Information return penalties: How to avoid or contest them.

• Author: Moore, Guinevere

Information returns are one of the most important enforcement tools the IRS has to ensure that taxpayers are reporting and paying the correct amount of tax. Today, there are over 40 information returns, all of which carry potential penalties for taxpayers who fail to file required information returns correctly and on time. Sees. 6721, 6722, and 6723 provide for penalties to be assessed when required information returns are incorrect, incomplete, filed late, or not filed at all. Penalties related to information returns are among the most significant penalties in the Internal Revenue Code. (1)

What are information returns?

An information return is a form designed to give the IRS and other government agencies the "information" needed to check taxpayers' tax returns. (2) Information returns include forms most U.S. taxpayers are familiar with, such as Form W-2, Wage and Tax Statement, more obscure forms such as Form 8937, Report of Organizational Actions Affecting Basis of Securities, and newer forms, such as Forms 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and 1095-C, Employer-Provided Health Insurance Offer and Coverage.

Forms W-2 and W-3

Form W-2 is one of the most commonly known information returns. It is used to report the wages paid to employees and the taxes withheld from them. Employees are familiar with Form W-2 because they receive it from their employer each year and use it to prepare their personal income tax returns. Employers must prepare and provide Form W-2 to each employee and must also prepare Form W-3, Transmittal of Wage and Tax Statements, which transmits the Forms W-2 and summarizes key information from each W-2 regarding all employees' wages, taxes, and other vital tax information to the IRS and the Social Security Administration.

Forms 1094-C and 1095-C

Forms 1094-C and 1095-C are among the newest information returns. They were created to facilitate the implementation of the Patient Protection and Affordable Care Act (PPACA), P.L. 111-148. Employers with 50 or more full-time employees that are subject to the employer mandate under Sec. 4980H use Forms 1094-C and 1095-C to report the information required under the PPACA regarding offers of health coverage and enrollment in health coverage for their employees. (3) Form 1095-C is similar to Form W-2 in that it provides the relevant health care information offered regarding that particular employee. Form 1094-C is used to transmit Forms 1095-C to the IRS, as well as provide summary information for each employer to the Service.

How are information returns used?

The IRS employs the Information Returns Program (IRP) to match information returns to individual tax returns to determine compliance. (4) These forms are a vital part of the self-reporting income tax system in the United States. If employers do not prepare and file Forms W-2 and W-3 as required, then employees will not have the information needed to prepare their personal income tax returns, the IRS will not have a way to check the information contained in the employees' returns against what the employer actually paid them, and the Social Security Administration will not have a way to calculate what each individual's benefits should be once those individuals reach retirement age.

Due to the vital role information returns have in the self-assessment income tax system, Congress has prescribed severe penalties for the failure to timely file correct information returns, (5) as well as the failure to furnish correct payee statements. (6) An employer who fails to prepare required information returns such as Forms W-2 and 1095-C will likely be assessed penalties for both the failure to file them and the failure to furnish employees with them.

What penalties are imposed for information return failures?

The penalties imposed for the failure to file and furnish complete, accurate, and timely information returns are contained in Sees. 6721, 6722, and 6723.

Sec. 6721: Failure to timely file correct information returns

Sec. 6721 provides for a three-tier penalty structure for the failure to timely file correct information returns. The penalty tier is based on when, if at all, filers meet their obligations. The penalty for the late filing, incorrect filing, or an absolute failure to file information returns is:

* Tier 1: $50 for each failure, up to a maximum of $500,000 per year if the failure is corrected on or before 30 days after the information return's due date; (7)

* Tier 2: $100 for each failure, up to a maximum of $1,500,000 per year if the failure is corrected on or before Aug. 1 of the calendar year in which the information return was required to be filed; (8) and

* Tier 3: $250 for each failure, up to a maximum of $3,000,000 per year, if the required information returns are not filed in a complete and accurate manner on or before Aug. 1 of the calendar year in which the information returns are required to be filed. (9)

Small businesses, which are defined for purposes of this statute as having gross receipts of less than $5 million, have lower maximum penalties. (10) The statute also provides a safe harbor for certain de minimis errors. (11)

Under this penalty regime, an employer that has 15,000 employees and fails to file complete and accurate Forms W-2 and W-3 by the Jan. 31 due date faces the following penalties:

* Tier 1--forms filed on or before March 1:

** $50 x 15,000 = $750,000.

** Penalty is capped at $500,000.

** Penalty exposure is $500,000.

* Tier 2--forms not filed by March 1, but filed on or before Aug. 1:

** $100 x 15,000 = $1,500,000.

** Penalty is capped at $1,500,000.

** Penalty exposure is $1,500,000.

* Tier 3--forms not filed by Aug. 1:

** $250 x 15,000 = $3,750,000.

** Penalty is capped at $3,000,000.

** Penalty exposure is $3,000,000.

An employer of more than 50 employees also is required to file PPACA health care coverage forms. (12) Assume the employer of 15,000 people fails to file Forms 1094-C and 1095-C for all of its employees. (13) The penalties for Forms 1094-C and 1095-C are calculated as follows:

* Tier 1--forms filed on or before March 28:

** $50 x 15,000 = $750,000.

** Penalty is capped at $500,000.

** Penalty exposure is $500,000.

* Tier 2--forms not filed by March 28, but filed on or before Aug. 1:

** $100 x 15,000 = $1,500,000.

** Penalty is capped at $1,500,000.

** Penalty exposure is $1,500,000.

* Tier 3--forms not filed by Aug. 1:

** $250 x 15,000 = $3,750,000.

** Penalty is capped at $3,000,000.

** Penalty exposure is $3,000,000.

Accordingly, an employer with 15,000 employees that fails to timely file complete and accurate Forms W-2, W-3, 1094-C, and...