Proactive penalty defense: avoiding IRS penalties during examination and appeals

One of the most overlooked areas of IRS representation is prevention. Many practitioners don’t start defending against penalties until after they’ve been assessed. But the truth is, the best time to fight IRS penalties is long before they’re imposed during the examination and appeals stages.

This discussion focuses on proactive strategies to mitigate penalties before they hit, including examination tactics, appeals approaches, and building your client’s defense from day one.

Set the tone during the IRS examination

From the first meeting, show the examiner that your client is cooperative, timely, and transparent. This builds trust and may help later when arguing against penalties. 

Rather than hoping for the best, document the case as if you know penalties are coming:

• Note communications with the IRS
• Track client efforts to comply
• Secure documentation early

Engage the examiner on the issues

Have a candid conversation before a 30-day letter is issued. Negotiate from a position of strength by highlighting any efforts to comply, reasonable cause factors, or unusual circumstances.

At the appeals level, tell the whole story

Appeals officers won’t concede just because you ask. You need to present a compelling case that fits within the policy framework:

• Voluntary compliance
• Fairness and equity
• IRS resource conservation

What appeals officers want to see

• That your client had legitimate reasons for noncompliance
• A history of compliance before and after the issue
• That your client relied on a competent tax professional
• That your client incurred legitimate expenses and attempted to comply 

Practice tip: Include everything, even if it is in the audit file. Appeals assumes nothing. Assume they’re working remotely and can’t access prior submissions. 

Supporting documentation

Whether you’re arguing about a reasonable cause, reliance on tax advice, or simple oversight, your package must support your claim:

• Transcripts to show history
• Proof of effort (emails, payments, extensions)
• Medical, financial or legal documentation

Common reasonable cause scenarios:

• Illness or death in the family
• Natural disasters
• Bad advice from a tax professional
• Serious financial hardship 

Insufficient funds alone are not a reason enough, but hardship plus documentation may sway the IRS.

Reasonable reliance on tax advice

Another common strategy is proving your client relied on a tax professional’s advice. This can be achieved if:

• The advice was based on complete and accurate information
• It was objectively reasonable
• The client wasn’t negligent or willfully ignorant

Preparer penalties

Tax professionals aren’t immune. If you’re facing IRC §6694 or §6695 penalties, you must contest them early before they’re assessed. 

Defense includes: 

• Substantial authority or reasonable basis
• Reasonable cause and good faith
• Lack of willful or reckless conduct

Remember: failing to challenge a preparer penalty can result in Office of Professional Responsibility (OPR) action and even license suspension.

Be the advocate before the problem arises

Effective representation isn’t reactive, it’s proactive. By anticipating penalties, understanding how IRS agents think, and preparing thoroughly from the start, you can protect your client’s interests and elevate your practice. Tax professionals themselves are not immune from IRS penalties. If you are facing preparer penalties under IRC §6694 or §6695, it is crucial to contest them early before they are assessed.

Defenses include demonstrating substantial authority or a reasonable basis for the position taken, showing reasonable cause and good faith, and proving a lack of willful or reckless conduct. Failing to challenge a preparer penalty can result in action by the OPR, including possible license suspension.

Be the professional who doesn’t just clean up messes but prevents them from happening in the first place.