Reasonable Cause: A Powerful Defense to IRS Penalties

Penalties can quickly become one of the most expensive aspects of a tax dispute with the IRS. Penalties can arise from a late return, late payment, inaccurate reporting, or a missed information return, and often compound with interest, significantly increasing taxpayer exposure. Fortunately, many IRS penalties contain an exception for reasonable cause, which can give taxpayers the chance to wipe away hefty penalties given the right circumstances. 

Understanding where reasonable cause succeeds is critical for taxpayers and practitioners alike. While courts and the IRS tend to apply the reasonable cause standard narrowly in many circumstances, and not every mistake qualifies, the reasonable cause defense can be highly effective when properly developed and supported. 

What Is the Reasonable Cause Standard? 

The Internal Revenue Code contains several sections under which a penalty may be imposed as an addition to the tax, typically due to a failure to file a form or failure to timely pay tax. Under these sections and the accompanying regulations, many of the imposed penalties may be waived if the taxpayer demonstrates that their failure was due to reasonable cause, as opposed to “willful neglect.” Although the precise standard may differ depending on the penalty involved, regulations and case law generally define reasonable cause as exercising “ordinary business care and prudence,” but nevertheless being unable to comply.

Determinations to waive penalties are made on a case-by-case basis, and the IRS and courts evaluate all of a taxpayer’s circumstances, including the taxpayer’s knowledge, complexity of the tax law, reliance on professionals, and the nature of the noncompliance itself. Importantly, reasonable cause is not the same as ignorance of the law, inconvenience, or mere oversight. Taxpayers must generally demonstrate that they acted responsibly under the circumstances. 

Boyle and the Limits of Reliance 

One of the most significant reasonable cause cases is United States v. Boyle, where the U.S. Supreme Court established that taxpayers cannot avoid late-filing penalties merely because they relied on a tax professional or preparer to file a return on time. 

In Boyle, an executor relied on an attorney to timely file an estate tax return. The attorney failed to do so, and the return was filed late, leading to the assessment of penalties. The Supreme Court held that reliance on a tax professional, merely to meet a filing deadline, did not constitute reasonable cause. In doing so, the Supreme Court clarified that ensuring that a return is timely filed is a “nondelegable duty” of the taxpayer. 

Successful Reasonable Cause Claims 

Although Boyle narrowed reasonable cause relief in the context of reliance on tax professionals, reasonable cause remains viable in many situations. Some common successful scenarios include: 

• Serious Illness or Incapacity: Courts and the IRS frequently grant relief where taxpayers experience severe illness, hospitalization, or incapacitation that directly prevents tax compliance. To qualify, taxpayers must generally prove that the illness or incapacity directly prevented timely compliance with any tax filing obligations; accordingly, the illness or incapacity must occur prior to the failure to file. 
• Inability to Obtain Necessary Records: Reasonable cause may exist where taxpayers exercised diligence but were nevertheless unable to obtain records needed for their required returns. For example, records that have been destroyed due to hurricanes, fires, floods, or other natural disasters; inaccessible foreign records; or third-party financial information that could not be reasonably resolved before a filing deadline. 
• Reliance on Tax Professionals: Unlike general filing obligations which are nondelegable under Boyle, courts and the IRS may recognize reasonable cause where taxpayers reasonably relied on competent professional advice regarding substantive tax issues. However, courts have clarified that taxpayers must show the tax professional was adequately qualified, the taxpayer provided complete and accurate information, and the taxpayer actually relied on the advisor in good faith.  
• Circumstances Beyond the Taxpayer’s Control: Cybersecurity incidents, identity theft, sudden record loss, banking interruptions, and payroll processor failures may support reasonable cause depending on the facts in each situation. 

What Is Not Considered Reasonable Cause? 

Just as important as knowing when reasonable cause succeeds is understanding where it typically does not. Common unsuccessful arguments include forgetfulness or mere oversight, busy schedules or staffing shortages, lack of funds, reliance on an agent to simply file a return, mere ignorance or confusion of filing obligations, or failure to review IRS notices. The IRS and courts expect taxpayers, particularly sophisticated businesses and individuals, to maintain contemporaneous documentation and systems that enable them to maintain compliance. 

Additionally, some penalties do not contain a reasonable cause exception, so the IRS is prohibited from abating them based on reasonable cause. These penalties include the following: 

• Estimated Tax Penalty under IRS Sec. 6654 
• Trust Fund Recovery Penalty under IRC Sec. 6672  
• Frivolous Return Penalty under IRC Sec. 6702  

However, even where a reasonable cause defense is not available, taxpayers may have other avenues for penalty relief, including First Time Abatement penalty relief and other administrative remedies.  

How Our Tax Controversy Team Can Help 

A successful showing of reasonable cause often requires more than simply submitting a brief explanation to the IRS. Effective submissions need to include a well-developed factual narrative, supportive legal authority, and supporting documentation, and positioning the case for Appeals if necessary. 

At EisnerAmper, our Tax Controversy & Dispute Resolution team assists taxpayers with showings of reasonable cause at every stage of the dispute process, including IRS audits/examinations, Appeals proceedings, and collection matters. Regardless of the penalties facing a taxpayer, early analysis can significantly improve the likelihood of a favorable resolution. Contact our team below to find out how we can assist.