Businesses, financial institutions and governmental entities (state and local) are required to file tax information returns with the U.S. Social Security Administration (“SSA”) or Internal Revenue Service (“IRS”). Common information returns include W-2 and 1099 forms for employees and contractors, 1098s for mortgage interest, and various 1099s for dividends, interest and miscellaneous income. Some organizations file hundreds of thousands of these forms on a regular basis.
The IRS imposes penalties for information returns that are incorrect. In some cases, the IRS identifies the issue and imposes penalties. For example, the IRS often asserts penalties in the case of a mismatch with respect to a Taxpayer Identification Numbers (“TIN”) reported on an information return and the name/TIN information that the IRS has on its system.
In other circumstances, the taxpayer files information returns but later determines that those original returns contained incorrect information or were untimely filed. The IRS imposes penalties when the taxpayer files corrected information returns. Penalties may apply to both the information returns filed with the SSA or IRS and with respect to the returns furnished to the payees, borrowers or other recipients.
These penalties are often substantial. In recent years, Congress has almost tripled the penalties applicable to incorrect information returns. Congress also has raised the maximum annual charts published by the IRS (included in the full alert) which provides the applicable penalty rates and caps.
As an illustration, assume that a large financial institution filed 12,000 forms for tax year 2016 with incorrect information. The error was not identified until late 2017. The penalty exposure, in general, could be as much as $3.12 million (12,000 returns x $260 per return penalty). In some cases, the penalty could be even higher depending on the number of years involved, the penalty cap amount and whether the error is deemed to be an “intentional disregard.”
Although the penalties are substantial, the IRS may waive penalties if the taxpayer establishes reasonable cause for the incorrect information return or untimely filing. Hunton & Williams’ tax practice has considerable experience responding to IRS information return penalties. We have secured waivers of penalties by establishing reasonable cause with the IRS.
The IRS provides an informal program to disclose incorrect information reporting pursuant to a voluntary correction agreement. In many cases, a voluntary correction agreement may be negotiated to avoid unnecessary burden on the taxpayer and the affected employees, contractors, borrowers, payees or other information return recipients.
The penalty rates and maximums for not filing correct information returns and/or not furnishing correct payee statements, including inflationary adjustments if applicable, are reflected in the following table (*-as adjusted for inflation):