Enacted as part of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), the safe harbor for de minimis errors on information returns and payee statements always felt like one of those gifts with a string attached. This has not changed with the proposed de minimis error safe harbor regulations released by the IRS at the end of last week.
Section 6721(c)(3) and 6722(c)(3), as amended by the PATH Act, generally provide that an information return or payee statement with one or more errors in a de minimis amount appearing on the return or statement is treated as correct for penalty purposes. That is, penalties do not apply to these de minimis errors, thus obviating the need for correction. An error in dollar amount is de minimis if the difference between the error and the correct amount does not exceed $100 and, if the difference is with respect to tax withheld, not more than $25.
However, the PATH Act provisions also included an exception to this safe harbor: the person to whom a payee statement is being furnished (e.g., a broker’s customer receiving a Form 1099) can elect to have the safe harbor not apply. This would then return the payor/filer to the world of potential penalties unless the de minimis error is corrected in a timely fashion.
Initial guidance on the application of the de minimis safe harbor and procedures for the payee’s “override” election was provided last year in Notice 2017-09. Industry concern has been that administrative resources necessary to accommodate payee election might offset any benefit of the de minimis safe harbor from an operational perspective. Comments to the IRS principally sought to circumscribe the manner in which the payee’s election would apply.
In the proposed regulations released on Friday, October 12, 2018 (REG-118826-16), the IRS, while attending to industry comments, also affirmed the payee’s right to “elect” to have the safe harbor not apply. The sense from the preamble to the proposed regulations is that the IRS views this as reflective of the intent of the statute. The regulations are largely consistent with prior Notice 2017-09. They provide that a payee can always make the override election in writing by mail to the payor. The election applies to the current calendar year and all subsequent years and, unless otherwise specified by the payee, applies to all types of payee statements that the payor furnishes to the payee. The payee also has the right to revoke the election.
If the filer wants to allow for “reasonable alternative” means for the election such as by email, or filer’s website or by telephone, the filer needs to notify the payee of these reasonable alternatives. The filer is allowed to specify the information that the payee needs to provide to make an election under one of these alternative methods, but the provision of these alternatives does not limit the payee from making an election under the default method. The proposed regulations, however, would provide an October 15 (or, if later, 30 days after a statement is due) deadline for the payee to make an election that would apply for the current year.
Two particular points might be of interest to brokers attending to cost basis reporting. The first point relates to an industry comment that had requested that the payee election not apply to Form 8937, “Reporting of Organizing Actions Affecting Basis of Securities.” For Form 8937 reporting under Section 6045B, a filer need not issue individual Forms 8937 but can opt to post a single Form 8937 on its public website. As such, the form is not specific to a payee an election requested by one payee would affect the information for payees who have not made an election. The IRS noted that the PATH Act had not provided an exception for this and declined to include an exception for Form 8937 in the proposed regulations.
A second point involves a clarification of the cost basis amount that is treated as “correct” for cost basis reporting when there is a de minimis error. Section 6045(g)(2)(B)(iii) provides that a customer’s cost basis is determined by treating any incorrect dollar amount “which is not required to be corrected” by reason of the de minimis safe harbor rules as the correct amount. So what should be the correct cost basis for reporting if a payee does not make an election to override the safe harbor but the broker voluntarily corrects the de minimis error? The proposed regulations provide that the cost basis dollar amount voluntarily corrected by the broker becomes the cost basis to use for purposes of Section 6045 broker reporting.
The propose regulations for the most part are effective on or after January 1 of the calendar year immediately following the year when the regulations are finalized. This seems to mean that the guidance provided by Notice 2017-09 would remain in effect until that time.
Industry participants will need to evaluate the proposed regulations and Notice 2017-09 to determine what administrative framework needs to be put in place to accommodate payee elections that override the de minimis error safe harbor. From an operational perspective, some firms may choose to continue correcting de minimis errors as a matter of policy and only use the safe harbor as a fallback position on audit. This safe harbor comes with strings.