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GainsKeeper Blog

Failing to Remedy Information Reporting System Flaws Could Result in Intentional Disregard Penalties

WALTHAM, Mass. – Oct. 25, 2010 – The cost basis reporting law enacted in 2008 requires brokers to report the cost basis and certain other information relating to covered securities sold on or after January 1, 2011 on Form 1099-B to both the IRS and investors. Issuers of specified securities must report the quantitative effect of corporate actions on the basis of specified securities for corporate actions occurring on or after January 1, 2011 to both the IRS and securities holders unless the information is made available on a public website of the issuer. Both Form 1099-B and issuer corporate action reporting statements to the IRS are considered information returns and penalties relating to the failure to timely file correct information returns are set forth in Internal Revenue Code Sec. 6721. The Form 1099-B copies and the issuer corporate action reporting statements delivered to securities holders are considered payee statements and penalties relating to the failure to timely provide holders with correct payee statements are set forth in Code Sec. 6722. Cost basis reporting also requires brokers, transfer agents, securities issuers and their agents to provide transferees with transfer statements when securities are transferred—transfer statements are also considered “payee statements” for information return tax penalty purposes under Code Sec. 6722.

Code Sections 6721(e) and 6722(e) provide that the IRS may assess significant tax penalties if the failure to timely file or provide correct information returns or payee statements is due to “intentional disregard” by the person obligated to file or provide the returns or statements. The penalty for intentional disregard for cost basis related required returns and statements is the greater of $250 or five percent of the amount that should have been reported on the return for failing to timely provide correct information to the IRS under Code Sec. 6721 without any annual maximum limit. There is also a separate penalty for intentional disregard relating to payee statements delivered to holders that is the greater of $250 or five percent of the amount that should have been reported on the return for failing to timely provide correct information to payees under Code Sec. 6722 without any annual maximum limit.

A recent court case decided by the Eighth Circuit Court of Appeals, Bale Chevrolet Co. v. US, 2010 U.S. App. LEXIS 18335 (8th Cir., Sept. 2, 2010), raises concerns that the IRS could sustain significant intentional disregard penalties if a person obligated to provide information reporting to the IRS or holders does not remedy reporting systems deficiencies. This could be important to brokers, transfer agents and others preparing to comply with cost basis reporting because inadequate reporting or systems that do not properly calculate cost basis and related information could potentially expose such persons to significant intentional disregard tax penalties.

In Bale, the taxpayer was audited and the IRS determined in a 1996 audit that the company had failed to file Form 8300, reporting cash transactions in excess of $10,000. Form 8300 is another information return that results in potential penalties under Code Sec. 6721. The taxpayer acknowledged the failure but indicated that procedures were being instituted to address compliance. In a 2000 audit, the IRS found additional failures to file Form 8300 in four cases and proposed intentional disregard penalties of $25,000 per return ($100,000 in total). Although the IRS and the taxpayer later reached a settlement that resulted in no intentional disregard penalties, the taxpayer sued the government for costs and attorneys’ fees arguing that there was no substantial basis for the IRS imposing the intentional disregard penalties when there were systems failures rather than deliberate avoidance of return filing. The District Court found in favor of the IRS and the taxpayer appealed the decision to the Eighth Circuit Court of Appeals.

In Bale, the Eighth Circuit agreed with the IRS that there was a substantial basis for imposing intentional disregard penalties and stated “...we find nothing that precludes the IRS from concluding that an intentional disregard penalty may be appropriate where a company, despite knowing that its reporting system is inadequate to ensure compliance with § 6050I, fails to remedy those flaws and commits subsequent violations.”

The court’s conclusion raises concerns that the failure to fully report cost basis law required information or remediate reporting systems to correctly report such information could result in intentional disregard penalties in certain cases.


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