Strategies for information return penalties and Form 945 assessments

Editor: Arthur Auerbach, CPA, CGMA

The IRS requires taxpayers operating businesses and making payments to employees, independent contractors, and other payees to file annual information returns. These include Form W-2, Wage and Tax Statement; forms in the 1099 series; and Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, all of which report payments and withholding. Many taxpayers must also file other information returns, including Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, reporting health insurance coverage offered to employees. For more information about the various types of information returns, due dates, and who must file, the IRS provides an overview on its webpage “A Guide to Information Returns.”

Failing to timely and correctly file these information returns can lead to penalties under Secs. 6721 and 6722 and, potentially, penalties and assessments of tax for failing to perform backup withholding as required by Sec. 3406. Most information return penalties are assessed on a per-return basis, which can add up quickly for taxpayers filing large numbers of these information returns. Furthermore, the backup withholding rate is currently 24% of the total payment to applicable payees, meaning potentially hefty assessments where backup withholding is triggered, if payers do not deduct and withhold the proper amount.

This column covers how the IRS notifies taxpayers about information return failures and proposed penalties and asserts backup withholding liabilities. It also provides potential solutions for the related IRS notices. This column covers only federal tax implications; additional services may be required for state and local issues.

Electronic filing requirements for information returns

Most taxpayers that file information returns, including businesses that contract with employees or vendors that were not subject to this requirement before, must file electronically as of 2024. Prior to the 2024 filing season, filers were required to file information returns electronically only if they were filing more than 250 of any one type of information return. However, in 2023, the IRS and Treasury issued final regulations that, starting with the 2024 filing season and applying to forms reporting on the 2023 tax year, require taxpayers filing 10 or more of any type of information return to file all returns electronically (T.D. 9972). Information returns can be filed electronically through the IRS’s free online portal, Information Returns Intake System (IRIS).

CP2100 and CP2100A notices

Twice a year, in October and April, the IRS systematically sends out Notice CP2100 or CP2100A to taxpayers that filed information returns that contained payee name and taxpayer identification numbers (TINs) that do not exactly match IRS records or are missing TINs altogether. The IRS issues a CP2100 when the payer has filed 50 or more information returns with errors. It issues CP2100A when the payer has filed fewer than 50 information returns with errors.

A TIN discrepancy could be a simple transposition error in the TIN or reporting the payee’s first and last names in the wrong order. A missing or incorrect TIN could be the result of a system error or a failure to input data completely or the result of a payee’s providing false information. The IRS mails these notices to alert taxpayers that their data is incorrect and they should solicit correct information and potentially begin backup withholding.

Taxpayers that receive a CP2100 or CP2100A notice do not need to respond to the IRS; however, they must take steps to address the issues identified in the notice. The notice will include a list of the errors or discrepancies identified in the taxpayer’s information return filings. This list should include enough payee information that a taxpayer can identify the payee and compare the IRS information to the corresponding records. The taxpayer should verify whether the information reported matches their records.

If a TIN has been marked as missing or incorrect due to a typographical error, where the TIN was keyed in incorrectly or in the wrong format when the return was prepared, taxpayers typically only need to correct their records and ensure that the correct TIN is used in future filings. If the information from the IRS does not match the information the taxpayer has on file, the taxpayer must solicit correct information from payees or information return recipients.

For most information returns, if a taxpayer requested updated payee TIN information and the payee provided it, they do not need to notify the IRS of the updated information if the amounts reported on the information return were accurate. However, for Forms W-2, if the payee provides a TIN that is different from what was on the filed Form W-2, then the taxpayer must prepare and file Form W-2c, Corrected Wage and Tax Statement, with the correct TIN.

The CP2100 or CP2100A notice gives taxpayers specific instructions on what to do where a TIN is truly incorrect or missing, such as soliciting correct information with “B Notices” and beginning backup withholding on subsequent payments where payee information is not corrected. IRS Publication 1281, Backup Withholding for Missing and Incorrect Name/TIN(s), and Publication 1586, Reasonable Cause Regulations & Requirements for Missing and Incorrect Name/TINs on Information Returns, provide detailed steps for soliciting TINs. Taxpayers should follow these steps carefully to ensure the best defense against penalty and backup withholding tax assessments.

Notice 972CG

The IRS typically issues Notices 972CG, Notice of Proposed Civil Penalty, once a year in the fall. These letters notify taxpayers of proposed civil penalties relating to filing errors, including returns filed late, incorrectly, or with inaccurate information. These notices apply different penalty rates depending on the type of error (such as late filing, incorrect filing method, and TIN errors), based on the number of affected returns. The IRS caps information return penalties with a maximum amount for each type of error; the maximum depends on whether the taxpayer is considered a large or small business, determined based on the taxpayer’s average gross receipts in the three most recent tax years.

Information return penalty rates vary depending on the reason for the penalty. For late-filed returns, there is a three-tier approach for calculating late-filing penalties: tier 1 for returns filed not more than 30 days late, tier 2 for returns more than 30 days late but filed by Aug. 1 of the year the return is due, and tier 3 for returns filed after Aug. 1 or not at all (Secs. 6721(b)(1) and (2); IRS Publication 1586). The applicable penalties for returns required to be filed in 2025 are $60, $130, and $330 per information return for tiers 1, 2, and 3, respectively (all subject to calendar-year maximums). In cases where information returns are required to be filed electronically, returns filed on paper are considered not filed at all.

Once a Notice 972CG is issued, taxpayers have 45 days to respond to it, including by requesting an extension; otherwise, the proposed penalties will be manually input onto the taxpayer’s account as civil penalties, and the IRS will begin sending notices of balance due followed by collection actions. Taxpayers can still request penalty waivers as detailed below after the 45-day due date, but it is best to respond timely to avoid collection activity. If a penalty is proposed for late filing and the returns were actually filed timely or the deadline was postponed under a federal disaster declaration, the taxpayer should respond with proof of timely filing or reference to the disaster declaration.

Requesting a waiver of information return penalties

If a taxpayer receives Notice 972CG proposing penalties or if information return penalties have already been assessed, a taxpayer may request that the IRS waive or abate the penalties based on a finding of reasonable cause. To make this request, a taxpayer must provide a written explanation of the circumstances that caused the errors or the late filing. The taxpayer must also indicate the specific provision under which the waiver is being requested, as defined by the Treasury regulations under Sec. 6724. The request must also contain the signature of the person required to file the return and a declaration that the statement is made under penalties of perjury.

In order to establish reasonable cause for failures to file correct and timely information returns, a taxpayer must be able to show that there were either (1) “significant mitigating factors” related to the filing failures or (2) events “beyond the filer’s control” that prevented proper filing. In addition to one of these factors, a taxpayer must also demonstrate that they (or any agents involved) acted in a responsible manner both before and after the failure occurred and that there was no willful neglect relating to the failure to file timely or accurately (Regs. Sec. 301. 6724-1(a)).

In other words, the IRS will typically only waive or abate penalties for taxpayers that took steps to ensure that their filings would be timely and correct and, once an error occurred, also took steps to correct or prevent future occurrences of the errors.

According to the regulations, “significant mitigating factors” include that a taxpayer has never had to file the information return in question before or that the taxpayer has an established history of complying with information reporting requirements. The regulations also provide that, in determining whether a filer has an established history of compliance, the IRS will consider whether the filer has incurred any penalty for information return errors in prior years and, if so, the extent to which the filer has lessened their error rate from year to year (Regs. Sec. 301.6724-1(b)). Therefore, even where a taxpayer has made errors in filing, they may still qualify for a reasonable-cause waiver if they have a steadily improving compliance history.

Regs. Sec. 301.6724-1(c) provides examples of events outside the filer’s control, including being unable to access relevant business records or if actions of agents or payees prevented the taxpayer from filing or filing accurately. Where payees provided incorrect information, the regulations include very specific guidance on actions the payer must take upon receiving notice from the IRS of incorrect information. For example, where a payer receives a CP2100 notice, as described above, they must take actions to correct their records in the case of an incorrect TIN to qualify for the penalty waiver under Sec. 6724.

Additionally, a taxpayer requesting reasonable cause must demonstrate they acted in a responsible manner, which generally requires that the taxpayer took actions that a “reasonably prudent” person would take under the circumstances in the course of business and that the taxpayer took steps to avoid or mitigate the filing failures.

Arguing for reasonable cause requires a detailed, fact-based analysis of the taxpayer’s specific circumstances. Ignorance of filing requirements is typically not a viable argument for reasonable cause except in limited circumstances and where the taxpayer can prove other mitigating factors or events outside their control. A taxpayer should consider working with an experienced tax consultant in preparing a request for a reasonable-cause waiver, to ensure their request for waiver includes the necessary facts and arguments.

Backup withholding assessments

Backup withholding is the requirement that a payer withhold tax from payments not otherwise subject to tax withholding. This is triggered by a payee’s failure to provide a TIN or a notification from the IRS that a TIN provided for a payee is incorrect. For example, an independent contractor who receives Form 1099-NEC, Nonemployee Compensation, for service performed is not typically subject to any withholding. If that independent contractor provides an incorrect TIN to a payer that later receives a CP2100 stating that the TIN is incorrect, the requirement to begin backup withholding will be triggered unless the payee corrects the information provided to the payer. Once the requirement is triggered, the payer must withhold tax on any future payments to that individual payee. If the payee provides the correct TIN, backup withholding should end within 30 days of receiving the payee’s updated information.

When backup withholding is required, the payer must apply the backup withholding rate (24% for all subject payments made after Dec. 31, 2017) to any ongoing payments to affected payees. This covers most normal payments, such as nonemployee compensation, rents, royalties, etc.; however, certain transactions, such as real estate transactions and distributions from retirement accounts, may be exempt from these requirements (see IRS Publication 1281). Taxpayers applying backup withholding must report the subject payments and taxes on Form 945, Annual Return of Withheld Federal Income Tax, which is due by Jan. 31 of the following year, or Feb. 12 if all deposits were made timely.

Letters 6112 and 6112-A: Requests for Form 945, backup withholding tax

A taxpayer that files information returns with missing or incorrect TINs may end up with a case assigned to the IRS Campus Backup Withholding Compliance Program (see Internal Revenue Manual §4.19.26). These taxpayers will receive Letter 6112 requesting that they file Form 945 reporting withheld tax or provide an explanation for why Form 945 is not required. If taxpayers do not respond, Letter 6112-A will follow, proposing a tax assessment based on the IRS’s preparation of a “substitute” Form 945. For substitute forms, the IRS estimates the subject payments and taxes due based on the information returns filed. Because backup withholding is asserted at a rate of 24% of the payments, these backup withholding liabilities can be hefty. The IRS can also assert penalties for failure to file, failure to pay, and failure to deposit in conjunction with these proposed assessments.

Responding to Letters 6112 and 6112-A

The obligation to backup withhold is triggered only where an information return must be filed and the payer is missing the payee TIN or has received notice the TIN they are reporting under is incorrect. Therefore, the first approach to responding to a Letter 6112 or 6112-A can be explaining why information returns were not required in the first place. For example, a payer may have mistakenly filed Form 1099-NEC for a payee that is a corporation and therefore did not require information reporting.

Alternatively, if the taxpayer had the correct TIN for a payee but inadvertently failed to include it on an information return, the payee can respond to the IRS with an explanation that backup withholding was not required because the payee was in possession of the correct TIN. Successful arguments that backup withholding was not triggered should lead to a withdrawal of the proposed Form 945 tax.

Generally, if a taxpayer fails to backup withhold on a payee’s earnings, the taxpayer is liable for the taxes that should have been withheld. However, Sec. 3402(d) provides that if a payer fails to withhold where required, the tax will not be collected from the payer if the tax is otherwise paid by the payee. This typically applies where the payer did not begin backup withholding but the payee reported the payments on their own tax return and paid taxes accordingly. To qualify for the relief provided in Sec. 3402(d), a payer must coordinate with any affected payees to complete and file Forms 4669, Statement of Payments Received, and Forms 4670, Request for Relief of Payment of Certain Withholding Taxes.

Form 4669 reports the amounts paid to a particular payee. Each payee must complete Part 2 of Form 4669 and sign under penalty of perjury in Part 3, certifying that the subject payments were reported and applicable taxes paid. Form 4670 acts as a cover sheet, and only one should be completed per tax year, regardless of the number of Forms 4669. (See the IRS instructions for each form for more details.)

Timely response avoids penalties

Information returns filed late or containing incorrect information automatically trigger IRS notices proposing penalties. Timely responses providing evidence of timely filing, solicitation of correct information, or reasonable cause can help filers avoid penalties. If these information return penalty notices are ignored, costly penalties and proposed backup withholding tax assessments can follow.

Contributors

Marissa Lenius, J.D., is a senior manager, and Kelly Field, J.D., is a manager, both in the tax controversy group in RSM US LLP’s Washington National Tax Practice. Arthur Auerbach, CPA, CGMA, is an independent tax consultant in Atlanta. Lenius is a member, and Auerbach is vice chair, of the AICPA Tax Practice and Procedures Committee. For more information about this column, contact thetaxadviser@aicpa.org.