On June 29, 2015, President Obama signed into law the Trade Preferences Extension Act of 2015. Neatly tucked away in the “Offsets” provision of the Act are sizeable increases in the dollar amounts of the penalties under Internal Revenue Code sections 6721 and 6722. The new provisions are apply to information returns and statements required to be filed after December 31, 2015 (i.e., returns for payments made this year)—so the cost for failing to file or filing incorrectly just got more expensive.
As any payroll tax professional will tell you, Code sections 6721 and 6722 are the penalty provisions for Forms W-2 and Forms 1099. The Act increases the penalty for a single incorrect return by 150 percent—from $100 to $250. The annual cap on all such failures was doubled—from $1,500,000 to $3,000,000. The penalty for intentionally failing to file was increased from $250 to $500 for a single return.
In calculating these penalties, employers must double the above numbers. There are two statutes at issue, and for every employee or payee an employer has, there are two filing requirements: (1) Code section 6721 applies to the returns required to be filed with the Internal Revenue Service (IRS) and (2) Code section 6722 applies to the returns required to be provided to employees or other recipients of taxable compensation. Thus, a single incorrect Form 1099 will now cost an employer $500.
Most Forms W-2 and Forms 1099 are routine and do not present issues for employers. However, when settling an employment-related lawsuit that may result in awards for multiple types of damages, each with different tax consequences, the stakes just got higher. When allocating wages and other non-wage damages among plaintiffs’ various causes of action, employers and plaintiffs are required to allocate the settlement payments in good faith based on the facts and circumstances giving rise to the lawsuit. However, it is the employer who bears the filing requirements.
Moreover, the IRS when determining the tax consequences of settlement awards is not bound by the allocations made by the employer and the plaintiff. In a typical wage-based lawsuit, the employer files at least six information returns—(1) Forms W-2 to the plaintiff; (2) Forms 1099 to the plaintiff; (3) Form 1099 to the plaintiff’s attorney; (4) a Form W-2 to the IRS; and (5) two Forms 1099 to the IRS. If the IRS determines that the amount reported on the Forms W-2 and Forms 1099 to the plaintiff are incorrect, the employer could now incur $1,000 in penalties. These penalties are in addition to the amounts the IRS usually collects from the employer, including any increased Federal Insurance Contributions Act (FICA) taxes and income tax withholdings. In addition, the employer will eventually hear from its local state department of revenue.
Employers should always exercise reasonable judgment when settling employment-related lawsuits. Now, the costs of failing to do so have increased.