Information Reporting Penalty and the Reasonable Cause Defense
Forms W-2 are subject to information reporting penalties under Sections 6721 and 6722 of the Internal Revenue Code. Section 6721 imposes a penalty for any failure to file an information return timely, for any failure to include all required information, or for the inclusion of incorrect information. Section 6722 imposes a penalty in the case of any failure to furnish a payee statement on or before the required date, any failure to include the required information, or the inclusion of incorrect information.
For 2018, the penalty under both Section 6721 and 6722 is $260 per return, to a maximum limit of $3,218,500 per filer per year. The amount of the penalty may be reduced to $50 per return, to a maximum of $536,000 per year, if the failure is corrected within 30 days of the due date. The penalty may be reduced to $100 per return, to a maximum of $1,609,000 per year, if the failure is corrected by August 1. The maximum annual penalties are lowered for filers with gross receipts of less than $5 million. In the case of failures due to intentional disregard of the information reporting requirements, the penalty is the greater of $530 per return or 10 percent of the amount to be reported correctly, with no annual limit. All the penalties are adjusted for inflation under Sections 6721(f) and 6722(f).
Section 6724 provides for a waiver of these penalties due to reasonable cause. The regulations provide that the penalty will be waived only if the filer establishes that either (1) there are significant mitigating factors with respect to the failure; or (2) the failure arose from events beyond the filer’s control (an impediment). In addition, the filer must establish that the filer acted in a responsible manner; both before and after the failure occurred. See § 301.6724-1 (a)(2).
Section 301.6724-1(b) of the regulations provides that “significant mitigating factors" may include the fact that the filer was never required to file this type of information return or statement before, or that the filer has an established history of complying with this information reporting requirement in the past, with consideration given to the filer's penalty history.
Section 301.6724-1(c) provides that “events beyond the filer's control" may include such impediments as the unavailability of business records or actions of other parties such as the IRS, the filer’s agent, or the payee. The regulations provide that in order to establish reasonable cause based on the actions of the payee (i.e., an employee who provides an incorrect social security number (SSN), the filer must show that the failure resulted from the failure of the payee to provide information to the filer, or that the failure resulted from incorrect information provided by the payee upon which information the filer relied in good faith. See § 301.6724-1(c)(6). Thus, an employer may claim that the failure to include correct information on the Form W-2 was due to the actions of the payee, if the employer received an SSN from its employee, relied on that number in good faith, used it on a Form W-2, and subsequently received a penalty notice from the IRS notifying the employer that the employee's SSN was incorrect.
To qualify for a waiver of the penalties imposed by Sections 6721 and 6722, the filer must also demonstrate that it acted in a responsible manner, both before and after the failure. Section 301.6724-1(d) of the regulations provides that "acting in a responsible manner" means that the filer exercised reasonable care, which is the standard of care that a reasonably prudent person would use under the circumstances, and that the filer undertook significant steps to avoid or mitigate the failure, including attempting to prevent an impediment or failure, acting to remove the impediment, and rectifying the failure promptly. Where a filer is seeking a waiver of the penalty based on the failure of a payee to provide a correct SSN, special requirements apply for establishing that the filer acted in a responsible manner. See § 301.6724-1(f). Under these rules, an employer would have to show that it made an initial solicitation for the employee’s SSN at the time the employee began work. Following that solicitation, no additional solicitation for the SSN is required unless the IRS notifies the employer that the employee's SSN is incorrect. Following receipt of such IRS notice, the employer may be required under the regulations to make an annual solicitation for the correct SSN. The employer may be required to make up to two annual solicitations following IRS notices.
The first annual solicitation of the employee's SSN is required only if the IRS notifies the employer that the employee's SSN is incorrect, and if the employer's records contain that incorrect SSN at the time it receives the notice. The solicitation for the SSN must be made by December 31 of the year in which the penalty notice was received, and may be made by mail, telephone or in person. The solicitation need not be made if there will not be any reportable payments to that employee in that year. A second annual solicitation would be required if the employer receives an IRS notice of incorrect SSN for the employee in any subsequent year. An employer may rely on the SSN that an employee provides in response to a solicitation, and the employer may use that SSN in filing a Form W-2 for that employee. The employer is required by the regulations to make only two annual solicitations. If the employer receives an IRS notice of an incorrect SSN after having made two annual solicitations and reporting the SSN provided by the employee, the employer is not required to make further solicitations. The employer's initial and two annual solicitations will demonstrate that the employer has acted in a responsible manner before and after the failure and will establish reasonable cause under the regulation.
To obtain a penalty waiver based on reasonable cause and not willful neglect, the filer must submit a written statement to the IRS, signed under penalties of perjury, which provides the specific provision under which the file is requesting the waiver, and the facts forming the basis for reasonable cause.