The following article is reprinted from The M&A Tax Report, Vol. 13, No. 3, October 2004, Panel Publishers, New York, NY.


By Robert W. Wood and Dominic Daher

Corporate counsel (and all counsel) for defendant corporations are frequently concerned about any applicable IRS penalties in the unlikely event that the IRS should scrutinize settlement payments and the related information reporting returns filed by a corporation. The truth is the basic penalty for failure to file a Form 1099 is a mere $50 per failure (big woop!). See I.R.C. §6721.

A second penalty applies to failures to file Form 1099 only in cases of willful or intentional failures to file Forms 1099. I.R.C. §6721(e). This penalty is equal to the greater of $100 or 10% of the aggregate amount of items required to be reported. Id. We have never seen the IRS successfully assert this penalty. Of course, there is a threshold question in every circumstance whether the choice to not issue the plaintiff a Form 1099-MISC for certain types of payments could possibly be considered a willful or intentional "failure" to file such form. There is a separate penalty for failure to include correct information on an information return, or the inclusion of incorrect information. I.R.C. §6722. This penalty is also $50 per failure.

Finally, Section 6722(c) imposes an intentional disregard penalty for information returns which are incorrect and where the reporting person has intentionally disregarded the information return rules. As in the case of the penalty for willful failures to file Forms 1099, this penalty is equal to the greater of $100 or 10% of the aggregate amount of items required to be reported. I.R.C. §6722(c). Again, as we noted with respect to the §6721(e) penalty (discussed above), we have seen the IRS successfully assert this penalty, even outside the damages/settlements area.

It is clear from the regulations that inconsequential errors and omissions will not trigger even the basic $50 penalty for failures to furnish correct payee information. Treas. Reg. §301.6722-1(b). It follows that the willfulness penalty also applies only where there has been a failure that is beyond this inconsequential error or omission standard.

Indeed, the Internal Revenue Code itself provides specific reasonable cause abatement provisions. The above-discussed penalties for information reporting failures may be waived if the filer (in this case, the defendants), can establish that the failure is due to reasonable cause and not to willful neglect. I.R.C. §6724. The regulations provide that a penalty will be waived for reasonable cause if the filer can establish that either: (a) there are significant mitigating factors with respect to the failure; or (b) the failure arose from events beyond the filer's control. Treas. Reg. §301.6724-1(a)(2).

The "significant mitigating factors" which can result in a penalty being waived include (among other factors), the established history of compliance of the filer. Treas. Reg. §301.6724-1(b). In addition to establishing a bases for reasonable cause waiver (either significant mitigating factors or events beyond the filer's control), it would be necessary to show that the filer acted in a responsible manner. The regulations suggest that what is necessary is simply reasonable care, doing what a reasonably prudent person would do under the circumstances in the course of its business in determining its filing obligations. Treas. Reg. §301.6724-1(d)(1)(i). Reasonable care includes things like seeking professional advice. Ultimately you'll want something to hang your hat on here, so make sure you have it!

Information Return Reporting for Settlement Payments: Are Most Corporations in the Dark?, by Robert W. Wood and Dominic L. Daher, Vol. 13, No. 3, The M&A Tax Report (October 2004), p. 8.