I would reply (to the address provided on the letter, with exactly what you have said here, and ask for "Reasonable Cause Abatement."
Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed.
Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations.
The criteria that the IRS uses (from an internal manual for IRS managers) are as follows:
"Taxpayers have reasonable cause when their conduct justifies the non-assertion or abatement of a penalty. Each case must be judged individually based on the facts and circumstances at hand. Consider the following in conjunction with specific criteria identified in the remainder of this subsection:
What happened and when did it happen?
During the period of time the taxpayer was non-compliant, what facts and circumstances prevented the taxpayer from filing a return
, paying a tax, and/or otherwise complying with the law
How did the facts and circumstances result in the taxpayer not complying?
How did the taxpayer handle the remainder of their affairs during this time?
Once the facts and circumstances changed, what attempt did the taxpayer make to comply?"
If you uses each of these criteria in your explanation and show how you have satisfied these (and from the facts you provide, I believe you have a good case, if you have never requested abatement of penalty before, it is my opinion that they will grant abatement.
Do include copies of checks, bank records, anything that will substantiate.