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Watchdog report says some employers avoid penalty for failure to file correct wage documents

TIGTA Report: Employers Who Do Not Comply With Requests to Provide Complete and Accurate Wage Documents Are Not Always Assessed Penalties.

A new audit by the Treasury Inspector General for Tax Administration (TIGTA) found that IRS didn’t always assess penalties under Code Sec. 6721 against employers that fail to respond to IRS’s requests to resolve discrepancies between wages and withholdings as reported to IRS on filed tax returns and as reported on Forms W-2 to the Social Security Administration (SSA). The audit could lead to a sharper IRS focus on such discrepancies.

Background. Employers must annually report to the SSA wage and withholding for each employee on Form W-2, Wage and Tax Statement. Employers must submit their Forms W-2 to the SSA by March 31 each year along with a Form W-3, Transmittal of Wage and Tax Statements (a summary of the submitted Forms W-2). In addition, employers must submit federal taxes withheld from employees and report to IRS federal taxes withheld from employees on Form 941, Employer’s Quarterly Federal Tax Return; Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees; or Form 944, Employer’s Annual Federal Tax Return.

Code Sec. 6721 gives IRS the authority to penalize an employer if it fails to file complete and accurate Forms W-2 and W-3. An IRS tax examiner will attempt to resolve the discrepancies identified by the SSA. When IRS tax examiners are unable to resolve a discrepancy, IRS sends the employer a Letter 0098C, Wage Discrepancy per SSA; Information/Verification Requested. This letter requests copies of Forms W-2 and notifies the employer of a potential penalty assessment if the forms are not submitted to IRS.

IRS may assess civil penalties if the employer does not resolve the discrepancy by either: filing missing Forms W-2; amending its employment tax return; or providing other information to resolve the discrepancy. Once an employer has been assessed a penalty, it may provide missing Forms W-2 and request an abatement of the penalty assessed.

A comparison of SSA and IRS records is performed each year in a process known as the Annual Wage Reporting reconciliation. A program called SSA-CAWR (Combined Annual Wage Reporting) includes a reconciliation to identify discrepancies in which earnings and tax withholdings reported to IRS on filed tax returns differs from amounts reported on Forms W-2 submitted to the SSA. A discrepancy can indicate that employees’ earnings were not credited to their Social Security account. These discrepancies are called SSA-CAWR cases.

IRS assessed fewer penalties than it should have. TIGTA found that IRS did not always assess penalties against employers that did not reply to IRS’s requests to resolve the SSA-CAWR discrepancy. TIGTA’s analysis of SSA-CAWR cases referred to IRS by the SSA for TY 2011 found that IRS did not correctly assess penalties on 32 cases referred by the SSA. A comparison of wages and withholding reported by these 32 employers on their tax return to Forms W-2 submitted to the SSA identified underreported Forms W-2 wages totaling more than $2 billion. Each of these cases involved an employer who failed to reply to the IRS’s requests to provide Forms W-2 not submitted to the SSA.

According to TIGTA, under Code Sec. 6721, IRS could have assessed a 10% intentional disregard failure-to-file penalty totaling more than $200 million for the underreported Forms W-2 wages. IRS had not established a process to identify these cases and, as a result, the penalties were not assessed as required.

Additionally, TIGTA’s analysis of discrepancy cases identified that IRS excluded 22,814 of the 134,937 cases referred from the SSA. Of the 22,814 cases, 608 did not meet IRS’s case processing exclusion criteria and were erroneously excluded from being worked. As a result, the IRS did not assess more than $22 million in penalties. A comparison of wages and withholding reported by these 608 employers on their tax returns to Forms W-2 submitted to the SSA identified underreported Forms W-2 wages totaling more than $225 million.

Recommendations. The TIGTA audit recommends that the Commissioner, Small Business/Self-Employed Division: (1) develop a process to identify and ensure that penalties are assessed as required on those employers that do not reply to the IRS’s requests for missing Forms W-2, and (2) correct computer programming errors to ensure that cases are accurately reflected in open inventory as needing to be worked and penalties are assessed when appropriate.

IRS agreed with TIGTA’s recommendations, although it quibbled with how TIGTA determined the amount of tax it could have collected but didn’t. It pledged to take appropriate corrective actions to identify and properly pursue employers that didn’t submit complete and accurate wage documents.

References: For penalty for failure to file information returns and provide payee statements, see FTC 2d/FIN ¶  V-1803  ; United States Tax Reporter ¶  67,214  ; TaxDesk ¶  861,053  ; TG ¶  71704  .

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