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Penalty Relief and Premium Tax Credit Reconciliation

Posted on Apr. 21, 2015

Today we welcome back Christine Speidel, an attorney with Vermont Legal Aid who directs the low income taxpayer clinic there. Christine has specialized over the past year in tax issues arising from the Affordable Care Act and co-authored a new chapter in “Effectively Representing Your Client before the IRS” on ACA issues.  Keith

This is the first tax season that people who received advance payments of the Premium Tax Credit (APTC) must reconcile those payments on their federal income tax returns. APTC was paid during 2014 based on a person’s projected 2014 income (and other eligibility criteria), which may have been estimated as early as October 2013. Not surprisingly, many people are discovering that they received too much APTC or do not qualify for a Premium Tax Credit (PTC) at all, and they are having to repay all or a portion of it with their tax return. As of late February, H&R Block announced that fifty-two percent of its clients who received APTC had to repay a portion of the subsidy.

Taxpayers who have a balance due because of APTC reconciliation do get some relief. In Notice 2015-09 (IRB 2015-6, 2/9/15), the IRS announced limited penalty relief for 2014 only, for taxpayers who have a balance due as a result of excess APTC. However, Notice 2015-09 imposes several conditions that must be met for penalty relief to be granted. It also sets out procedural hurdles that will be difficult for some taxpayers to overcome.

The rationale behind the penalty relief for taxpayers with excess APTC is not fully set out in the Notice. However, some exchanges made erroneous APTC determinations in 2014 amid technological and operational difficulties. Also, many consumers did not understand how APTC worked. This issue was described in a recent New York Times article. The penalty relief is provided under the authority of Sections 6651(a)(2) and 6654(e)(3).  Thus, one could say that Notice 2014-09 amounts to a blanket finding of reasonable cause for late payment, and a concession that the imposition of the estimated tax penalty would be against equity and good conscience. (There are also administrative penalty waivers such as First Time Abate.)

This post will describe the penalty relief available under Notice 2015-09 and some of the barriers that may prevent low-income taxpayers from accessing the relief. I will then offer some thoughts on improvements that could be made.

Relief under Notice 2015-09

Notice 2015-09 provides relief from two penalty provisions: the penalty imposed by Section 6651(a)(2) for late payment of a balance due, and the penalty under Section 6654(a) for underpayment of estimated tax. Unfortunately, relief is not automatically applied to qualifying accounts, and relief from both penalties cannot be requested at one go.

The substantive criteria for relief are the same for both penalties. The penalties will be abated if a 2014 balance due was caused by APTC and: (1) the taxpayer filed a timely 2014 return (including by a properly extended due date); (2) the return reports excess APTC; (3) the taxpayer is current in all tax filing and payment obligations; (4) if the 2014 tax return was filed after 4/15/15, the taxpayer paid the balance due by 4/15/16; and (5) the taxpayer has requested relief. (See Notice 2015-09 at pages 4-5, and also Publication 974 (Mar. 2015) at page 8.)

Taxpayers will be considered current in their tax filing obligations if they “have filed, or filed an extension for, all currently required federal tax returns.” (Notice 2015-09 at page 5.) More controversial (in the LITC community at least) is likely to be the Notice’s definition of when a taxpayer is considered current in their payment obligations. If a taxpayer has any outstanding balances, the taxpayer must either have a current installment agreement or have entered into an offer in compromise. A taxpayer will also be considered in compliance if a “genuine dispute” is pending regarding the existence or the amount of a liability, so long as the liability has not been “finally determined.” (Notice 2015-09 at page 5). This definition of compliance will exclude many LITC clients from relief.

There are distinct procedures to request relief from each penalty. For the late payment penalty (known as the Failure to Pay or FTP penalty), relief is not requested with the tax return. Rather, the taxpayer must respond in writing to the IRS notice demanding payment of the balance (and charging penalties and interest). The taxpayer’s letter must request relief under Notice 2015-09 specifically. (See Notice 2015-09 at page 6.) In all cases, it seems the IRS will impose the FTP penalty before abating it.

There is a different procedure for requesting waiver of the estimated tax penalty. According to Notice 2015-09, “taxpayers should check box A in Part II of Form 2210, complete page 1 of the form, and include the form with their return, along with the statement: ‘Received excess advance payment of the premium tax credit.’” (p. 6) Theoretically at least, this penalty should never be assessed against taxpayers who qualify for relief.

Barriers to Relief

Two substantive restrictions on eligibility for penalty relief will bar deserving taxpayers from accessing relief. First, the narrow definition of compliance excludes many taxpayers, including people who have prior-year IRS debts in Currently Not Collectible status due to disability, unemployment or other hardship. Second, taxpayers who timely file a 2014 return after 4/15/15 are denied relief unless they pay off their balance by 4/15/16. There is no consideration given to the reason why the taxpayer filed under extension.

The complexity of the procedures for requesting relief is also worrisome. Notice 2015-09 was issued after the filing season had started, and well after most tax professionals had completed their annual continuing education courses. People are not likely to request relief from the estimated tax penalty unless prompted to do so by their preparer or software. I question whether the unrepresented low-income taxpayer population will be able to follow the procedures required to obtain relief from the FTP penalty (or even know to look them up). LITC practitioners will need to review future clients for this issue and request penalty relief for taxpayers when appropriate.

Broader context and ideas for improvement

Some of Notice 2015-09’s restrictions on eligibility for relief are puzzling given the circumstances that the policy is presumably intended to address. The procedural requirements mean that many people will not benefit from it even though they qualify. Other people will not qualify even though their 2014 circumstances relating to APTC are just as compelling.

Penalties should be administered with the goal of improving tax compliance. The IRS takes this approach in Policy Statement 20-1, found at IRM 1.2.20.1.1 (06-29-2004). Compliance is improved when people believe that the system is fair. (See the National Taxpayer Advocate 2014 Annual Report to Congress, MSP#8, especially pp. 100-101 and n. 47.) One component of fairness is a rational relationship between the problem and the solution.

With all that in mind, there are three things that should be improved about APTC penalty relief.

First, the IRS should not penalize taxpayers who file under extension. There is no rationale given for requiring someone who timely files pursuant to an extension to finish paying the debt by 4/15/16, while imposing no such requirement on someone who timely files on 4/15/15. This requirement will entirely exclude some taxpayers from relief, without good reason.

Some people may not file by 4/15/15 because they still have not received correct 1095-A forms. I have two clients in that situation currently. It is possible that the forms will not arrive before 4/15. Treasury directs taxpayers who know that corrected forms are pending to wait and file their return when the corrected form arrives. (March 20, 2015 press release and accompanying FAQs.) In Notice 2015-30 (scheduled to appear in IRB 2015-17 on April 27), Treasury issued guidance extending penalty relief to taxpayers who are affected by a delayed or incorrect Form 1095-A. (Notice 2015-30 merits its own post and will not be discussed in detail here.) This is a good step, but it does not go far enough. There are other valid reasons for a taxpayer to file on extension. For example, Joe Kristan recently explained why K-1s are often filed as late as September 15.

It makes sense to encourage taxpayers to file timely returns, including by the extended deadline. However, I question whether restricting APTC penalty relief will actually prevent any late filed returns. Also, some of the other restrictions on relief do not seem to have a policy basis other than reluctance to extend any relief to “bad” taxpayers.

Not everyone will be able to repay their APTC promptly. I know of one Vermont taxpayer who must repay over $11,000 in APTC due to a change in circumstances that he did not realize he should report to the exchange. Just because a taxpayer’s 2014 AGI was over 400% of the poverty line, and thus they are ineligible for APTC repayment caps, that does not mean the taxpayer has plenty of cash now. For my clients, AGI is often inflated by cancelled debt. Many of my taxpayers have also taken lump sum retirement distributions that were withdrawn and used for a specific purpose well before tax time.

Second, a prior-year clean slate should not be a necessary condition before one can find that a taxpayer deserves relief from penalties caused by 2014 APTC reconciliation. If this penalty relief policy were permanent rather than applicable only to 2014, it would make more sense to take prior year compliance into account. The government certainly does not want to see taxpayers with significant, unpaid, or late-paid excess APTC year after year. It might slightly encourage taxpayers to gamble or even intentionally try to receive more APTC than they should if penalty relief were available every year. In the first year of this program, however, whether taxpayers have unresolved/unpaid prior-year liabilities does not seem particularly important to the question of whether they deserve relief from APTC-related penalties for 2014.

In general, prior-year compliance is not a requirement for reasonable cause penalty relief. Rather, it is one factor that the IRS considers in determining whether the taxpayer exercised ordinary business care and prudence. See IRM 20.1.1.3.5 Requesting Penalty Relief (11-25-2011), #6. And that makes sense. The IRS should consider priory-ear compliance in the same way for APTC penalty relief.

The Service could at least specify some CNC closing codes that would be acceptable for purposes of qualifying for relief under Notice 2015-09. Taxpayers who are uncollectible due to residence in a foreign country need not be treated the same as taxpayers who are uncollectible due to unemployment or disability. (See table of CNC closing codes in IRM 5.16.1.2 Currently Not Collectible Procedures (1-1-15)).

Third, the procedural complexity is worrisome. The NTA and other stakeholders have repeatedly criticized IRS for its tendency to impose penalties automatically and correct them later. See the National Taxpayer Advocate 2014 Annual Report to Congress, MSP#8, especially notes 26-33 and accompanying text on pages 97-98. The National Taxpayer Advocate’s 2014 Annual Report to Congress highlighted the IRS penalty regime as Most Serious Problem #8.

Generally, failure-to-file and failure-to-pay penalty relief may be requested in writing or over the phone. The Internal Revenue Manual (IRM) allows consideration of oral requests under reasonable cause or FTA. See IRM 20.1.1.3.1 (08-05-2014), Unsigned or Oral Requests for Penalty Relief. This section does not currently encompass relief under Notice 2015-09. Relief from estimated tax penalties is not included at all in current oral waiver authority; a signed written request must be submitted. See IRM 20.1.1.3.1, #6 (08-05-2014).

Conclusion

When an individual owes tax to the IRS, several different penalty provisions of the Internal Revenue Code (IRC) may come into play. The penalty and interest provisions of the IRC often confound the taxpayers I work with. Many unsophisticated taxpayers are afraid to file a tax return showing a balance due. They frequently fail to understand how important a timely-filed return is.

Penalty relief that must be specifically requested by the taxpayer is less effective than a blanket policy that is automatically applied by the IRS. This is particularly the case for relief that must be requested in writing.

Taxpayers have the right to a fair and just tax system. (IRS Pub. 1) APTC penalty relief should be simplified substantively and procedurally so that it actually reaches the deserving taxpayers for whom it was designed. The penalty relief provided in Notice 2015-09 is a welcome step. But the Notice does not go far enough to help taxpayers confused by a new system. Penalties only promote tax compliance when they are administered in a way that is perceived as fair.

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