IRS Provides Guidance on De Minimis Safe Harbor from Information Reporting Penalties

(Parker Tax Publishing January 2017)

The IRS has issued guidance for complying with Section 202 of the Protecting Americans from Tax Hikes Act of 2015, which provides that an error on an information return or payee statement need not be corrected to avoid a penalty if the error relates to an incorrect dollar amount and differs from the correct amount by no more than $100 (or $25 in the case of tax withheld). Notice 2017-9.

Background

Code Sec. 6721 and Code Sec. 6722 authorize civil penalties for (1) the failure to file correct information returns, and (2) the failure to furnish correct payee statements, respectively. The amount of each penalty varies based on (1) when the return/statement is filed or furnished; (2) whether the failure to file or furnish is corrected on or before 30 days after the required filing date, or after the 30th day but on or before August 1; and (3) whether the failure to file or furnish is due to intentional disregard of the rules.

As part of the Trade Preferences Extension Act of 2015, Congress increased the Code Sec. 6721 and Code Sec. 6722 penalty amounts, effective January 1, 2016. Generally, the penalties under Code Sec. 6721 and Code Sec. 6722 range from $50 to $260 for each occurrence of a failure to furnish correct information returns or a failure to furnish correct payee statements. Both penalties are annually adjusted for inflation.

Penalty for Failure to File Correct Information Return

Under Code Sec. 6721(a)(2), the penalty for failing to file a correct information return applies to failures to (1) file an information return with the IRS by the due date (failure to file timely), and/or (2) include correct information on the return (failure to include correct information). The second type of failure encompasses situations where a business does not include all required information on the return, or includes incorrect information. Depending on the facts, the failure to include information in the correct format can be a failure to file timely or a failure to include correct information.

A failure to file timely includes a failure to file in the required manner, for example, on magnetic media or in other electronic form as provided by Code Sec. 6011(e). However, under Reg. Sec. 301.6721-1(a)(2), no penalty is imposed for failing to comply with Code Sec. 6011(e)(2) - which mandates special electronic filing requirements for return preparers filing 11 or more Form 1040 series returns, Form 1041 returns, or a combination of these returns - except to the extent that such a failure occurs on more than 250 information returns or in the case of a partnership with more than 100 partners, more than 100 information returns (collectively, the threshold requirements).

The threshold requirements apply separately to (1) each type of information return, and (2) original and corrected returns. For example, if a business files 300 Forms 1099-DIV and later files 70 corrected Forms 1099-DIV, the corrected returns can be filed on paper (because they fall below the 250-threshold requirement) or electronically.

The penalty for the second type of failure, the failure to include correct information on a return, does not apply to:

(1) A de minimis number of information returns with such failures if the failures are corrected by August 1 of the calendar year in which the due date occurs. This exception cannot apply to the greater of 10 returns or 0.5 percent of the total number of information returns required to be filed for the year.

(2) Inconsequential errors or omissions, which are failures that do not prevent or hinder the IRS from processing the return, correlating the information with the taxpayer's return, or otherwise putting the return to its intended use. However, errors or omissions relating to the following are never inconsequential: (1) a taxpayer identification number, (2) the taxpayer's surname, or (3) dollar amounts.

Example: Assume that a Form 1099-MISC misspells the taxpayer's first name as "Willaim." If the error does not prevent the IRS from processing the form or correlating the Form 1099-MISC information with William's tax return, a penalty will not be imposed. But if the Form 1099-MISC misspells William's last name as "Simth" instead of "Smith," a penalty will be imposed because an incorrect surname is never an inconsequential error.

Penalty for Failure to Furnish Correct Payee Statements

Under Code Sec. 6722(b), the penalty for failing to furnish correct payee statements applies to failures to (1) furnish a payee statement by the due date (failure to furnish timely), and/or (2) include correct information on the payee statement (failure to include correct information). The second type of failure encompasses situations where a business does not include all information required to be shown on the statement, or includes incorrect information on the statement.

Reg. Sec. 301.6722-1(d)(2) provides that the term "payee statement" includes the following statements:

(1) Form 1099-MISC, Miscellaneous Income; Form 1099-INT, Interest Income; Form 1099-DIV, Dividends and Distributions; Form 1099-C, Cancellation of Debt; Form 1099-OID, Original Issue Discount;

(2) Form W-2, Wage and Tax Statement;

(3) Schedules K-1 required in conjunction with Forms 1041, 1065, and 1120S;

(4) Form 1098, Mortgage Interest Statement;

(5) Form 8300, Report of Cash Payments Over $10,000 Received in Trade or Business;

(6) Form 8282, Donee Information Return;

(7) Information returns reporting minimum essential coverage; and

(8) Information returns relating to offers of health insurance coverage by applicable large employers.

The penalty for the failure to include the correct information on a payee statement does not apply to inconsequential errors or omissions. An inconsequential error or omission is a failure that cannot reasonably be expected to prevent or hinder the taxpayer from timely receiving correct information and reporting it on his/her/its tax return, or from otherwise putting the statement to its intended use.

However, errors or omissions relating to the following are never inconsequential: (1) dollar amounts; (2) significant items in the taxpayer's address; (3) the appropriate form for the information provided; and (4) the manner of furnishing a statement required under Code Secs. 6042 (Form 1099-DIV), 6044 (Form 1099-PATR), 6049 (Form 1099-INT), or 6050N (royalties reported on Form 1099-MISC).

Example: Assume that a Form 1099-MISC misspells the word "boulevard" in the taxpayer's address. The error cannot reasonably be expected to prevent the taxpayer from timely receiving correct information and reporting it on his/her/its tax return or otherwise putting the statement to its intended use. Therefore, a penalty will not be imposed. But if the form lists the taxpayer's address as "4821 Grant Boulevard" when the correct address is "8421 Grant Boulevard," a penalty will be imposed.

Safe Harbor for De Minimis Errors on Information Returns

Section 202 of the Protecting Americans from Tax Hikes Act (Pub. L. 114-113), also known as the PATH Act, amended Code Secs. 6721 and 6722 to establish a safe harbor from the application of these penalties when the information return or payee statement is correctly filed but includes a de minimis error in the amount required to be reported. The safe harbor applies to information returns required to be filed and payee statements required to be furnished after December 31, 2016. In general, an incorrect amount need not be corrected if the error for any single amount does not exceed $100, or $25 for errors in reporting a withholding or backup withholding amount.

Therefore, under the safe harbor, businesses need not correct an error on an information return or payee statement, and are not subject to penalties for failing to file a correct information return or payee statement, if the error relates to an incorrect dollar amount and is not more than $100, or $25 if the error relates to the amount of tax withheld.

According to Notice 2017-9, which is discussed more fully below, the de minimis safe harbor only applies to inadvertent errors on information returns or furnished payee statements. This means that:

(1) The safe harbor does not apply to a business that intentionally misreports a dollar amount, since doing so falls under the intentional disregard rules of Code Secs. 6721(e) and 6722(e).

(2) The safe harbor only applies to information returns that have been filed and payee statements that have been furnished.

Election Not to Have the Safe Harbor Apply

The PATH Act also added (1) Code Sec. 6722(c)(3)(B), which provides that the safe harbor does not apply to any payee statement if the payee makes an election for the safe harbor not to apply; and (2) Code Sec. 6721(c)(3)(B), which states that the safe harbor does not apply to an incorrect dollar amount for which an election has been made under Code Sec. 6722(c)(3)(B). If an election is made, penalties for incorrect information on the return or statement continue to apply (i.e., the business may be subject to penalties for an incorrect dollar amount on an information return or payee statement even if the incorrect amount is a de minimis error).

Observation: While payors are not required to correct payee statements with de minimis errors in the absence of an election by the payee, the IRS is encouraging employers to correct any errors on Form W-2 to ensure that employees receive proper credit for their earnings and ensure that employers have paid and reported the proper amount of taxes.

The IRS recently issued Notice 2017-9 to provide guidance on the de minimis error safe harbor and the election by a payee to not have the safe harbor apply. Specifically, the notice (1) addresses the time and manner for making and revoking the Code Sec. 6722(c)(3)(B) election; (2) clarifies that the de minimis safe harbor does not apply to intentional errors or businesses that fail to file an information return or furnish a payee statement; (3) requires businesses to retain certain records; (4) solicits comments on the rules in the notice, including potential abuse of the de minimis safe harbor; and (5) confirms that to the extent future regulations incorporate the rules in the notice, the regulations will be effective for returns required to be filed, and payee statements required to be furnished, after December 31, 2016.

According to Notice 2017-9, if a payee makes the election under Code Sec. 6722(c)(3)(B), but the business furnishes a corrected payee statement to the payee and files a corrected information return with the IRS within 30 days of the date of the election, the error will be treated as due to reasonable cause and not willful neglect. Therefore, the Code Sec. 6721 and 6722 penalties will not apply to the error. When other rules or regulations provide additional time to file a corrected information return or furnish a corrected payee statement, Notice 2017-9 confirms that those rules or regulations apply instead of the 30-day rule.

Businesses cannot impose prerequisites, conditions, or time limitations on the payee's ability to request a corrected payee statement. However, they can prescribe reasonable rules for making the election, including whether the election can/must be made in writing, online (electronic), or by telephoneassuming the business provides written notification of the rules before the payee makes the election. Nevertheless, an online (electronic) option cannot be the exclusive way to make the election. If the business has not prescribed rules for making the election, the election can be made in writing to the address appearing on a payee statement furnished by the business to the payee, or as directed by the business after the payee makes "an appropriate inquiry."

The election must (1) clearly state that the payee is making the election; (2) provide the payee's name, address, and taxpayer identification number; (3) identify the type of payee statement(s) and account number(s), if applicable, to which the election applies; and (4) confirm that the election only applies to payee statements required to be furnished in a specified calendar year, if the payee wants the election to only apply to that year.

If the payee does not identify the type of payee statement and account number or the calendar year to which the election relates, the business must treat the election as applying to all types of payee statements required to be furnished to the payee in the calendar year in which the election is made and any succeeding calendar years.

Reasonable Cause Exception to Penalties

Regardless of whether the PATH Act de minimis safe harbor applies, Code Sec. 6724 provides that no penalty is imposed under Code Sec. 6721 or 6722 if the failure is due to reasonable cause. While "reasonable cause" is not defined in the Code, Reg. Sec. 301.6724-1(a)(2) clarifies that the business must establish one of the following:

(1) There were significant mitigating factors for the failure to file. Two examples are the business was not previously required to file the particular return or furnish the particular statement, or the business has an established history of complying with the particular information reporting requirement at issue.

(2) The failure was due to events beyond the business's control. Examples of this include the unavailability of pertinent business records, reliance on erroneous written information from the IRS, or contracting with an agent to file timely and correct returns and/or furnish timely and correct payee statements.

Internal Revenue Manual (IRM) 20.1.7.8.1 provides additional guidance on meeting the reasonable cause exception.

In addition to satisfying one of these prongs, Reg. Sec. 301.6724-1(a) provides that the business must have acted in a responsible manner before and after the failure occurred. According to IRM 20.1.7.8.2, businesses act in a responsible manner when they (1) exercise reasonable care in determining their filing obligations and handling the account numbers and balances; and (2) take significant steps to avoid the failure, such as requesting an extension of time to file, attempting to remove the cause of a failure once it has occurred, and correcting the failure once the cause has been removed.

For a discussion of information reporting penalties, see Parker Tax ¶262,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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