How High-Net-Worth Individuals Can Reduce or Eliminate IRS Penalties: Legal Options Explained

The Hidden Cost of Tax Penalties for the Affluent

When high-net-worth individuals face IRS or California Franchise Tax Board (FTB) audits, the focus is usually on taxes owed. But a huge financial sting also often comes from penalties and interest, which can amount to 20%, 50%, or even 75% of the tax at issue (plus interest).

Fortunately, these penalties can be reduced or eliminated through various legal procedures, if handled by the right professionals.

Why This Matters

Who this article is for:

• CPAs and accounting professionals advising high-net-worth clients
• Offices managing complex tax portfolios
• High-net-worth individuals facing IRS notices or audits

What you’ll learn:

• The legal grounds for penalty relief
• How attorneys increase success rates in penalty abatement
• When to involve legal counsel in penalty disputes
• A real-world example of a $350,000 penalty reduction
• How Sideman & Bancroft works in tandem with CPAs to defend against IRS and FTB penalties

Understanding IRS Penalty Abatement

Penalty abatement refers to the partial or full removal of tax penalties when specific legal defenses apply. These defenses are codified in Federal and California statutes and include both automatic and discretionary relief provisions.

To request and receive penalty abatement, taxpayers or their representatives must: 

• Understand the penalty provisions
• Make the appropriate arguments under the applicable procedures.
• Follow the correct administrative or litigation procedures

Key Point: Federal and state tax penalties, including those for negligence, late filing, fraud, and international violations can be challenged and are often reduced or defeated entirely.

Common IRS Penalties Include:

Failure-to-File & Failure-to-Pay (IRS & FTB)

• Typically imposed automatically
• 5% per month for late filing, 0.5% per month for late payment

FTB “Demand Penalty” (California)

• Assessed if a taxpayer fails to respond to a notice demanding return filing
• Based on the tax shown on the return even if it was paid in full

Accuracy-Related & Negligence Penalties

• 20% of the underpayment
• Common in high dollar audits 
• Rebuttable with a “reasonable cause and good faith” defense

Fraud Penalties

• Generally the highest penalties at 75% of the tax at issue
• Require proof of willfulness and intent to evade
• Imposed in the most serious cases

International Penalties (FBAR, 3520, 5471, etc.)

• FBAR:
  • Non-willful violations: Up to $10,000 per violation (adjusted for inflation, currently $12,921).
  • Willful violations: The greater of $100,000 or 50% of the account balance at the time of the violation.
  • Criminal Penalties: For willful violations, fines up to $250,000 and/or up to five years in prison are possible.  
• Form 3520 (foreign trusts): Greater of $10,000 or 35% of the gross reportable amount
• Form 5471 (foreign corporations): $10,000 per form plus continuation penalties 
• Frequently misapplied due to complexity

Grounds for IRS Penalty Relief

The IRS and FTB evaluate abatement requests under specific criteria. Legal counsel becomes crucial in building persuasive factual narratives, citing legal precedent, and securing penalty abatement.

Common Abatement Grounds:

Reasonable Cause Relief
Applies when circumstances like illness, reliance on incorrect advice, or natural disasters have led to noncompliance. The argument must prove ordinary business care and prudence.

First-Time Penalty Abatement (FTA)
One-time relief for taxpayers with a clean history, often used strategically in combination with other grounds.

Statutory Exceptions or IRS Errors
Less common but powerful when provable, such as an IRS processing error or misleading communication.

Reliance on a Tax Professional
Often the strongest defense for high-income individuals. You must show the taxpayer relied on advice in good faith. Important: This defense is best argued by a third-party attorney — not the CPA who gave the original advice.

Fraud Penalty Defense
IRS or FTB bears the burden of proving intentional tax evasion. This requires strong legal challenge and, in many cases, litigation.

Common defenses:

• Lack of intent
• Clerical error
• Misunderstanding of reporting requirements

Why High-Net-Worth Taxpayers Face Unique Risks

Affluent taxpayers are more likely to:

• Have pass-through entities with delayed K-1s
• Maintain international investments that trigger FBAR, FATCA, or Form 5471 obligations
• Rely on complex structures and multiple advisors
• Be subject to higher scrutiny and audit risk

Even a small misstep or reporting delay can result in disproportionately high penalties. For example, a late-filed FBAR for a foreign account valued at $1M could yield a willful penalty of $500K.

Advocacy: A Critical Component of Penalty Defense

IRS and FTB penalty defense involves knowledge of key legal rights and procedures for which attorneys bring critical tools to the table:

Why Attorneys Matter in Penalty Relief:

• Drafting compelling reasonable cause letters grounded in legal precedent
• Navigating the IRS an dFTB Appeals process 
• Filing litigation in the U.S. Tax Court or defending enforcement actions in Federal District Courts
• Protecting client privileges in sensitive cases
• Coordinating response strategies for audits, summons, and investigations

Case Study: $350,000+ Penalty Reduced Through Legal Action

A California-based taxpayer faced a $370,000 penalty related to late return filling. Working collaboratively with the client’s CPA, Sideman & Bancroft demonstrated that the “demand penalty” was not applicable resulting in full concession of the penalty—preserving both financial and reputational capital

CPA + Attorney Collaboration: Who Does What?

CPAs and attorneys each bring specialized skills to the penalty defense process. Collaboration ensures full-spectrum defense and maximizes the chances of abatement success.

Role	CPA	Tax Attorney
Identifies penalties and compliance gaps	✅
Gathers and organizes financial records	✅
Advises on legal risks and defense strategies		✅
Prepares IRS correspondence and legal briefs		✅
Represents client in Appeals or Tax Court		✅
Coordinates filings and supports documentation	✅	✅

When Legal Help Is Not Optional

You should involve an attorney when:

• FBAR or international penalties are involved
• There is criminal exposure
• IRS summonses are issued
• Fraud penalties are asserted
• Litigation may be necessary

Next Steps: Protect Your Client or Yourself

If you’re a CPA:
Refer high-stakes penalty cases early. Sideman & Bancroft offers confidential legal consultations and works as an extension of your team to protect client interests and reputation.

If you’re a taxpayer:
Avoid compounding mistakes. Our attorneys are former federal prosecutors and civil litigators who understand IRS tactics and defense strategies.

Schedule a Confidential Consultation Now

About Sideman & Bancroft
With decades of experience in high-stakes tax defense, Sideman & Bancroft LLP helps high-net-worth individuals and their advisors navigate complex IRS disputes. From penalty abatement to criminal investigations, our attorneys deliver personalized, discreet, and effective legal strategies that protect your wealth and your future.