Information Reporting to U.S. Persons — Payments Subject to Back-up Withholding (Portfolio 643)

Tax Management Portfolio, Information Reporting to U.S. Persons — Payments Subject to Back-up Withholding, No. 643, discusses the requirements relative to backup withholding as required under §3406 and the types of payments that may be subject to the imposition of this tax.

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Tax Management Portfolio, Information Reporting to U.S. Persons — Payments Subject to Back-up Withholding, No. 643, discusses the requirements relative to backup withholding as required under §3406 and the types of payments that may be subject to the imposition of this tax. Backup withholding is imposed on certain reportable payments when a payee or recipient fails to provide a taxpayer identification number or the appropriate documentation. The Portfolio describes the timing as to when withholding is required, the process to remit the tax to the IRS, and the reporting required at year end. The Portfolio discusses the various types of payments that may be subject to backup withholding, including interest, original issue discount (OID), dividends, broker proceeds, and miscellaneous payments. It addresses special reporting issues such as REMICs, REITs, and WHFITs, and the reporting requirements applicable at year end for payments subject to backup withholding that are reportable on Forms 1099 to payees or recipients and the IRS. The Portfolio also focuses on the penalties that may be imposed due to failures to correctly prepare information returns and report to recipients and the IRS.


Bloomberg BNA Portfolios are written by leading tax professionals who set the standard as leaders in their fields. The Information Reporting to U.S. Persons — Payments Subject to Back-up Withholdingportfolio was authored by the following attorney.

Carol A. Kassem, B.S. Accounting, Louisiana State University (1978); Consultant; Conference Speaker (Information Reporting); Information Reporting Manager, Bank One Corporation (1999–2004); Vice President (Information Reporting Group), JP Morgan Chase Bank, NA (2004–2005); IRS Information Reporting Advisory Committee (IRPAC), American Bankers Association (2002–2005); former member, New York Clearing House Tax Withholding and Information Reporting Committee.

Table of Contents

Detailed Analysis

I. Introduction

II. Failure to File Penalties

A. Introduction

B. General Penalty

1. In General

2. Timeliness of Filing

3. Sufficiency of a Return

a. Proper Form

b. Signature Requirement

c. Data Sufficient to Calculate Tax Liability

4. Computation of the Penalty

a. Rate

b. Penalty Period

c. Net Tax Amount

5. Reasonable Cause Exception

C. Certain Information Returns and Payee Statements

D. Partnership Returns

1. Required Returns

2. Penalty

3. Reasonable Cause Exception

E. REMIC Return

1. Income Tax Return

2. Information Return

F. Certain Corporate Transactions

G. Low Income Housing Bonds

H. S Corporation Returns

III. Failure to Pay Penalties

A. Tax Shown on Return

1. In General

2. Computation of the Penalty

a. Rate

b. Penalty Period

c. Delinquent Amount

3. Exceptions

a. Reasonable Cause

b. Bankruptcy

c. Postponement of Deadline

B. Tax Not Shown on Return

1. In General

2. Computation of the Penalty

a. Rate

b. Penalty Period

c. Net Amount Due

3. Exceptions

C. Stamp Tax

D. Federal Tax Deposits

1. Deposit Requirement

2. Methods for Making Deposits

a. Federal Tax Deposit Coupon Method

b. EFT Deposit Method ("EFTPS")

3. How the IRS Applies Deposits

4. Penalty

5. Reasonable Cause Exception

6. Special Exception for First-Time Depositors

7. One Time Refund of Penalty

E. Bad Checks

F. Regulated Investment Companies

IV. Accuracy-Related Penalties

A. Background

B. General Rules

1. Scope of Penalty

2. Amount of Penalty

a. In General

b. Qualified Amended Return

c. Rebate

d. Gross Valuation Misstatements

e. Suspension of Accrual

C. Reasonable Cause Exception

1. In General

2. Reasonable Cause for Tax Shelter Items of a Corporation

3. Waiver of Attorney-Client Privilege

D. Negligence and Disregard

1. Definition of Negligence and Disregard

a. Statute and Regulations

b. Case Law

2. Exception for Adequate Disclosure

3. Carrybacks and Carryovers

4. Prior Law

E. Substantial Understatement of Income Tax

1. In General

2. Definition of Substantial Understatement

a. In General

b. Carrybacks and Carryovers

3. Exception for Substantial Authority

a. What Constitutes "Substantial Authority"

b. IRS List of Unsupported Positions

4. Exception for Adequate Disclosure

5. Special Rules for Tax Shelter Items

a. Noncorporate Taxpayers

b. Corporate Taxpayers

c. Tax Shelter Defined

d. 2002 Tax Shelter Disclosure Initiative

6. Prior Law

F. Reportable Transaction Understatements

1. In General

2. Amount of Penalty

3. Definition of Reportable Transaction Understatement

4. Reasonable Cause Exception

a. In General

b. Disqualified Tax Advisor

(1) Participating Material Advisor

(2) Disqualified Compensation Arrangement with a Material Advisor

(3) Disqualified Contingent Compensation

(4) Disqualified Financial Interest

c. Disqualified Tax Opinion

5. Coordination with Other Penalties

6. Prior Law

G. Substantial Valuation Misstatements

1. In General

2. Gross Valuation Misstatement

3. Penalty Thresholds

4. Pass-Through Entities

5. Carrybacks and Carryovers

6. Charitable Deduction Property

7. "Attributable to" a Valuation Misstatement

8. Section 482 Transfer Pricing Penalty

9. Prior Law

H. Substantial Overstatement of Pension Liabilities

1. Statutory Provisions

2. Prior Law

I. Substantial Estate or Gift Tax Valuation Understatements

1. Statutory Provisions

2. Prior Law

J. Appraiser Penalties

V. Fraud Penalty

A. Statutory Provisions

B. Burden of Proof

C. Underpayment Plus Intent

D. Relevant Factors

1. In General

2. Failure to Report Income

3. Lack of Cooperation with IRS

4. Awareness of Tax Laws

5. Criminal Prosecution

6. Failure to File Tax Returns - Prior Law

E. Possible Defenses

1. Reliance on Third Parties

2. Innocent Spouse Relief

a. In General

b. Taxpayers Who Are Separated or No Longer Married

(1) In General

(2) Allocation of Deficiency

(a) In General

(b) Regulations

c. Joint Return Requirement

d. Lack of Knowledge Requirement

e. Inequitable to Hold Spouse Liable

f. Notice Requirements

g. Judicial Review

h. Community Property Income Rule

(1) Traditional Relief

(2) Equitable Relief

(3) Effect of Relief

(4) Exceptions

(5) Application for Relief

i. Equitable Relief

j. Prior Law

(1) Elements of Law

(2) Understatement Attributable to Grossly Erroneous Item

(a) Omissions from Income

(b) Erroneous Deductions

F. Prior Law

VI. Certain Information Returns and Payee Statements

A. In General

B. Information Returns Subject to Penalty

1. Reporting Requirements

2. Penalty for Failure to Timely File or Include Information

a. Reduced Penalties for Prompt Correction

b. Exception for De Minimis Failures

c. Increased Penalties for Intentional Disregard

d. Reasonable Cause Defense

3. Penalty for Failure to Furnish Correct Payee Statements

a. Reporting Requirements

b. Penalty

4. Penalty for Failure to Comply with Other Reporting Requirements

C. Reasonable Cause Exception

1. In General

2. Significant Mitigating Factors

3. Events Beyond Filer's Control

4. Acted in a Responsible Manner

D. Broker Notification Requirements

E. OID Information Requirements

F. Attorney Fee Reporting

G. Foreign Bank and Financial Accounts

VII. Tax Return Preparer Penalties

A. Background

B. Definition of Tax Return Preparer

1. Who is Considered a Preparer

a. Signing Tax Return Preparer

b. Nonsigning Tax Return Preparer

2. Defining Who is a Preparer Within a Firm

C. Understatement of Taxpayer's Liability by Tax Return Preparer

1. Reliance on Taxpayer Information/Duty to Verify

2. Income Derived Determination in Computing Penalty Amount

3. Reasonable Belief/More Likely Than Not Standards

a. Reasonable Belief/More Likely Than Not Standard

b. Adequate Disclosure

4. Tax Shelter Transactions


5. Willful or Reckless Conduct

6. Reasonable Cause

7. Penalty Due to Willful, Reckless or Intentional Conduct

8. Assessment, Collection and Refund of Penalty

D. Other Duties of a Preparer and Related Penalties

1. Duty to Sign Return

2. Furnish Preparer Tax Identification Number

3. Providing Copy of Return to Taxpayer

4. Retain Copy or List

5. Reporting of Preparers

6. Due Diligence in Determining Eligibility for the Earned Income Credit

7. Negotiation of Check

8. Fiduciary Duty

E. Assessment of Preparer Penalties

1. Assessment Procedure

2. Claim for Refund of Preparer Penalty

3. Suit for Refund

4. Abatement of Penalty

5. Special Procedures Regarding Understatement Penalties

6. Application of Overpaid Penalty

7. Interest

F. Other Preparer Penalties

1. Aiding and Abetting

2. Disclosure or Use of Information

3. Action to Enjoin Preparer

4. Coordination of Preparer Penalties

VIII. Promoter and Protester Penalties

A. Tax Shelters

1. Promoting Abusive Tax Shelters

a. In General

b. Who Is a Promoter?

(1) In General

(2) Organization of a Tax Shelter

(3) Participation in the Sale

c. Conduct to Which the Penalty Applies

(1) False Statements

(2) Gross Valuation Overstatement

2. Action to Enjoin Promoter

3. Failure to Furnish Information

a. Tax Shelter Disclosure Statement by Participant

(1) Transactions On or After February 28, 2003

(a) In General

(b) Reportable Transactions

(c) Participation

(d) Reporting

(2) Transactions Before March 1, 2003

(a) Who Must Submit

(b) Indirect Participation

(c) Reportable Transactions

(i) Transactions On or After January 1, 2003

(ii) Transactions Before January 1, 2003

(d) Manner of Disclosure

(3) Penalty

b. Tax Shelter Disclosure Statement by Material Advisor

(1) Requirements

(a) In General

(b) Reportable Transaction

(c) Material Advisor

(d) Multiple Material Advisors

(e) Filing of Return

(2) Penalty

(3) Action to Enjoin Material Advisor

c. Registration with IRS - Prior Law

(1) Requirements - Prior Law

(a) In General

(b) Tax Shelter Organizer

(c) Tax Shelter

(d) Confidential Corporate Tax Shelters

(2) Penalty - Prior Law

d. Furnish Registration Numbers - Prior Law

e. Include Registration Numbers on Return - Prior Law

f. List of Advisees

(1) Requirements

(2) Preparation and Maintenance of Lists

(3) Multiple Material Advisors

(4) Penalty

(5) Action to Enjoin Material Advisor

g. List of Investors - Prior Law

(1) Transactions On or After February 28, 2003 - Prior Law

(a) In General

(b) Potentially Abusive Tax Shelter

(c) Organizer and Seller

(d) Preparation and Maintenance of Lists

(2) Transactions Before February 28, 2003

(3) Penalty - Prior Law

B. Aiding and Abetting an Understatement of Tax

1. In General

2. Prohibited Conduct

a. Activities Subject to Penalty

b. Knowledge Required

c. False or Fraudulent Return Standard

3. Amount of Penalty

4. Action to Enjoin Advisor

5. Disciplinary Action

C. Frivolous Positions

1. Frivolous Income Tax Returns

2. Frivolous Positions in Court

D. Procedural Rules

1. Coordination of Penalties

2. Burden of Proof

3. Statute of Limitations

4. Deficiency Procedures Do Not Apply

5. Special Procedures to Contest Penalty

IX. Compensation Statements, Pension Plans, and Higher Education Savings

A. Compensation

1. Employee Statements

2. False Information with Respect to Withholding

3. Tips

B. Reports Relating to Plan Participants

1. In General

2. Annual Registration

3. Notification of Change

4. Statement to Plan Participants

5. Reasonable Cause Exception

C. Notices to Recipients of ERISA Qualified Plan Distributions

1. Notices Regarding Withholding

2. Notices Regarding Rollovers

D. Exempt Organizations and Certain Trusts

1. In General

2. Failure to File Annual Return

3. Public Inspection and Copies of Annual Returns

4. Willful Failure to Allow Public Inspection

5. Return Reporting Liquidation of Exempt Organization

6. Failure to File Trust Return

7. Reasonable Cause Exception

8. Chapter 42 Tax

9. Charitable Contributions

a. Quid Pro Quo Contributions

b. Donations of Motor Vehicles, Boats and Airplanes

10. Fundraising Solicitations

a. Nondeductible Contributions

b. Premium Available from Federal Government

E. ERISA Qualified Plan Trusts and ESOPs

1. Owner-Employees

2. Designated Distributions

3. Employee Stock Ownership Plans

4. Certain Fringe Benefit Plans

5. Penalty

F. Deductible Employee Contributions

G. IRA, SEP, and SIMPLE Reports

1. Annual Reports

2. Nondeductible Contributions to or Distributions from IRAs

3. Notices Relating to SIMPLE Retirement Accounts

H. Actuarial Reports

1. Periodic Reports

2. Merger or Consolidation

I. Savings Accounts

1. Archer Medical Savings Accounts

2. Health Savings Accounts

3. Coverdell Educational Savings Accounts

J. Qualified Tuition Programs

K. Mortgage Credit Certificates

L. Transfers at Death and by Gift

X. Certain Foreign Persons

A. Foreign Persons Investing in U.S. Real Property

B. Information with Respect to Foreign Trusts

1. In General

2. Penalty

C. Returns with Respect to Foreign Corporations and Foreign Partnerships

1. Organization, Reorganization or Acquisition of Stock in Foreign Corporation

2. Interests in Controlled Foreign Corporations

3. Interests in Foreign Partnerships

4. Outbound Transfers to Foreign Corporation

5. Returns of Officers, Directors, and Shareholders of Foreign Personal Holding Companies - Prior Law

6. Penalties

D. Foreign-Owned Corporations

E. Foreign Corporations Engaged in a U.S. Trade or Business

F. Foreign Corporation Personal Holding Company Return

G. FSC and DISC Returns

H. Notice of Redetermination of Foreign Tax

I. Residents of U.S. Possessions

J. Treaty-Based Return Positions

XI. Reasonable Cause Exception

A. In General

B. Time and Manner of Claiming the Exception

C. Requirements for the Exception

1. Good Faith or Absence of Willful Neglect

2. Reasonable Cause Standard

3. Causation and Duration

D. Common Reasons Given as Reasonable Cause

1. Reliance on Tax Advisor

a. Filing Return vs. Substantive Law

b. Reasonable Reliance

2. Death, Serious Illness, or Unavoidable Absence

3. Records Unavailable

4. Inability to Pay

5. Ignorance of the Law

6. Mistake or Forgetfulness

7. Misfeasance by Employee or Agent

8. Erroneous Written or Oral Advice from the IRS

9. Time and Business Pressures

10. Invalid Extension

11. Constitutional Objections and Religious Beliefs

12. Service in Combat Zone and Federally Declared Disaster or Terroristic or Military Actions

13. Failure Arising from Fifth Amendment Concerns

14. Fire, Casualty, Natural Disaster or Other Disturbance

XII. Assessment and Collection

A. In General

B. Appeals of Penalties

1. Deficiency Procedures

2. Post-Assessment Appeal

3. Collection Due Process Hearing

4. Equivalent Hearing

5. Taxpayer Assistance Order

6. Collection Appeals Program

7. Refund Claim

C. Persons Responsible for Penalty

1. In General

2. General Partners

D. Transferee Liability

Working Papers

Working Papers

Table of Worksheets

Other Resources

Worksheet 1 Guide to Most Common Information Returns: Names; What to Report; Amounts to Report; Due Dates

Worksheet 2 Guide to Commonly Used Frivolous Arguments

Worksheet 3 Tax Shelters - Guide to Listed Transactions

Worksheet 4 Penalty Relief - Application Chart (Reasonable Cause and Other Relief)

Worksheet 5 Excerpts from IRM 1.2.1 (Policies of the Internal Revenue Service)

Worksheet 6 [Reserved]

Worksheet 7 Excerpts from Conference Report to Accompany H.R. 3299, The Omnibus Budget Reconciliation Act of 1989 (Dealing with Revision of Civil Penalties)

Worksheet 8 Excerpts from Conference Report to Accompany H.R. 4520, American Jobs Creation Act of 2004 (Dealing with Additions and Revision of Tax Shelter Disclosure and List Maintenance Penalties, Accuracy, and Advisor, Promoter, and Advisee Penalties)




Treasury Regulations:

Committee Reports:

Treasury Rulings and Procedures: