One of the most frustrating situations my clients confront is the IRS’s addition of large amounts of tax or Civil Penalties to tax periods that ended a long time ago. There can be several reasons for additions to tax or Civil Penalties, but the most common ones I encounter are reporting and reconciliation deficiencies across the state, the Social Security Administration, and the IRS. In our voluntary tax reporting system, one of the most powerful tools available to the taxing authorities to ensure accurate and timely reporting is the imposition of fines and Civil Penalties. This article addresses the most common use of that tool for return and reporting discrepancies.
Eliminate an IRS Civil Penalty Arising from Payroll Discrepancies
At the most basic level, all of the returns and reports that a taxpayer files should report identical figures for payroll issued to employees. Of course, in most states, an employer must file regular returns and reports to three major government entities: the state, the IRS, and the Social Security Administration. The state and the Social Security Administration then report to the IRS the figures reflected on the forms they received. If any of the numbers do not match, a problem arises. Usually, that problem is that the IRS charges money (e.g. Civil Penalties) for the discrepancy.
It takes a frustratingly long time for the IRS to complete its annual reconciliation of records. For most employers, it will take at least a year for the IRS to issue a notice regarding a problem with the records, but for larger employers, with many employees, or a large amount of turnover, I have seen the IRS take two years or more to issue a notice. This is one very important reason for an employer to keep and maintain good records, going several years back. If the internal records available are inadequate, the authorities can provide missing information, provided it is requested in the correct way. This is one instance where a tax professional, who is familiar with the jargon and bureaucratic framework used by the taxing authorities can be a real help. We know who to ask, what to ask for, and how to ask for it, so that the authorities provide the correct information in a timely manner.
The easiest of the reconciliation problems to address is a situation in which the Social Security Administration did not receive the required W-2s and W-3 from the taxpayer. The business records may reflect that the reports were filed, and the taxpayer may be absolutely sure that they remember mailing them to Social Security, but, two years later, the IRS sends a notice, proposing to assess an enormous Civil Penalty for failure to file with Social Security. The taxpayer may be tempted to argue about when and how the reports were submitted, on principal, but those arguments will not remove the penalty.
The best course of action is to submit all of the W-2s, the W-3, and the IRS 941s and 940 to the IRS, after confirming that the total payroll matches across all of the forms. The IRS will forward the W-2s and W-3 to the Social Security Administration, but that is not the end of the problem. There was a time when the IRS would automatically waive the penalty, upon the taxpayer submitting the forms and returns. However, now they require that the taxpayer offer an explanation for not filing, and make a specific request that the penalty be abated. This is another situation where representation is a good idea, because a tax professional can be the difference between a waiver, and the IRS refusing to remove the penalty.
A more difficult problem arises when the reports were all filed timely, but the numbers don’t match. Then, the IRS will generally assess an additional tax liability, based on the highest reported payroll. To address such a situation, the first step is to gather copies of all of the reports that were filed for the year in question. Next, compare the figures reported to the various authorities to determine whether they match. The IRS notice regarding the discrepancy will list what was reported to whom, and where the discrepancy that led to the additional assessment arose, so compare your reports to the figures on that notice as well. Determine which set(s) of forms were correct, then prepare amended or corrected forms for the set(s) that didn’t match.
If the forms submitted to Social Security were the problem, submit all 941s, 940s, W-2s, and W-3s to the IRS. The Discrepancy Notice that the IRS issued will contain instructions for where and how to submit the documents. The IRS will work with Social Security to correct and reconcile all of the records. Again, the taxpayer must request that the additional tax is abated.
If the problem lies within the forms submitted to the state, the taxpayer must request a recertification from the state taxing authority. To do this, the taxpayer must amend or correct the state filings, and then contact the correct state taxing authority (often called the Department of Revenue) to request that they certify the corrected amounts to the IRS. Even after the state issues the recertification, it can take a considerable amount of follow up to ensure that the additional assessment is waived, so a competent representative can help.
Reconciliation problems can cost a taxpayer considerable amounts of money unless action is taken to resolve the issue and request abatement or waiver of the additions. The good news is that if a taxpayer takes enough time to address the problem, it is one liability to the IRS that can be resolved without huge expenditures of money. In other words, these penalties can often be abated (removed). I have been able to save my clients hundreds of thousands of dollars by resolving these types of paperwork mistakes, so the effort is certainly worth the headache.