This blog was last updated on September 20, 2024
Millions and millions of tax dollars are lost to fraud every year due to stolen identities, dishonest tax preparers or claims of false tax losses or dependent information. The IRS deploys a variety of processes to detect fraud including analyzing information reported on third party information returns like 1099s and W-2s compared to information reported by the same taxpayer on their annual income tax return. However, the majority of third parties do not file information returns with the IRS until long after the copies of those same returns are sent to the taxpayer.
Determining whether gaps in the information return filing deadlines currently meet the needs of the agency was one of many recommendations made in the Government Accountability Office (GAO) report to congress in 2020 called Better Coordination Could Improve IRS’s Use of Third-Party Information Reporting to Help Reduce the Tax Gap. Last month, the GAO released TAX ENFORCEMENT: IRS Can Improve Use of Information Returns to Enhance Compliance to lawmakers and again reiterated that the IRS leadership should reevaluate the information return filing deadlines among other recommendations that have not been addressed from that 2016 report.
How can 1099 fraud be perpetrated through information returns?
One of the most prevalent schemes the IRS has reported is related to Form W-2, where people are encouraged to create and file W-2s that contain fake income, withholding and employer information in the hopes of getting a sizeable refund.
There are also several schemes involving identity theft. In a case reported in the Washington Post in 2022, a scammer stole a person’s identity to get work, and the fraud went undetected until the third-party issued a 1099-NEC to the real taxpayer at the end of the year. In a case prosecuted by the United States District Court of New Jersey last year, the scammers stole taxpayers’ identities and create fictitious Forms W-2G and W-2 that reported fake income and withholding amounts and filed corresponding Forms 1040 generating false refunds.
The PATH Act of 2015 accelerated filing deadlines for Forms
1099-NEC and W-2 to minimize fraud
In the 2016 Consolidated Appropriations Act congress included the measures from what was more formally known as The PATH Act of 2015. The Protecting Americans from Tax Hikes (PATH) Act included a variety of provisions to prevent taxpayer fraud associated with refundable tax credits such as the Earned Income Tax Credit, the Advanced Child Tax Credit and others. A key change in the law accelerated the filing deadline for Forms W-2 and 1099-NEC from the end of March to the end of January annually. Lawmakers argued that moving the filing due date up allowed the IRS to match information reported on third party returns to corresponding income tax returns for the same taxpayer in real time which would prevent refunds from being issued associated with fraudulent claims.
Treasury recommended changes to 1099 filing due dates in the annual Greenbook
In the FY25 Greenbook, the Treasury Department proposed that congress amend Section 6071(b) to require earlier electronic filing due dates for information returns reported following Sections 6041 through 6050Z of the Code. The change would require filers to electronically file information returns with the IRS on the same date that they issue those returns to the recipient.
These sections of the Code cover something like 50 different information returns that report taxable and/or deductible transactions including the Form 1099 series, Form 1098 series, Form 5498 series and more.
In the Greenbook, the government argues that the change is needed because the current March 31 deadline is so far after the start of tax season, it limits the IRS’s ability to match off information from third party returns to income tax returns in real-time hindering their ability to detect and prevent identity theft and other fraud. Additionally, having the information sooner would assist the taxpayer in preparing their return by ensuring they are reporting accurate information and reducing inadvertent omissions of income or expense information.
Reality check: high volume issuers need more time
Most information returns are required to be issued to the recipient by the end of January, which means organizations have about 23 – 25 business days to prepare statements to be mailed or issued electronically to all employees, vendors, customers and other payees in a very short period of time.
The vast majority of information returns issued to recipients on January 31st are accurate but large enterprises – including financial services companies that are responsible for issuing thousands, hundreds of thousands or even millions of information returns – have a very difficult time getting all those statements issued accurately by the end of January. In fact, the window of time between the end of January and the end of March is when organizations make the most corrections to information returns, in large part, because they have time to continue to evaluate the data and correct errors or because recipients contact them to report errors on statements that were issued.
In over 15 years of practice, my experience tells me that no matter the amount of preparation a large organization does to prevent these issues, something is always lurking in the background that wasn’t detected that requires corrections or late originals to be issued long after the January 31st date.
Information return penalties should be modified
If congress intends to pass legislation to require accelerated filing due dates for information returns, they should also change the current law related to penalties applicable to information returns.
Section 6721 penalties do not allow any wiggle room for mistakes. From the first day that a return is filed with the IRS, the organization is subject to penalties if that return contains invalid or missing information. Although the regulations provide for a de minimis error safe harbor exception, that exception doesn’t apply to all returns required to be issued under Sections 6041 through 6050Z of the Code.
Lawmakers should amend the regulations to provide a grace period of at least 30 days after the filing due date, before applying Section 6721 penalties to erroneous information returns. For example, the current law assesses penalties based on a tiered approach so that if an organization files corrected information returns within 1-30 days of the original filing due date, the penalty is less than if they wait to file that corrected return until after August 1st of the year in which the return was due. Congress should amend that structure so that the first tier of penalties (i.e., 1-30 days late penalties) are applicable 30-days after the information return filing due date.
