and local compliance. The taxpayer should demonstrate ordinary business care and prudence, and that, as an organization, the taxpayer conducts itself properly not just with respect to tax filings but with all compliance requirements. That way, the taxpayer better demonstrates that the event that resulted in the proposal or assessment of penalties was aberrational and that the taxpayer’s compliance levels are very high in all aspects of the business. 

Michael Chittenden: One of the things you want to do is review your transcript. When we’re preparing submissions for our clients, we get a power of attorney and look at their transcripts to see if there is a history of penalties. Smaller penalties are often seen as a nuisance, so companies pay them because they’re not much money. But when you do that, the taxpayer’s transcript may appear as though the taxpayer does not care about compliance. Then, if a large penalty is subsequently assessed, it can appear to the IRS that the penalty is justified, so the likelihood of abatement is diminished. The IRS assesses penalties to improve voluntary compliance based upon its penalty policy. When a taxpayer incurs frequent penalties, it is more difficult to challenge the penalty assessments on policy grounds. 

Sovos: What’s wrong with just paying penalties rather than taking the time to try and fight them? 

Michael Chittenden: Failing to act to refute penalties may make it seem like a taxpayer is noncompliant more often than they actually are. This can be problematic for larger penalties.  One example of penalties that should almost always be challenged are penalties for intentional disregard. There is generally no maximum for such penalties. Intentional disregard penalties can arise when a taxpayer’s Forms W-2 data does not agree with its Form 941 data. The penalty is computed based upon a 10 percent rate multiplied by the difference in wage data.  We have seen taxpayers decide to simply pay these penalties because it seemed too difficult to challenge them. The problem with that approach is that the taxpayer now has a history of intentional disregard penalties on its transcripts. 

Then imagine that in the next period, the taxpayer suffered some sort of systemic failure that prompted the maximum penalty under section 6721 of $3.3 million. The taxpayer will not only need to contest the system failure but also explain why it should not have admitted to intentional disregard in the prior period. The payment of the prior penalty makes it look like you don’t care. It’s the cost of compliance versus the cost of a penalty. You’ve determined it’s cheaper to pay the penalty. When you get hit for real, you might not be able to get out of it. 

Further, Congress has increased maximum and per-return penalties for standard penalties, so it takes fewer returns with errors to generate the maximum penalty than it did in the past. It now takes 12,131 returns filed late or with errors in order to hit the maximum in 2018. For a large organization, if there is a significant systemic problem, the taxpayer could be starting off with the maximum. 

Michael Lloyd: It’s prudent for taxpayers to really review their notices. Often, where there’s smoke, there’s fire. If you’re getting a lot of penalty notices, there may be something wrong that you need to pay attention to. As companies grow, they have more personnel to deal with issues. Ignoring penalties is just postponing a bigger problem. 

Sovos: What’s your feeling on hiring an outside vendor handle tax reporting? 

Michael Chittenden: The use of outside companies has a very positive effect on tax compliance. The IRS has recognized this for a long time. Having providers that know their stuff and have systems that are designed to provide the information the government is requesting is a net positive. When a taxpayer requests relief for reasonable cause, the IRS is not looking at your service provider. It’s looking at you as a taxpayer. The IRS would view a taxpayer with frequent failures with more of a jaundiced view than a taxpayer that uses a service provider and has a clean compliance history. 

Sovos: Does the service provider ultimately serve as a fall guy for penalties? 

Michael Lloyd: No, it should not.  Blaming a service provider for noncompliance is generally not the best approach. Most large taxpayers are careful when selecting their service providers, and they focus on the quality of those providers. This should be the focus when contesting penalties, even if the failure arose due to a failure by the provider. We tend to believe that throwing the service provider under the bus is not a good tactic because it undermines the theme of the abatement request, which is that the taxpayer conducts itself with ordinary business care and prudence. It the service provider was so awful, what did they hire them for? We tend to think that explaining the provider’s attributes demonstrates that the selection of the provider was a good decision. The vendor’s level of trust, sophistication, and compliance for all of its clients shows that the vendor and the taxpayer take compliance seriously. 

Take Action

Educate yourself. Empower your business. Engage with your community. Register now for GCS Intelligent Reporting Summit San Antonio! 

Sign up for Email Updates

Stay up to date with the latest tax and compliance updates that may impact your business.


Wendy Walker

Wendy Walker is the principal of Tax Information Reporting solutions at Sovos. She has more than 15 years of tax operations management and tax compliance experience with emphasis in large financial institutions, having held positions with CTI Technologies (a division of IHS Markit), Zions Bancorporation and JP Morgan Chase. Wendy has served as a member of several prominent industry advisory boards. She graduated with a BS in Process Engineering from Franklin University and earned her MBA from Ohio Dominican University, in Columbus, Ohio.
Share This Post

North America Sales & Use Tax
June 1, 2023
3 Things to Remember if You Get a Sales Tax Notice

Have you ever received a sales tax notice from a state department of revenue? Whether you answered yes or no, there are important things to keep top of mind to help keep your business prepared. Finding out that you have failed to comply with one or more of your sales tax obligations can be startling. […]

North America Unclaimed Property
May 30, 2023
How to Set Up a Successful Unclaimed Property Program

Unclaimed property compliance can be difficult and overwhelming. Clients often ask what they should be doing to ensure they are compliant with the various laws and regulations. It isn’t easy, especially if you have multiple property types such as checks, credits or customer accounts that have the potential to become unclaimed property in multiple states. […]

North America ShipCompliant
May 30, 2023
How Hold At Locations Improve Your Customers’ Wine Delivery Experience

Direct-to-consumer shipping wine lovers enjoy the convenience of having their favorite vinos shipped to their front door. But what happens when, for whatever reason, they aren’t available to accept their wine deliveries? Whether they aren’t available during the day or they don’t have someone 21 or older available to sign for their package, these challenges […]

North America Sales & Use Tax
May 30, 2023
Identifying Sales Tax Liabilities and Why They Matter

By Steve Claflin, CLA It’s incredible that it has now been five years since the landmark Wayfair decision. It seems like just yesterday we were reading the case, alerting clients and tracking the ever-developing state guidance. Unfortunately, many companies still are not familiar with their sales tax filing obligations caused by economic nexus, or they […]

North America ShipCompliant
May 25, 2023
Out-of-State Breweries Gain Self Distribution, DtC Rights in Oregon

Under a settlement agreement, breweries located outside of Oregon now have more options for selling into the Beaver State, including direct-to-consumer (DtC) shipping and self-distribution to retailers. The settlement arose out of a lawsuit filed by a group of Washington breweries last year challenging Oregon laws that limited beer self-distribution to in-state breweries and DtC […]