Information Return Penalties: The Reasonable Cause Waiver for 1099 and W-2 Failures

Businesses that file Forms 1099, W-2 and similar returns face their own penalty regime. IRC 6721 penalizes failures to file correct information returns with the IRS, including late filing and incorrect or missing information. IRC 6722 penalizes the parallel failures in statements furnished to payees.

The relief rules are different from the individual penalties most people know. The single most important point: IRM 4.19.25.8 says first-time abatement procedures do not apply to information return penalties. The IRS manual on first-time abatement lists Form 1099 series returns among those where FTA is not available. Relief here runs through the statute and the regulations instead.

The statutory waiver

IRC 6724(a) says no penalty shall be imposed under this part with respect to any failure if it is shown that the failure is due to reasonable cause and not to willful neglect.

Treas. Reg. 301.6724-1 defines what that means here, and the definition is more structured than ordinary reasonable cause. The IRS website and IRM 4.19.25.8 summarize it as two requirements, both of which must be met:

• You acted in a responsible manner, both before and after the failure.
• There were significant mitigating factors, or the failure arose from events beyond your control.

Acting in a responsible manner

The IRS reasonable cause page describes acting responsibly as requesting extensions when possible, trying to prevent a foreseeable failure, fixing the issue that caused the failure, and correcting it as quickly as possible.

IRM 4.19.25.8 tells employees how to test this in practice. Did the filer react timely upon discovering the error? Did the filer take actions to prevent it from happening again? If your response does not address prevention, the manual says the IRS may look at your next year's filing; if that year was filed correctly, it treats the prevention requirement as met, and if the same error repeated, it does not.

So your statement should say what you did when you found the problem, and what you changed so it would not recur.

Significant mitigating factors

IRM 4.19.25.8 lists two significant mitigating factors:

• First-time filer: you had not previously been required to file the information returns in question.
• Good compliance history: you have a history of complying with information reporting requirements. The manual says this should be considered whether or not you specifically ask.

These are the closest thing to first-time abatement in this area. A filer with a clean history and a single bad year is in a far better position than one with repeat failures.

Events beyond your control

The manual lists events generally considered beyond the filer's control, including:

• Actions by the IRS, such as reliance on erroneous written information from the IRS, documented with a copy.
• Actions by an agent, such as a payroll company or outside vendor. The agent must itself show it acted responsibly and faced mitigating factors or events beyond its control. If that fails, the manual notes the filer may still qualify on its own merits through compliance history and responsible conduct.
• Actions by a payee or other person who failed to provide necessary information, if you gave them what they needed and can document that the failure was theirs.
• Unavailability of business records due to a supervening event.
• A FEMA-declared disaster, casualty or loss, or death or serious illness, affecting your ability to comply.

The IRS website adds economic hardship that prevented electronic filing to its list.

Missing or incorrect TINs

Penalties for missing or incorrect taxpayer identification numbers have special rules. IRM 4.19.25.8.3 says that to show you acted responsibly, you generally must have made the solicitations for a correct TIN required by Treas. Reg. 301.6724-1(e) and (f): an initial solicitation when the account was opened, and annual solicitations when a TIN is missing or incorrect, with exceptions described in the manual.

Method matters. The manual says initial solicitations can be made by mail, telephone or electronic means, but annual solicitations must be made by mail or telephone. A filer who claims to have made annual solicitations only by email will be denied.

The IRS includes Publication 1586 with a proposed TIN penalty notice, explaining these requirements. The manual also points filers to the e-services TIN Matching Program for checking name and TIN combinations before filing certain returns. Using it is evidence of acting responsibly going forward.

Statutory reductions and safe harbors

Before arguing reasonable cause, check whether the statute already reduces or eliminates the penalty:

• IRC 6721(b) reduces the per-return penalty for failures corrected within 30 days after the required filing date, and by a smaller amount for failures corrected by August 1 of the filing year.
• IRC 6721(c)(1) treats a filed return as correct if a failure to include required information is corrected by August 1, up to the greater of 10 returns or one-half of one percent of the returns you were required to file.
• IRC 6721(c)(3) provides a safe harbor for de minimis dollar errors: if no single amount is off by more than $100, and no single amount of tax withheld is off by more than $25, no correction is required and the return is treated as correct, subject to the payee election referenced in the statute.

These are statutory, not discretionary. Prompt correction is itself money.

A hypothetical small employer

Imagine a hypothetical small business that switched payroll companies in November. The new provider never received the year-to-date data, and the W-2s were filed with the Social Security Administration six weeks late. The owner discovered the problem in February when employees asked for their forms, called the provider the same day, and had the forms filed and furnished within the week. The next year she added a January checklist and confirmed filing receipts herself.

Her response addresses both halves of the test. Responsible conduct: she reacted the day she learned of the problem and changed her process to prevent a repeat. Events beyond her control or mitigating factors: the failure arose from an agent's actions, and she has a clean history of timely filing in prior years. Under the manual, the agent's own conduct will be examined, and if that falls short, her history and conduct can still carry the request on their own.

That is how the regulation is meant to work: a specific failure, a specific cause, a prompt fix, and a system change.

Where payee statements fit

The same reasonable cause waiver in IRC 6724(a) covers the payee statement penalty under IRC 6722. If you were late filing with the IRS and late furnishing statements to payees, you may face both. Address both in your response. And because penalties are computed per return, a fix that covers your whole filing, rather than one form, matters. For how this relief fits with other penalty categories, see the four kinds of IRS penalty relief.

Making the request

IRM 4.19.25.8 lists what a waiver statement must contain: the specific provision under which the waiver is requested, all the facts alleged as reasonable cause, the signature of the person required to file the return, and a declaration that it is made under penalties of perjury. The manual specifies who signs for corporations and partnerships, and says a faxed signature is acceptable.

Information return penalties are usually proposed on Notice 972CG, with a short window to respond. How to answer that notice is covered in responding to Notice 972CG.

Two elements, both proven, in a signed statement. That is the waiver.