If taxpayer-employers fail to timely file accurate information returns (such as Forms W-2/W-3 and Forms 940/941), the IRS has the authority to impose civil penalties.
This authority is granted by Section 6721. The penalty varies under the three-tiered penalty structure of section 6721, primarily depending on when the correct information return is ultimately filed and, in some cases, the size of the employer.
A penalty of 10% “of the aggregate amount of the items required to be reported correctly” may be imposed by the IRS under section 6721(e) if the IRS can demonstrate that the failure to timely and correctly file an information return was caused by “intentional disregard.”
Thus, the IRS may impose a section 6721(e) penalty of $50,000 against a taxpayer-employer if, for instance, the taxpayer-employer submits a Form W-3 with incorrect information regarding the gross wages that should have been reported as $500,000 for the year.
There are defences available to taxpayer-employers who are subject to civil penalties under section 6721(e).
The intentional disregard penalty may be waived or reduced by appropriate justification, among other grounds, just like other federal civil tax penalties.
However, taxpayers who claim reasonable cause in these situations (i.e., for intentional disregard) need to be aware that reasonable cause is interpreted somewhat differently than it is for other civil penalty statutes.
To challenge the intentional disregard penalty under section 6721(e), the reasonable cause defence must be raised. This article discusses the parameters of the reasonable cause defence and the correct steps to take in this situation.
Reasonable Cause Is Defined In Section 6721(E)
An employer who willfully violates the employment tax filing requirements is subject to a civil penalty under Section 6721(e).
A failure is considered intentional disregard for these purposes if it is made knowingly or willfully.
Typically, federal courts have determined that a taxpayer has engaged in intentional disregard for these purposes if their actions are voluntarily taken, consciously considered, or on purpose.
Based on the totality of the relevant facts and circumstances, it is decided whether a person willfully or knowingly fails to file a timely information return or fails to include accurate information.
The intentional disregard penalty under section 6721(e) is absolutely defenceless in the face of reasonable cause.
Section 6724(a), which applies to any penalty under Section 6721, states more specifically that “no penalty shall be imposed under this part concerning any failure if it is shown that such failure is due to reasonable cause and not to willful neglect.”
Outside of the parameters of section 6721(e), taxpayers frequently demonstrate “reasonable cause” by demonstrating that the filing or payment requirement was not met despite using ordinary business care and caution.
Generally speaking, with a few notable exceptions, the intentional disregard penalty under section 6721(e) is subject to the same principle.
The general rule for reasonable cause under the applicable regulations is unchanged: “The penalty for a failure relating to an information reporting requirement… is waived if the failure is due to reasonable cause and is not due to willful neglect.”
However, the governing regulations go a step further and state that “[t]he penalty is waived for reasonable cause only if the filer establishes that either” there are:
I significant mitigating factors concerning the failure; or (ii) the failure resulted from circumstances that were out of the filer’s control (“impediment”).
Both times, the taxpayer must additionally demonstrate that it “acted responsibly,” a phrase that is specifically outlined in the regulations.
The taxpayer may argue that it falls under the “due diligence safe harbour” even if they are unable to meet the significant mitigating or impediment factors.
Important Mitigating Factors
The taxpayer must demonstrate that it “acted responsibly” and had significant mitigating factors present to meet the “significant mitigating factors” prong.
If a taxpayer, among other things,
(1) was never required to file that specific employment form, or
(2) had a track record of adhering to the Code’s reporting requirements for employment taxes, then the taxpayer has significant mitigating circumstances.
Typically, the IRS examines its transcripts to see if certain failure-to-properly-file penalties have been assessed against the same taxpayer in previous years to determine whether the taxpayer has a history of compliance.
Factors That Pose Obstacles
The taxpayer must once more demonstrate its responsibility to satisfy the “impediment factors” prong.
In addition, the taxpayer must demonstrate that the failure to comply was brought on by circumstances that were out of their control.
These circumstances may include, without limitation:
(1) the taxpayer’s lack of pertinent business records; or
(2) a failure brought on by the IRS, the agent, or the payee.
Each of these events is described in greater detail in the regulations, along with any particular requirements.
Showed Responsibility In Their Actions
As mentioned earlier, the taxpayer must demonstrate that it acted responsibly to satisfy both the significant mitigating factors and the impediment factors.
Generally speaking, taxpayers can demonstrate responsible conduct if they did two things:
(1) they exercised reasonable care or the level of care that a reasonably prudent person would have used in the given situation; and
(2) they took sizable steps to prevent or mitigate the failure.
The taxpayer may still be eligible for penalty relief for reasonable cause under the “due diligence safe harbour” even if they don’t meet either the mitigating or impeding factors prongs listed above.
Read more:-
- To Expand the Scope of the Internal Revenue Service, Democrats Intend to Spend Almost $80 Billion.
- Have You Still Not Received Your Stimulus Payment of $1,400? Here’s How to Put in a Request:
- A ‘broad variety of CEOs and labour bosses, including Bill Gates, were among those who urged Senator Manchin to change his mind about the Inflation Reduction Act: report
Obtaining a Waiver or Abatement: The Process
To submit a legitimate section 6721(e) civil penalty defence request, the taxpayer must follow a long list of requirements, including having a reasonable cause.
These procedures require that the penalty waiver or abatement request include the following:
(1) a statement of the precise regulation(s) under which the waiver or abatement is requested;
(2) a statement of all facts alleged as the basis for the reasonable cause;
(3) the signature of the person required to file the relevant return; and
(4) a proper statement that the request is made under penalty of perjury.
The IRS may reject the request outright without considering the validity of the claim if taxpayers don’t follow these procedures, and do so at their own risk.
According to the author’s experience, taxpayers who follow the aforementioned procedures and provide a succinct and clear statement of all material facts have the best chance of having the section 6721(e) penalty waived or abated.
It is also a good idea to include relevant federal case law in the request, particularly about the intentional disregard penalty and reasonable cause in general.
Finally, it’s important to note that taxpayers must make sure they are sending their request for a penalty waiver or abatement to the correct IRS office or campus that is in charge of making the penalty determination.
