Section 6721 provides the IRS with authority to impose civil penalties against taxpayer-employers who fail to timely file correct information returns (e.g., Forms W-2/W-3 and Forms 940/941).  Under section 6721’s three-tiered penalty structure, the penalty varies, depending primarily on when the correct information return is eventually filed and, in some cases, the size of the employer.  However, if the IRS can show that the failure to timely and properly file an information return was due to “intentional disregard,” the IRS is permitted under section 6721(e) to impose a penalty of 10% “of the aggregate amount of the items required to be reported correctly.”  Thus, for example, if a taxpayer-employer improperly files an incorrect Form W-3 where gross wages should have been reported as $500,000 for the year, the IRS can impose a section 6721(e) penalty in the amount of $50,000 against the taxpayer-employer.

Taxpayer-employers subject to section 6721(e) civil penalties are not without defenses.  Similar to other federal civil tax penalties, the intentional disregard penalty may be waived or abated due to a proper reasonable cause defense, among others.  But taxpayers who assert reasonable cause in these instances (i.e., for intentional disregard) must be aware that reasonable cause is interpreted somewhat differently than it is for other civil penalty statutes.  This article discusses the scope of the reasonable cause defense for purposes of contesting the section 6721(e) intentional disregard penalty and the proper procedures that must be followed to raise a reasonable cause defense in these circumstances.

Section 6721(e) – Reasonable Cause. 

Section 6721(e) imposes a civil penalty against an employer who intentionally disregards the employment tax filing requirements.  For these purposes, a failure is due to intentional disregard if it is done knowingly or willfully.[i]  Generally, for these purposes, federal courts have held that a taxpayer demonstrates intentional disregard if the taxpayer’s conduct is voluntary, conscious, or intentional.[ii]     Whether a person knowingly or willfully fails to file timely or fails to include correct information on an information return is determined based on all of the facts and circumstances.[iii]

Reasonable cause provides an absolute defense to the section 6721(e) intentional disregard penalty.  More specifically, section 6724(a), which applies to any penalty under section 6721, provides: “No penalty shall be imposed under this part with respect to any failure if it is shown that such failure is due to reasonable cause and not to willful neglect.”

In many instances outside section 6721(e), taxpayers show “reasonable cause” by showing that, despite the exercise of ordinary business care and prudence, the taxpayer’s filing or payment obligation remained unmet.  This same concept generally applies to the section 6721(e) intentional disregard penalty, with some notable differences.

Under the governing regulations, the general rule for reasonable cause remains the same: “The penalty for a failure relating to an information reporting requirement . . . is waived if the failure is due to reasonable cause and is not due to willful neglect.”[iv]  But the governing regulations go further, and provide that “[t]he penalty is waived for reasonable cause only if the filer establishes that either” there are:  (i) significant mitigating factors with respect to the failure; or (ii) the failure arose from events beyond the filer’s control (“impediment”).[v]  In both instances, the taxpayer must also show that it “acted in a responsible manner,” a term specifically defined in the regulations.[vi]  Even if the taxpayer cannot meet the significant mitigating factors or impediment factors, the taxpayer may nevertheless contend that it falls under the “due diligence safe harbor.”[vii]

Significant Mitigating Factors. 

To meet the “significant mitigating factors” prong, the taxpayer must show that it “acted in a responsible manner” and had significant mitigating factors present to cause the failure.  A taxpayer has significant mitigating factors if, among other things:  (1) the taxpayer was never required to file that particular employment form; or (2) the filer had an established history of complying with the employment tax reporting requirements of the Code.[viii]  Generally, to determine whether the taxpayer has a history of compliance, the IRS reviews its transcripts to determine whether certain failure-to-properly-file penalties have been imposed against the same taxpayer in prior years.

Impediment Factors. 

To meet the “impediment factors” prong, the taxpayer again must show that it acted in a responsible manner.  In addition, the taxpayer must show that the failure to comply was due to events beyond the taxpayer’s control.  These events may include, without limitation: (1) the taxpayer did not have relevant business records; or (2) the failure was caused by the IRS, the agent, or the payee.[ix]  The regulations clarify each of these events and their unique requirements in more detail.

Acted in a Responsible Manner

As indicated supra, to meet both the significant mitigating factors and the impediment factors, the taxpayer must show that it acted in a responsible manner.   As a general matter, taxpayers may show responsible conduct if:  (1) the taxpayer exercised reasonable care, or the standard of care that a reasonably prudent person would have used under the circumstances; and (2) the taxpayer took significant steps to avoid or mitigate the failure.[x]

If the taxpayer fails to meet either the mitigating factors or impediment factors prongs above, the taxpayer may nevertheless qualify for penalty relief for reasonable cause under the “due diligence safe harbor.”[xi]

Procedure for Seeking a Waiver or Abatement. 

Taxpayers must comply with a litany of procedures to make a valid section 6721(e) civil penalty defense request, including reasonable cause.  Under these procedures, the penalty waiver/abatement request must: (1) state the specific provision of the regulations under which the waiver or abatement is being requested; (2) set forth all of the facts alleged as the basis for reasonable cause; (3) be signed by the person required to file the return at issue; and (4) contain a proper description that the request is made under penalties of perjury.[xii]  Taxpayers who fail to comply with these procedures do so at their own peril, as the IRS may deny the request outright without reaching the merits of the claim.

In the author’s experience, taxpayers who comply with the above procedures and who provide a clear and concise statement of relevant facts stand the greatest likelihood of having the section 6721(e) penalty waived or abated.  Relevant federal case law on the intentional disregard penalty itself and reasonable cause generally are also helpful to put into the request.  Finally, and worth noting, taxpayers should make sure that they are sending the penalty waiver/abatement request to the proper IRS office or campus in charge of the penalty determination.

Conclusion. 

Without doubt, the section 6721(e) intentional disregard penalty is one of the harsher civil penalties in the Code.  But taxpayers are not without defenses to the civil penalty, provided they are timely and properly raised.  Thus, taxpayers who receive notice that the IRS has imposed the section 6721(e) intentional disregard penalty (e.g., through receipt of Notice CP215) should act quickly to respond to the notice and assert all proper defenses.  Taxpayers who properly raise the reasonable cause defense—as that term is defined in the governing regulations—and who comply with all of the applicable procedures stand the best chance of having the section 6721(e) penalty reduced or eliminated entirely.

[i] Treas. Reg. § 301.6721-1(f)(2).

[ii] See, e.g., Gerald B. Lefcourt, P.C. v. U.S., 125 F.3d 79, 83 (2d Cir. 1997).

[iii] Treas. Reg. § 301.6721-1(f)(2).

[iv] Treas. Reg. § 301.6724-1(a)(1).

[v] Treas. Reg. § 301.6724-1(a)(2).

[vi] Treas. Reg. § 301.6724-1(a)(2) (flush language).

[vii] Id.; see also Treas. Reg. § 301.6724-1(g).

[viii] Treas. Reg. § 301.6724-1(b).

[ix] Treas. Reg. § 301.6724-1(c).

[x] Treas. Reg. § 301.6724-1(d).

[xi] Treas. Reg. § 301.6724-1(g).

[xii] Treas. Reg. § 301.6724-1(m).

Have a question? Contact Matthew Roberts, Freeman Law.