Chapter four: where tax law actually comes from, the penalties that do the most damage, and the two routes to getting penalties waived.
Many business owners believe the IRS creates tax law. It does not. Congress creates tax law, and the difference matters enormously when you are fighting an audit.
Chapter four of my book, The IRS Survival Guide, covers where federal tax law comes from, how it fits together, and the penalties that surprise most people.
Watch my full video on this topic below, or watch on YouTube.
Knowing the hierarchy explains why some arguments win and others go nowhere.
The Internal Revenue Code is the foundation. Over 5,800 pages, written and passed by Congress. Section 61 defines gross income, section 162 defines deductible business expenses, and so on.
Treasury Regulations are the IRS's interpretation of the Code. They fill in how the law applies in real situations. Worth remembering: this is the IRS's reading, not automatically the correct one. It tells you how they are likely to see your situation.
Revenue rulings are official IRS positions on specific scenarios. Not technically law, but highly persuasive.
Revenue procedures are practical guidance on how to comply.
Private letter rulings are IRS guidance on one taxpayer's situation. They bind only the taxpayer who requested and paid for one, but they are published, so they show how the IRS thinks.
Case law sits alongside all of it: how courts have actually interpreted the Code and the regulations.
In a dispute you have to check each of these buckets for anything that helps your case.
Failure to file. 5% of unpaid tax per month, capped at 25%. This is the punishing one.
Failure to pay. Half a percent per month, also capped at 25%. Much smaller monthly, but it compounds.
Those two numbers are the reason I tell people to file on time even when they cannot pay.
Accuracy related penalty. 20% of the underpayment, where the IRS shows negligence or a substantial understatement. Owe an extra $10,000 and this adds $2,000 on top.
Fraud penalty. 75% of the underpayment. With interest, you can end up paying roughly double what you would have owed by filing correctly.
Payroll tax penalties. These include failure to file and failure to pay, but also the trust fund recovery penalty. That one lets the IRS hold business owners and other responsible individuals personally liable for unpaid employment taxes even when the business is an LLC or a corporation.
Abatement means waiving penalties, and most taxpayers do not realize it is available.
Reasonable cause means you had a legitimate reason for the failure. Serious illness, natural disaster, a death. Generally things outside your control. Reliance on incorrect professional advice can sometimes qualify, though penalties tied to a CPA's mistakes are trickier.
First time abatement applies if you have a clean compliance history, generally meaning you filed and paid on time for the three prior years. This is one of the most overlooked routes to getting penalties removed.
There are also statutory exceptions, including for individuals in the military or serving overseas.
I have seen six-figure penalty abatements approved when the argument was made correctly. Do not assume a penalty is permanent. It is often worth challenging.
Go to TheIRSSurvivalGuide.com to get your free PDF copy of my book today.
