A restaurant client calls, relieved. The IRS just removed a $2,000 payroll tax penalty for the first quarter of 2024. The owner was seriously ill that spring, and the CPA had asked for reasonable-cause relief for the first and second quarters. Everyone assumes the illness explanation worked and the $700 second-quarter penalty is next.
That assumption may be wrong. The IRS granted First Time Abate, which rests on the client’s compliance history, not on why the deposits were late. Nobody at the IRS has ruled on the illness yet.
When I was a revenue officer, I watched a practitioner assume a payroll tax penalty was fully resolved because the IRS had granted an abatement. The business had a strong explanation: a payment had been posted to the wrong tax period. But instead of removing the penalty based on that correction or on reasonable cause, the IRS applied FTA.
The penalty disappeared, so the paperwork looked fine. But the business had unknowingly used up its FTA, the safety net it might need if a real problem came up in the next three years. The lesson was simple: a penalty being removed is not enough. You need to know why it was removed.
Here is how I work a file like this now.
Start by finding out why the penalty came off
Set each quarter’s account transcript next to the IRS letter. The transcript shows how much came off; the letter shows why. When the IRS grants FTA, it must say relief was based on prior compliance, usually in Letter 168C or collection letters 4722 through 4724. Internally, FTA carries penalty reason code 018 or 020.
If the letter is vague, call and ask for the relief basis, the reason code, and the status of the June request.
FTA is applied before reasonable cause and covers one tax period, so the IRS never had to decide whether the illness counted. For the second quarter, it will. And despite what the letter says, FTA isn’t a one-time break for life; eligibility returns once the three-year lookback is clean again.
Before you argue reasonable cause, check the IRS’s math
The owner fell ill Feb. 10 and got payment access back May 10, while payroll kept running. The restaurant is a monthly depositor with $10,000 in tax each month, paid electronically.
| Liability month | Due (2024) | Deposited | Days late | Penalty |
| April | May 15 | May 20 | 5 | $200 |
| May | June 17 | June 24 | 7 | $500 |
| June | July 15 | July 15 | 0 | $0 |
June 15, 2024, was a Saturday, so the May deposit was due Monday, June 17. Up to five days late costs 2%, and six to 15 days costs 5%, for a $700 second-quarter penalty.
Check two things first. One, did the IRS average the penalty? If line 16 of Form 941 (or Schedule B) was missing or wrong, the IRS may have spread the liability evenly, and it can’t consider reasonable cause on an averaged penalty until it gets a valid schedule and recalculates. If the numbers won’t reconcile, ask for the IRS’s computation.
Two, if the IRS moved a misapplied payment into the right quarter, don’t assume the penalty followed. Once a quarter has a manual penalty adjustment, the system stops recalculating it, and someone at the IRS has to redo it by hand. I’ve seen this happen many times over the years.
Here’s how the trap usually happens. The business made its payroll tax payment on time, but the IRS posted it to the wrong quarter, creating a penalty that should never have existed. If the IRS then removes that penalty with FTA instead of correcting the account, the business has spent its FTA on the IRS’s own mistake, even though the IRS’s manual tells employees not to use FTA for IRS errors.
Before closing the file, confirm the IRS fixed the posting and recalculated the penalty. Make the IRS-error argument only when the records show the IRS, not the taxpayer or payroll provider, misposted the payment.
Each late deposit needs its own explanation
The test is ordinary business care and prudence, applied deposit by deposit. The IRS can grant relief on one and deny the other.
I start with how payroll kept running while the owner was sick. Did wages run automatically while deposits waited on the owner’s approval? If bank records show a second signer, find out whether that person could make tax deposits; signing checks isn’t Electronic Federal Tax Payment System access. If someone else could have made the deposit, the IRS would ask why they didn’t.
Take the $200 penalty first. Access came back May 10, and the deposit was due May 15. A February hospitalization doesn’t explain that gap on its own. Get medical records for May 10 to 20 and everything the owner paid that week. If the owner paid a vendor on May 12, explain why the tax deposit was different.
The $500 penalty is harder. The owner says cash was tight, but lack of funds alone isn’t reasonable cause. Check bank balances and what did get paid. Then ask the uncomfortable question: wages went out, so where did the withheld taxes go?
If the records show the owner could have deposited on time and had the money, I’d stop leaning on the illness for May.
Explaining it to the client
The client conversation matters as much as the account work. I tell clients: “The penalty came off, which is good. But the IRS may not have agreed with the reason we gave. It may have used your prior compliance history instead.”
For a $700 penalty, I also discuss scope before doing more work. I look for the one missing fact that could change my advice and weigh the cost of getting it against the amount at stake. If no new fact is likely to help, the client deserves that honest answer before paying for more representation.
What I check before telling a client we’re done
- I confirm the basis for relief and the penalty reason code, not just the adjustment on the transcript.
- I make sure I know where every quarter we asked about stands.
- I rule out averaged penalties and moved payments before arguing reasonable cause.
- I tie each explanation to a specific late deposit and the records for those dates.
First Time Abate removed the $2,000, but it didn’t prove the illness was reasonable cause. The $700 still has to earn its way off on the evidence. When the evidence isn’t there, the best service you can give a client is an honest answer.
Sources
- IRM 20.1.1.3.3.2.1 (First Time Abate), paras. (10)–(12), (13), (15); IRM 20.1.1.3.2 and 20.1.1.3.2.2.1 (reasonable cause; illness or absence). IRM 20.1.1
- IRM 20.1.4.7.1 (penalty tiers); 20.1.4.7.3 (business days); 20.1.4.22(3) (credit transfers on restricted modules); 20.1.4.25(4)–(5) (liability-specific computation); 20.1.4.26(2)–(3) and 20.1.4.26.1(2)–(3) (relief; averaged penalties). IRM 20.1.4
- IRS: Administrative penalty relief (First Time Abate)
- IRS: Penalty relief for reasonable cause
- IRS: Instructions for Form 941
ABOUT THE AUTHOR:
Robert Valenzo, MBA, EA, is the founder of Falcon Tax Resolution Group (falcontaxrelief.com), whose team includes former IRS revenue officers, managers, and appeals officers. A former U.S. Air Force officer and B-52 navigator, he served as an IRS revenue officer, a high-priority enforcement ATAT revenue officer, and manager of the South Texas Collection Region.
General information only; not legal or tax advice for any specific taxpayer.
Photo credit: andreyoskirko/Freepik
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