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Comments on proposed information reporting penalty regulations.

On behalf of Tax Executive Institute, I am pleased to submit these comments on the Internal Revenue Service's temporary and proposed regulations under sections 6721 through 6724 of the Internal Revenue Code, relating to the imposition of penalties for failure to comply with information reporting requirements. The temporary regulations (T.D. 8333) and proposed regulations (IA-119-90) were issued by the IRS on February 15, 1991, and were the subject of a public hearing on September 9, 1991. The temporary and proposed regulations were published in the Federal Register on February 15, 1991 (56 Fed. Reg. 6969 and 56 Fed Reg. 7001, respectively), and were reprinted in the March 11, 1991, issue of the Internal Revenue Bulletin (1991-10 I.R.B. 6 and 1991-10 I.R.B. 28, respectively). For simplicity's sake, the regulations are generally referred to as "the temporary regulations" and specific provisions are cited as "Temp. Reg. [section]." References to page numbers are to the temporary regulations (and preamble) as published in the Internal Revenue Bulletin.


Tax Execution Institute is the principal association of corporate tax executives in North America. Our nearly 4,600 members represented more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of tax-payer and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that evinces solid tax policy, that taxpayers can comply with, and that the IRS can audit.

TEI members are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed information reporting penalty regulations.


The Improved Penalty Administration and Compliance Act was enacted as part of the Omnibus Budget Reconciliation Act of 1989. The 1989 Act substantially revised the civic penalty provisions of the Internal Revenue Code. With particular regard to the imposition of penalties for failure to comply with certain information reporting requirements, sections 6721 through 6724 were amended to consolidate the information reporting penalty provisions, thereby obviating the imposition of multiple penalties for failures relating to a single information reporting return.

Specifically, the penalty for failure to include correct information on information returns, which was formerly found in section 6723, was made part of section 6721's penalty for failure to timely file correct information returns. The penalty for failure to include correct information on payee statements, which was formerly found in section 6723, was incorporated into section 6722, which imposes a penalty for failure to timely furnish correct payee statements. In addition, section 6723 was amended to impose a penalty for failure to comply with specified information reporting requirements not covered by section 6721 and 6722. (The penalties relating to specified information reporting requirements were formerly contained in sections 6672 and 6676(a), (c), and (d).) Section 6724 sets forth rules for the non-imposition of penalties where a failure is due to reasonable cause and not to willful neglect.

Rules Relating to

Information Returns

1. Prop. Reg. [section] 301.6721-1T(a)(2)(ii) provides that a failure to timely file "includes a failure to file in the required manner, for example, on magnetic media or in other machine-readable form as provided under section 6011(3)." Hence, a $50 per return penalty would be imposed under the regulations if the IRS is unable to process the magnetic media transmitted by a filer. Under section 12 of Rev. Proc. 91-33, 1991-24 I.R.B. 4, however, a filer is permitted to resubmit unprocessed tapes without penalty if the filer does so within 45 days after having been returned by the IRS for format or coding errors that prevent processing. [sup.1] TEI endorses the rule contained in the revenue procedure and recommends that the regulations be revised to include a reference to administrative pronouncements that set forth remedies for resubmitting data on magnetic media without penalty.

2. Prop. Reg. [section] 301.6721-1T(a)(2)(ii) provides that a failure to include correct information encompasses "a failure to include information required by applicable information reporting statutes or by any administrative pronouncements (such as regulations, revenue rulings, revenue procedures, or information reporting forms and instructions)." [sup.2] Although the knowledge presumed by this rule does not pose a substantial problem for sophisticated filers, it may suppose a level of "tax literacy" above that of many individuals who are subjec to the Internal Revnue Code's information reporting provisions. It may seem like heresy to tax professionals (including both TEI members and individuals who work at 1111 Constitution Avenue in Washington, D.C.), but many filers have no idea what a revenue procedure or revenue ruling is, let alone have access to such documents. The point is not to excuse noncompliance, but rahter to underscore the IRS's obligation to provide the necessary guidance to filers.

Thus, consistent with the IRS's Compliance 2000 initiative, TEI recommends that the IRS redouble its efforts to make forms, instructions, and information guides clear, complete, informative, easy to understand, and readily available on a timely basis to the average filer. Again, although filers themselves are ultimately responsible for compliance, no one should be liable for a penalty for failure to comply with an information reporting requirement when he or she had no reasonable way to be aware of it.

3. To encourage filers to submit corrected information to the IRS as promptly as possible, section 6721 provides a time-sensitive tiered penalty structure, under which the basic $50 penalty is reduced to $15 if a failure is corrected within 30 days of the required filing date and to $30 if a failure is corrected after the end of such 30-day period but on or before August 1 of the year in which the return is to be filed. 1991-10 I.R.B. at 6. Prop. Reg. [section] 301.6721-1T(b) prescribed rules under which a reduced penalty will be imposed where the correction is made within specified periods.

The proposed regulations contain a special rule for the reduction of the penalty in connection with returns not due on February 28. Specifically, Prop. Reg. [section] 301.6721-1T(b0(6) provides that a $15 penalty will be impowed where a failure is corrected within 30 days. The proposed regulations continue, however, that there is no period during which the penalty will be reduced to $30. Thus, notwithstanding the tiered structure in section 6721(b), a $50 penalty will be imposed in respect of failures relating to returns not due on February 28 that are not corrected within 30 days.

The legislative history of the 1989 Act contains no support for distinguishing between returns due on February 28 and other returns in applying the time-sensitive penalty. In addition, we question the statement in the preamble that "[c]orrection by August 1 of returns having required filing dates other than February 28 has limited, if any, practical effect." 1991-10 I.R.B. at 7. The House Report on the 1989 Act states that the August 1 date was selected because "this is approximately the date on which the IRS begins intensive processing and use of this data." H.R. Rep. No. 101-247, 101st Cong., 1st Sess. 1383 (1989). In the absence of a declarative, substantiated statement that the IRS "begins intensive processing and use of th[e] data" on, for example, a Form 8281 (Information Return for Publicly Offered Original Issue Discount Instruments) before August 1, there is no basis -- let alone authority -- for disregarding the second tier of the penalty.

Consequently, we recommend that the regulations be revised to expand the scope of the second-tier $30 penalty so that it will apply in respect of any information returns corrected by August 1. This result is especially proper where (i) the due date of the return is a date specific (without regard to the date of a transaction), and (2) the return relates to payments made in the prior year. Thus, a filer who corrects Forms 1042 and 1042S (which are due on or before March 15 in respect of taxes withheld on U.S.-source income of foreign persons) after April 14, but on or before August 1, should be subject to at most a $30 penalty. [sup.3]

In addition, given the structure of the statute, we believe the $30 penalty should generally apply in respect of failures corrected more than 30 days but less than 150 days after the due date of the return, regardless of whether the due date is linked to the date of a transaction. [sup.4] This proposed 150-day rule would be compared to the "more than 30 days but prior to August 1" rule set forth in Prop. Reg. [section] 301.6721-1T(b)(2) for returns due on February 28. [sup.5] Indeed, the filer's correction of the failure within the 150-day period could well excuse the assertion of any penalty on the grounds that it manifested the filer's acting in a "responsible manner" pursuant to Prop. Reg. [section] 301.6724-1T(d) (relating to the reasonable cause exception).

4. Prop. Reg. [section] 301.6721-1T(c) provides that "[a]n inconsequential error or omission is not considered a failure to include correct information." It continues to provide that the term "inconsequential error or omission" means --

any failure that does not prevent or hinder the Internal Revenue Service from processing the return, from correlating the information required to be shown on the return with the information shown on the payee's tax return, or from otherwise putting the return to its intended use. (6)

TEI commends the IRS for developing the "inconsequential error or omission" rule. The importation of a "no harm, no foul" rule into the regulations makes eminent sense.

We regret, however, that the examples under Prop. Reg. [section] 301.6721-1(c)(3) undermine the vitality of the rule. Thus, Example 2 provides that a penalty will be imposed because a wrong address -- the correct city and zip code but incorrect state -- "prevents the Internal Revenue Service from correlating the information required to be shown on the information return with the information shown on the payee's tax return." We submit that if a payee's name and taxpayer identification number (TIN) are correctly reported on a Form 1099, the payee's address is not necessary to match the Form 1099 to a payee's income tax return. Since a payee's address can change at any time, filers may be penalized under the proposed regulations even where a failure has no effect on the IRS's use of the return.

Consequently, TEI recommends that Example 2 be deleted or, alternatively, modified to provide that an error in the "payee address" on an information return will be deemed inconsequential where the payee's name and TIN are correctly reported. In addition, we believe the regulations should recognize that filers and the IRS may reasonably disagree over what is "inconsequential" and that the reasonable cause exception in section 6724(a) could operate to excuse a failure even if the IRS concluded that the error was not inconsequential. Thus, if a taxpayer has a reasonable basis for concluding that an error is inconsequential (e.g., in the fact pattern in Example 2) and took steps to forestall its reoccurrence, no penalty should be imposed even if the error does not fall within the scope of Prop. Reg. [section] 301.6721-1T(c).

5. Prop. Reg. [section] 301.6721-1T(d)(1) provides that a penalty will not be imposed for a de minimis number of failures to include correct information if the filer corrects such failures on or before August 1 of the year in which the required filing date occurs. Section 6721(c)(2) and Prop. Reg. [section] 301.6721-1T(d)(2) state that the number of allowed corrections without penalty shall not exceed the greater of 10 or one-half of one percent of all information returns required to be filed by a person during the year.

The proposed regulations are unclear whether the "one-half of one percent" prong of the de minimis rule is to be calculated on an aggregate or a per-type-of-return basis. TEI is concerned that the examples under Prop. Reg. [section] 301.6721-1T(d)(3) could be read as requiring that "one-half of one percent" will be calculated separately for each type of information return as opposed to the aggregate of all types of information returns. (7) Hence, if a filer timely filed 100,000 of 100,000 Forms 1099-INT but only 1,990 of 2,001 Forms 1099-DIV, a penalty would be imposed even though -- in the aggregate -- the filer correctly filed 99.99 percent of required information returns. To eliminate this possibility, we recommended that the regulations expressly confirm that the de minimis rule will be applied on an aggregate basis. We also recommend that an example be included illustrating the application of the refined de minimis rule to an individual who files several different types of information returns (e.g., Forms W-2, 1099-INT, 1099-DIV, and 1099-MISC).

Rules Relating to Reasonable

Cause Exception

6. Section 6724(a) of the Code provides that no penalty for a failure relating to an information reporting requirement is to be imposed "with respect to any failure if it is shown that such failure is due to reasonable cause and not to willful neglect." Although the statutory provision is captioned "reasonable cause waiver," it is clear from both the statutory language and its legislative history that the provision is not discretionary: if reasonable cause exists, no penalty is to be imposed. Thus, we believe the statute imposes an obligation on the IRS to inquire whether reasonable cause exists before asserting a penalty. This shift in emphasis, while subtle, is important: it was intended to signal Congress's intention that the IRS should avoid a "gotcha" mentality and apply the reasonable cause exception in a flexible, rational, and balanced manner.

In this regard, we note that the legislative history of the 1989 Act contains several administrative recommendations to the IRS concerning information reporting penalties. H.R. Rep. No. 101-247, supra, at 1405-06. The most pertinent recommendation is, as follows:

The IRS should better use its limited enforcement resources to ensure that taxpayers who continually fail to comply with the reporting requirements are identified and penalized, rather than focusing only on taxpayers who are working with the IRS in an attempt to comply with the law.

Although the proposed regulations represent a meaningful step toward the implementation of this administrative recommendation, we believe further changes are necessary to effectuate the spirit of reform behind the 1989 Act changes. Our recommendations with respect to the reasonable cause exception are set forth in the ensuing comments.

7. Prop. Reg. [section] 301.6724-1T sets forth several objective criteria for determining whether reasonable cause exists. Although we commend the IRS for endeavoring to bring clarity to this area, we are concerned about the exclusive nature of the proposed regulations. For example, Prop. Reg. [section] 301.6724-1T(a)(2) provides that the penalty will be waived "only if" the filer --

(i) establishes that either --

(a) there are "significant mitigating factors" for the failure (which are set forth in Prop. Reg. [section] 301.6724-1T(b)), or

(b) the failure arose from events "beyond the filer's control" (which are discussed in Prop. Reg. [section] 301.6724-1T(c)); and

(ii) establishes that the filer "acted in a reasonable manner" (as described in Prop. Reg. [section] 301.6724-1T(d)) both before and after the failure occurred.

Notwithstanding the statutory structure of the reasonable cause exception, the proposed regulations impose a high burden of proof for a filer to secure relief.

TEI believes that the IRS should temper the unduly stringent slant of the reasonable cause provision by revising the regulations to confirm that the examples of "mitigating factors," "events beyond the filer's control" and the description of "acting in a responsible manner" in the regulations are just that--examples. Thus, an examining agent should not be precluded from using his or her judgment in determining that non-specified "reasons" for a failure should also give rise to the application of section 6724(a).

8. Prop. Reg. [section] 301.6724-1(b)(2) states that the filer's "established history of complying with the information reporting requirement" constitutes a significant mitigating factor establishing reasonable cause. For this purpose, the proposed regulations state that significant consideration is to be given to whether the filer has incurred any penalties in prior years, and if so, the extent of the filer's success in lessening the error rate from year to year.

We recommend that, in applying this rule, a filer who is successful in invoking the reasonable cause exception in section 6724(a) should not be considered to have "incurred" a penalty for the year. In other words, a finding that reasonable cause existed for the failure should wipe the slate clean for purposes of the filer's "history of complying with the information reporting requirement." <8>

9. Under Prop. Reg. [section] 301.6724-1T(c)(2), a filer will not be able to establish reasonable cause for a failure owing to the unavailability of the relevant business record unless the records --

have been unavailable for at least a 2-week period prior to the due date of the required return (or the required date for furnishing the payee statement), and the unavailability. . . [is] caused by a supervening event.

With due respect, the inclusion in the regulations of a two-week standard is unjustifiably arbitrary. It blithely ignores the fact that a supervening event preventing the availability of records could occur far less than two weeks before the due date of the return but nevertheless preclude timely filing. For example, under the rule, a filer who is unfortunate enough to suffer a fire that destroys all business records one week before the due date would not qualify for this exception. We recommend that the regulations be revised to provide that no penalty will be imposed in such a situation.

10. Under Prop. Reg. [section] 301.6724-1T(c)(2)(ii), a statutory or regulatory change having a direct effect on data processing will be considered a "supervening event" supporting application of the reasonable cause provision where the statutory or regulatory change "is made so close to the time that the return (or payee statement) is required that, for all practical purposes, it cannot be compiled with . . . ." TEI believes that the provision should be clarified to obviate disputes between filers and the IRS. Specifically, a "reasonable efforts" standard should be incorporated into the regulations. For example, a filer should not be required to incur significant expenses (in overtime charges or consulting fees) in order to defeat a penalty assertion. Hence, if a filer can comply with a regulatory change only by having its data-processing staff work 12-hour days for the two weeks prior to the required filing date, it should not find itself outside the "supervening event" rule merely because it declines to incur the expenses associated with such an extraordinary effort. To ensure such a result, we recommend that the regulations provide that a statutory or regulatory change will constitute a "supervening event" unless the filer is able to comply with the change through the normal course of business without significant, extraordinary expense.

11. Prop. Reg. [section] 301.6724-1T(c)(6) states that, in order to substantiate reasonable cause owing to the actions of the payee or another person, a filer must provide documentary evidence upon request by the IRS showing that the failure was attributable to the payee or other person. With respect to reasonable cause for missing TINs, Prop. Reg. [section] 301.6724-1T(e) describes the payee notifications that must be made by the filer to establish reasonable cause for failure to provide the missing payee TIN. (9)

Prop. Reg. [subsection] 301.6724-1T(e)(2)(ii)(D) and (E) provide the only guidance regarding what may constitute "documentary evidence" by stating, in connection with telephone solicitation of TINs, that "contemporaneous records" must be maintained by the filer and provided to the IRS upon request. These provisions imply that the filer must maintain detailed payee records identifying the time a contact is made and who provided the TIN. Such documentation, however, could be an extremely costly endeavor, especially for large volume filers.

A more cost-effective approach for many filers would be to solicit TINs through the mail in accordance with Prop. Reg. [section] 301.6724-1T(e)(2)(i). Regrettably, the proposed regulations provide no guidance on what constitutes "documentary evidence" that a mail solicitation was made. We believe that the regulations should be amended to provide that reasonable cause exists where the filer can demonstrate that (i) it had established reasonable policies and procedures to ensure compliance with the solicitation rules, and (ii) it had made a good-faith effort to ensure that such policies and procedures were followed. Under this proposal, documentary evidence of the efforts undertaken in respect of specific payees would be unnecessary. We believe this approach woudl permit the filer to devote resources to compliance efforts that ensure the gathering and reporting of accurate information as opposed to maintaining a detailed audit trail on a payee-by-payee basis in an attempt to avoid penalties.

12. Under Prop. Reg. [section] 301.6724-1T(e)(1), reasonable cause will exist for a missing TIN only if the filer makes both an initial solicitation and annual solicitation for the TIN. Prop. Reg. [section] 301.6724-1T(e)(1)(i) states that an initial solicitation for a payee's correct TIN "must be made at the time an account is opened." TEI believes that the regulations should provide a reasonable grace period for the initial solicitation of TINs. In many cases, the opening of the account involves requesting service from a vendor who will receive a Form 1099 at the end of the year. Generally, this is done orally, and the individuals responsible for monitoring compliance will not be aware of the arrangement until an invoice is received. Allowing a grace period of 30 days from the later of the date the account is opened or an invoice is received would not vitiate the intent of this requirement but would eliminate potential disputes between filers and the IRS over what is considered ". . . at the time the account is opened."

13. Under Prop. Reg. [section] 301.6724-1T(e)(1)(iv), reasonable cause will not exist unless the filer, once a correct TIN is received, corrects the returns previously filed with incorrect or missing TINs. (10) TEI believes that this "amended return" requirement will be either impractical or economically infeasible for filers who do not maintain prior-year filing histories on readily accessible files. More fundamentally, the filing of corrected returns or late original returns pursuant to Prop. Reg. [section] 301.6724-1T(e)(1)(iv) could give rise to an ensuing round of penalty notices unless the corrected returns are segregated and treated differently by the IRS. To avoid this problem, we recommend that the requirement be eliminated.


Tax Executives Institute appreciates this opportunity to present our views on the IRS's temporary regulations under section 6621(c). If you have any questions about the Institute's comments, please do not hesitate to call Clifford H. Omo, chair of TEI's Federal Tax Subcommittee on Payroll and Other Taxes, at (214) 658-3199 or Timothy J. McCormally of the Institute's professional staff at (202) 638-5601.

(1) Rev. Proc. 91-33 sets forth the specifications for filing Forms 1098, 1099, 5498, and W-2G electronically or on magnetic media. Section 12 is captioned "Procession of Information Returns Magnetically/Electronically."

(2) Prop. Reg. [section] 301.6722-1T(a)(2)(ii) contains a similar rule in respect of the penalty for failure to furnish correct payee statements.

(3) Under the proposed regulations, a calendar-year corporation that files an incorrect Form 8594 (Asset Acquisition Statement under Section 1060) along with its Form 1120 on March 15 and, after April 14, files a corrected Form 8594 will be subject to a $50 penalty even though the corporation could have secured an automatic extension of time until September 15 to file its tax return and associated Form 8594. Such an anomalous result does not make sense.

(4) TEI recognizes that the legislative history does not specifically address the application of the tiered penalty structure to information returns that are not due on February 28. We do not believe, however, that this omission should be interpreted to a filer's detriment, especially in light of the overall purpose pf penalty reform. Consequently, should the IRS conclude that it does not have authority to adopt the proposed 150-day rule in respect of non-February 28 returns, we urge it to seek such authority.

(5) An analogous problem exists in Prop. Reg. [section] 301.6721-1T(d), relating to the de minimis exception under section 6721(c). Without any statutory authority, Prop. Reg. [section] 301.6721-1T(d)(4) provides that the exception only applies to returns due on February 28. We urge that this error be corrected in the final regulations.

(6) A similar rule is set forth in Prop. Reg. [section] 301.6771-1T(b), relating to the penalty for failure to furnish correct payee statements.

(7) Examples 1, 2, 3, and 4 each contain the statement that the specified number of returns "are all the information returns that [the taxpayer] is required to file . . . ."

(8) This change would be consistent with another of the Congress's administrative recommendations in respect of the 1989 penalty reform: "In the application of penalties, the IRS should make a correct substantive decision in the first instance rather than mechanically assert penalties with the idea they will be corrected later." H.R. Rep. No. 101=247, supra, at 1405.

(9) Prop. Reg. [section] 301.6724-1T(f) contains similar rules for demonstrating that a filer acted in a reasonable manner in connection with incorrect TINs.

(10) Prop. Reg. [sections] 301.6724-1T(d)(1)(ii)(D) and 301.6724-1T(f)(1)(iv) contain similar rules.
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Publication:Tax Executive
Date:Nov 1, 1991
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