September 29, 2010

TO: Distribution

FROM: FROM: Burt, Staples & Maner LLP

RE: Increase in Information Return Penalties Starting Next Year

Mistakes on information returns and payee statements just became a lot more expensive. Effective with returns required to be filed on or after January 1, 2011, the per-occurrence penalties for incorrect, late or missing Forms 1099 and 1042-S (among others) will be doubled and the maximum combined annual penalty for information returns and payee statements will be $3 million, or nearly 10 times the previous cap. The increases are part of the Small Business Jobs Act of 2010, which the president signed into law on September 27. This is yet another example of how filers of information returns are bearing the brunt of efforts to close the budget deficit without the government appearing to increase taxes.

Here is how the old and new information return penalties under IRC § 6721 compare:

Not only do the dollar values of the penalties change, but so do the number of returns subject to the penalty, thanks to the new maximums. Formerly, a reporting entity could be penalized for as many as 10,500 returns before reaching the $250,000 maximum (5,000 at $15, plus 5,000 at $30, plus 500 at $50). Under the new structure, as many as 24,166 returns could be subjected to a penalty (8,333 at $30, plus 8,333 at $60, plus 7,500 at $100). It is also important to remember that the existing “de minimis” rule for information returns remains unchanged, so if the erroneous returns do not exceed ½ of 1 percent of the total number of returns required, and are corrected on or before August 1, there generally would be no penalty. The payoff for making corrections by August 1 may justify temporarily bringing in more resources.

The new law also fundamentally changes the structure of the payee statement penalty under IRC § 6722. That penalty was formerly a flat $50 with no possibility of reductions for corrections, no matter how swift, and with an overriding $100,000 per year maximum (except in cases of intentional disregard). Like the information return penalty, the payee statement penalty now will be $100 per occurrence, subject to a $1.5 million annual cap, and the payee statement penalty structure includes the same discounts for rapid corrections as the information return penalty. The new law also extends the de minimis rule to payee statements.

With these changes, the combined maximums for information return and payee statement penalties increase from $350,000 per year to $3 million per year. In addition, the penalties and caps now will be indexed for inflation and adjusted every five years, starting in 2017.