If your organization is the recipient of a proposed penalty notice from the IRS, there are steps you can take to argue that you have reasonable cause for the errors.
The IRS mails proposed penalty notices, Notice 972CG, in August. The notice relates to the Forms 1099 filed the previous calendar year for payments made in the prior tax year. For example, a Notice 972CG mailed in August 2019, relates to Forms 1099 filed in 2018 for tax year 2017.
Rather than paying the penalty, the best strategy is to respond with a waiver request letter. The waiver letter must be postmarked no later than 45 calendar days after the basis date on the Notice 972CG. The basis date is calculated by reference to the date on the notice or the date the filer receives the notice, whichever is later.
Penalties are assessed for the following errors in a Form 1099 file:
- Incorrect dollar amounts;
- Filing in excess of 249 forms of a single type on paper.
In the absence of intentional disregard for the reporting requirements, penalties are assessed at a 2019 rate of $270 an error, with a maximum assessment of $3,275,500 per year for large businesses, $1,091,500 for small businesses, per type of error. (See the IRS site for scheduled 2020 increases.)
What Happens if the IRS Doesn't Accept Your Explanation?
Should the IRS determine the filer intentionally disregarded the reporting requirements, penalties are assessed at a rate of $540 an error in 2019, with no maximum assessment ceiling. (This will be adjusted for inflation to $550 in 2020.)
The penalties for failure to furnish payee statements have been revised to provide tiers and caps similar to those applicable to the penalty for failure to file the information return.
How to Write a Waiver Letter
According to Section 6724, which contains the “reasonable cause” regulations, the letter must be a written statement to the IRS that:
- Includes the specific provision (cite the paragraph reference) under which waiver is sought;
- Sets forth facts alleged as the basis for reasonable cause;
- Contains the signature of the person required to sign the return; and
- Contains penalty of perjury declaration.
In addition, in order to write a waiver request letter, filers must rely on the language found in regulations.
In order to establish that it has reasonable cause for its errors, a filer must demonstrate that:
- It acted in a responsible manner; and
- There are significant mitigating factors for its errors; or
- Its errors are due to events beyond its control.
For example, a filer might begin its waiver request as follows:
"XYZ Company requests a full waiver of the $7,000 in proposed penalties relating to its Form 1099 file. In this letter, XYZ Company will demonstrate that, pursuant to Section 6724, it has reasonable cause for the errors in its file. Specifically, XYZ will demonstrate that it acted in a responsible manner with regard to its Form 1099 reporting requirements, that significant factors mitigate its errors, and that its errors are due to events beyond its control; namely, the errors are the result of the actions of its payees."
Filers should also review the penalty assessment to determine whether penalties have been proposed for Forms 1099 the filer was not required to file, such as those sent to exempt recipients or for amounts below the dollar threshold (e.g., $600 for most Form 1099 reportable payments). If penalties have been proposed for these kinds of Forms 1099, filers do not have to establish reasonable cause for these types of errors, but should be sure to argue in the waiver letter that they should not be required to pay penalties for Forms 1099 they were not required to file in the first place.
Arguing 'Actions of the Payee'
Arguing that the errors are the result of the actions of the payee is by far the best excuse a filer could have. However, in order to argue this point successfully, the filer must demonstrate, by explaining in detail, that it asked the payees for the information at the time and in the manner required. That is, payers must have completed all required TIN solicitations.
Following the introduction, XYZ will be required to explain in detail its Form 1099 processes and procedures, including the manner in which it opens accounts, solicits payee information, processes its B Notice list, and effects backup withholding. In writing the waiver letter, XYZ must rely on the definitions of reasonable cause as set forth in the regulations. Specifically, the regulations define reasonable cause as follows:
A. "Responsible manner" means:
1. Requesting appropriate extensions of time to file;
2. Filing corrections promptly;
3. Fixing errors within 30 days of discovery; or
4. Conducting appropriate TIN solicitations (in order to argue mistakes were due to the actions of the payee).
B. Significant mitigating factors means:
1. You are a first-time filer; or
2. You have an established history of compliance, which means you have paid past penalties and/or lessened your error rate year-to-year.
C. Events beyond your control means:
1. Business records were not available due to a fire or casualty loss; a statutory or regulatory change with direct impact upon processing made so close to the time that the return or statement is required that, for all practical purposes, the change cannot be complied with; or an unavoidable absence (death, serious illness) of the person with the sole responsibility for filing.
2. Actions of the IRS (must be in writing).
3. Actions of an agent.
4. Actions of the payee.
Filers must specifically cite and reiterate the language in the reasonable cause regulations on which they are relying in support of their waiver request.
Requesting an extension of time to file Forms 1099 with the IRS can operate to assist a payer in achieving a penalty waiver. Payers should always request an extension of time to file. In addition, payers should fix errors in their filings as soon as they are made aware of them, and should complete the appropriate TIN solicitations for payees.
TIN solicitations are required in order to meet the requirements of the reasonable cause regulations, but these solicitations do not abolish the payer’s obligation to effect backup withholding on reportable payments for which it does not have the payee’s TIN or on reportable payments for which it does not have the payee’s appropriate B Notice response.
In fact, evidence of backup withholding, whether as a result of the payee’s initial failure to provide a TIN or to respond to a B Notice letter, is key to obtaining a waiver of these penalties.
All filers should be able to argue that they have an established history of compliance. The ability to argue an established history of compliance is one of the key reasons filers should never pay proposed penalties without first seeking a waiver of them.
Even if you paid penalties in the past, if the penalty amounts, or the number of errors, have lessened from year to year, or over time, you should always use this fact to your company’s advantage and include the information in the waiver letter. Indeed, lessening the error rate from year to year, even if some errors continue to exist, is one of the very definitions of having an established history of compliance.