IRS Wins Ruling Against Church for Misclassifying Employees

Key point. The tax code imposes penalties on employers, including churches, that fail to issue information returns (i.e., W-2, 1099) to employees and contractors, and these penalties are significantly increased if the failure is willful.

The United States Tax Court ruled that the Internal Revenue Service acted properly in assessing penalties against a church for intentionally refusing to issue W-2 forms to its employees.

Section 6721(a) of the tax code imposes a penalty on employers for failure to file correct W-2 and other information returns. This penalty applies when an employer required to file an information return neglects to file it on time or fails to include within all information required to be shown. For the tax years involved in this case the penalty was $100 for each return with respect to which such failure occurred. However, if an employer intentionally disregards the filing requirement for Form W-2 and other information returns, the penalty significantly increases.

The IRS determined that a church with several full- and part-time employees had failed, for 2010 and 2011, to provide the Social Security Administration (SSA) with Forms W-2 for these workers. The IRS sent the church a notice of penalty (a "CP215 Notice") for each year, informing the church of this discrepancy, requesting further information, and notifying the church that it risked penalties under section 6721.

Having received no response, the IRS, on December 2, 2013, assessed $5,942 of section 6721 penalties against the church for 2010. On November 3, 2014, the IRS assessed $6,354 of section 6721 penalties against the church for 2011. In an effort to collect these unpaid liabilities, the IRS sent the church a "Final Notice of Intent to Levy and Notice of Your Right to a Hearing." This notice informed the church that its unpaid liabilities, including accrued interest, then totaled $12,840. The notice stated: "If you wish to request an Appeals hearing, complete the enclosed Form 12153, Request for a Collection Due Process or Equivalent Hearing, and send it to us within 30 days from this letter's date."

An IRS agent hand delivered the notice to the church during a field visit on September 10, 2015. The church took no action in response to the levy notice and did not request an appeals office hearing. A few months later the IRS sent the church a notice of "Federal Tax Lien Filing and Your Right to a Hearing." The church requested a hearing in response to this notice. The IRS Appeals Office acknowledged receipt of the church's hearing request, explaining that if it wished to pursue a collection alternative, it would need to submit Form 433-B, Collection Information Statement, with supporting financial information. The scheduling of a CDP hearing was delayed while the church sought assistance from the IRS Taxpayer Advocate Service. An IRS settlement officer eventually held a telephone hearing with the church on December 1, 2016.

During the hearing, the settlement officer explained that the church could not challenge its underlying liability for the penalties because it had failed to take advantage of a prior opportunity to dispute the penalties in response to the levy notice. In any event, the settlement officer stated that the church had not supplied adequate documentation to justify abatement of the penalties. The settlement officer explained that the church did not qualify for a collection alternative because: (1) it had not proposed a collection alternative; (2) it had not submitted Form 433-B or the financial information required for consideration of a collection alternative; and (3) it was not in current compliance with its tax-filing obligations, having neglected to file Form 941, Employer's Quarterly Federal Tax Return.

The settlement officer reviewed the administrative file and concluded that the penalties had been properly assessed and that all requirements of law and administrative procedure had been satisfied. He determined that the church had submitted no information that would entitle it to withdrawal of the levy notice or penalties. The settlement officer concluded that the penalties had been properly assessed and that all requirements of law and administrative procedure had been satisfied. It determined that the church had submitted no information that would entitle it to a reduction in the penalty. The church appealed to the Tax Court.

The Tax Court noted that the tax regulations stipulate that if a taxpayer had a prior opportunity to dispute the existence or amount of an underlying tax liability, it cannot challenge the underlying liability when it receives a second notice from the IRS. Therefore, the only remaining basis for the church's appeal was the contention that the IRS settlement officer's acts constituted an abuse of discretion. Abuse of discretion exists "when a determination is arbitrary, capricious, or without sound basis in fact or law." The court reviewed the settlement officer's actions, and determined that the church had failed to meet the high standard of proving that he had acted with an abuse of discretion.

What this means for churches

The penalties addressed in this case for failing to issue information returns (i.e., W-2 or 1099-NEC) to employees and contractors have increased. The current penalties are as follows:

• A penalty of $270 for each information return not issued by the due date.
• A penalty of $270 for each information return that fails to include all the information required to be reported.
• In either case, the penalty is reduced to $50 per return if corrected within 30 days of the required filing date ($110 if corrected before August 1).
• The penalty is increased to $550 per return in cases of intentional disregard of the filing requirement. In some cases, this penalty may be increased.

Baptist Church v. Commissioner of Internal Revenue, T.C. Summ.Op. 2018-3.