Article – Penalty Relief & IRS Progress In Sight

by Lance Morris
Sep 4, 2022

As I’ve discussed previously over the last year, the state of operations at the IRS has been somewhat in disarray for quite some time. This has mainly been caused by a combination of reduced staffing during the pandemic, staff cuts in the prior decade, and a huge increase in tax returns to process due to the implementation of FATCA around the world.

This has been further exacerbated by the additional role the IRS has been required to play during the pandemic, with the issuance of the Economic Stimulus payments to almost all US citizens, and the resulting complications (ie missing cheques etc.), amongst other benefits provided.

However, things are beginning to take a turn, much to the relief of US citizens who are awaiting a refund, or for penalty relief.

As readers of my prior articles may know, the IRS has (since mid-2019) been issuing punitive late filing penalties to taxpayers around the world. These have mainly been issued for late filed Forms 3520 and 3520-A (foreign trusts, including Kiwisaver or Australian Superannuation). In at least 50% of the cases we see, the penalties have usually been issued in error due to a) an extension of time which was not processed correctly by the IRS, or b) The IRS not honouring their system of accepting the postmarked date as the filing date.

These penalties have caused a great deal of stress, panic and anxiety for those who’ve received them, especially given that the minimum penalty for a foreign trust is $10,000 USD or a penalty equal to the value of the trust, if it is under $10,000. But, there is now light at the end of the tunnel.

We’ll begin with an update on the current processing status at the IRS.

As of 19th August 2022, the IRS had 8.7 million unprocessed individual tax returns which were filed during 2022. The IRS say that this is a mixture of 2021 returns (current filing year) and late filed returns for prior years. For those awaiting a refund from the IRS, your tax return may well still be in the queue.

The IRS further specify that amongst the 8.7 million unprocessed returns, approximate 1.7 million contain errors which require manual processing, and a further 7 million are paper-filed (posted in the mail) returns which require human review and processing. This is particularly relevant for our clients based in New Zealand or Australia, as many of the forms we file to the IRS are required to be paper filed in the post. This applies to returns filed under the Streamlined Amnesty programme, and all trust filing on Form 3520 or 3520-A (which is incredibly common due to Kiwisaver and some Australian super being treated as a trust).

The IRS were quoted by Checkpoint as claiming “The IRS is opening mail within normal timeframes and all paper and electronic individual returns received prior to January 2022 have been processed if the return had no errors or did not require further review,” This does not necessarily tell us how many returns require further review, but for most paper filings, manual review is required.

Despite the seemingly dire figures above, this is a gradual improvement over the last 12 months, and we should expect that the IRS will further come up to speed over the next 12 months. A very large recruitment drive is already underway, to further beef up the IRS’ resources.

Now, onto the penalty relief, which will no doubt provide an even bigger sigh of relief for those who’ve been subjected to the IRS’ punitive penalties.

As a background on the current method that penalties are issued and waived. As it currently stands, the IRS issues a late filing penalty through an automated mail system, with no specific IRS agent listed as a response person. The penalty will usually arrive with a large 5 or 6 figure sum, with no consideration taken into the person’s wealth, or ability to pay. For example, we see $10,000 USD penalties issued to low-wage earners, with less in savings than the penalty amount.

As there is no specific IRS agent assigned to the penalty, it means that the taxpayer can only contact the IRS through two methods, telephone or written letters in the mail. They must enter the general queue to contact the IRS, but nobody with specific knowledge of their case will be available.

But, the IRS will not waive penalties over the telephone, except for extremely limited circumstances.

Instead, taxpayers must send a letter requesting relief of penalties in the mail, and wait for 9-12 months for a response (if one is ever sent). As you can imagine, having a 5-6 figure penalty hanging over you for a year or more can cause immeasurable stress and anxiety for most people. In the case that the IRS rejects the waiver, you are still required to respond by mail, and again wait another 9-12 months for a response.

In addition, many of the penalties require a response within a specific timeframe (ie 90 days), but even if the taxpayer responds in a timely manner, the IRS is not necessarily opening the correspondence in a timely manner. This is causing the timeframe for response to lapse, and the automated system pushing the penalty further down the bureaucratical route into collections, lessening the chances of the taxpayer having the penalty waived.

During the first quarter of 2022, the IRS sent more that 12 million notices to taxpayers around the world.

As of 22nd April 2022, the IRS had 5.3m pieces of unopened correspondence from taxpayers,

IRS staff canteen in Austin, TX, stacked with unopened mail – Taxpayer Advocate Service

This system of only being able to respond to penalties by mail has contributed to the huge backlogs that the IRS is facing, with regards to penalty remission.

Now, to discuss the relief offered…

On the 24th August 2022, the IRS issued Notice 2022-36, providing relief to taxpayers who’ve been issued penalties for the years 2019 and 2020. In addition, it provides relief for those who have not yet filed their 2019 or 2020 tax returns, provided they file them on or before 30th September 2022.

This means that penalties issued to taxpayers for the 2019 and 2020 tax year will have their penalties waived automatically. For our clients in New Zealand and Australia, nearly all of the penalties are related to foreign trust filing (ie Kiwisaver, family trust, Aussie super).

For those who have already paid a penalty, relief will be provided in the form of a tax refund, and abatements/waiver’s will be issued for those who haven’t yet paid.

This process will occur automatically, and taxpayers who’ve been issued or even paid a penalty, need not do anything. Whether this is an act of kindness from the IRS, or whether their hand has been forced is up to you to decide. The IRS say its intended to help those struggling because of the pandemic, while also freeing up agency resources.

For those who’ve already paid a penalty related to 2019 or 2020, you should allow a minimum of 6 months for the funds to be paid back to you.

Whilst there are some caveats to this remission, it is generally very far reaching. If you’re unsure if you qualify for remission, feel free to contact us.

If you have not yet filed your 2019 or 2020 tax return, and your return contains foreign trust, or corporation reporting, you must act now to take advantage of this relief, as you have only until 30th September to file.

This does raise the question and potentially provide some insight into the IRS’ current mindset, and whether their system of indiscriminately issuing penalties for minor infractions will continue. But, only time will tell.

If you require assistance or have questions related to your US tax filing obligations, reach out to me today at [email protected].

Thanks for reading!