Trials and Tribulations in the ITIN Unit

We welcome first time guest blogger Sarah Lora. Sarah is a supervising attorney in Legal Aid Services of Oregon located in Portland, Oregon. She is also a vice chair of the ABA Tax Section Pro Bono and Low Income Taxpayer Committee. She represents a high percentage of immigrant taxpayers. Today, she discusses the problems encountered by one of her clients trying to file a proper tax return. The process led to frustration and points to the need for a system that allows clients to have a further hearing when things go wrong. She cites us to the Taxpayer Bill of Rights and to administrative law in her discussion of the search for a clear answer. Julie Preciado, Willamette Law School 2L, helped edit this piece. Keith

Our clinic represents a U.S. legal permanent resident who supports his teenage daughter who resides in Mexico. Our clinic helped the client file his 2015 return tax return. The client rightfully included his daughter as a dependent on the return. The daughter qualifies as a dependent under Section 151 of the code, except that she does not have a TIN as required by Section 151(e). To satisfy that requirement, we helped prepare the W-7 application pursuant to Section 6109(i)(1) with supporting documents of an original birth certificate and school record as allowed by the W-7 instructions. A few weeks passed and we received a notice that stated that the supporting documents submitted were insufficient, without further explanation.

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Regarding school records, the W-7 instructions state:

School records will be accepted only if they are for a school term ending no more than 12 months from the date of the Form W-7 application. The school record must consist of an official report card or transcript issued by the school or the equivalent of a Ministry of Education. The school record must also be signed by a school official or ministry official. The record must be dated and contain the student’s name, coursework with grades (unless under age 6), date of grading period(s) (unless under age 6), and school name and address.

I carefully reviewed the documents and the W-7 instructions and could find no problem with the birth certificate. The only discrepancy I could find with the school record is that it contained a grade point average, and not individual coursework. We submitted a detailed explanation as to why the documents substantially complied with the W-7 instructions. The rejection letter came shortly thereafter, again, without explanation. I started to feel like I had entered Dickens’ Office of Circumlocution.

I posted to the ABA listserv requesting feedback from my fellow practitioners about how to appeal a rejected W-7. All the responses were the same: you cannot. The only recourse is to file another application. However, if I do not understand why the ITIN unit rejected the original application, how can I hope to be successful in a second application? Furthermore, the education record had become stale because, according to the W-7 instructions, the records are only acceptable for 12 months from the end of the school term for which the record pertains. To file another W-7 would mean the time-consuming and arduous task of obtaining other documents from Mexico.

The Taxpayer Bill of Rights guarantees my client the right to: challenge the IRS’s position and be heard; appeal an IRS decision in an independent forum; and pay no more than the correct amount of tax. How could we appeal and where could my client be heard? Several weeks later, we received a math error notice stating that my client had erred in calculating the correct amount of tax because he was denied a dependent exemption due to lack of a valid tax identification number for his dependent. A light bulb went off. We could get to the issue of the wrongly denied ITIN by protesting the math error notice!

Section 6109(i)(1) authorizes the Secretary to issue an ITIN, “if the applicant submits an application, using such form as the Secretary may require and including the required documentation.” Section 6109(i)(2) defines required documentation to include “such documentation as the Secretary may require that proves the individual’s identity, foreign status, and residency.” The implementing regulation is found at Section 301.6109-1(b)(3) and states, in relevant part, that the applicant “must apply for [an ITIN] on form W-7.” An ITIN will be assigned to an individual on the basis of information reported on Form W-7 . . . and any such accompanying documentation that may be required by the Internal Revenue Service. An applicant for an [ITIN] must submit such documentary evidence as the Internal Revenue Service may prescribe in order to establish alien status and identity.

The regulation gives latitude to the IRS to prescribe the types of allowable documents. However, that latitude is limited by the APA. Judicial review under the APA allows a court to examine a final agency action, so long as it is not committed to agency discretion or otherwise precluded from review by statute. Section 706 requires that with respect to any agency action, a reviewing court must “hold unlawful and set aside agency action found to be,” among other things, “arbitrary, capricious, [or] an abuse of discretion.”

The arbitrary and capricious standard requires agencies to engage in reasoned decision making prior to issuing a determination. Motor Vehicle Mfr. Ass’n v. State Farm Auto Mut. Ins. Co., 463 U.S. 29, 52 (1983). Courts will invalidate agency determinations that fail to “examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made.” Id. at 43 (internal quotation omitted).

In this case, a reasonable person could make the argument that the denial of my client’s dependent’s ITIN application was arbitrary and capricious under State Farm because the IRS did not articulate a satisfactory explanation for its action, much less show a rational connection between a report card with “coursework and grades” and proving an applicant’s identity. Not only are the W-7 instructions raising barriers for the most vulnerable taxpayers by requiring “coursework” rather than grade point averages, a rational connection with a legitimate state interest is tangential at best. If fraud prevention in supporting documentation is the IRS’s objective, requiring report cards including “coursework with grades” is both under and over inclusive. It excludes more official government issued educational proof documents, such as the one my client submitted with a grade point average, and includes easily falsified commonplace progress reports. The ITIN unit is wrong to offer no explanation for its decisions that create confusion, frustration, and ultimately an inefficient process that wastes taxpayer resources.

Another possibly narrower argument against the ITIN unit’s actions in my case is that the ITIN unit’s interpretation of Treasury Reg. 301.6109-1(b)(3) is “plainly erroneous” as set in Auer v. Robbins, 519 U.S. 452, 461 (1997). Here the ITIN unit’s requirement for specific coursework versus a grade point average (if this is indeed the problem in my case) does not appear to be at all rationally related to the regulation’s requirement that the document show “alien status and identity.”

Creating opaque guidelines for the most vulnerable taxpayers is fundamentally unfair. Administrative agencies have a duty to the public to provide clear guidelines, tied to legitimate state interests. After all, Nina Olson has told us on many occasions that “[a]t their core, taxpayer rights are human rights.”

Fighting a Form 1099 with Which You Disagree

We have written about cases involving Form 1099 previously on several occasions including one post early last year that provides approaches both the IRS and the taxpayer might take to the problems created by a Form 1099. I also wrote a post yesterday discussing how to approach a Form 1099-C contest. An order entered in the case of Horejs v. Commissioner, Dk. No. 4035-17 shows that, no surprise, the problem continues and that at least one petitioner was pretty upset about the trouble it took to fix the problem. A bad information return is costly to the IRS and to the taxpayer as Horejs demonstrates. Just as it is critical to the system to do everything possible to get tax returns correct at the outset it is critical to get information returns correct as well. The preparer of a bad information return, however, usually does not pay the price inflicted on the taxpayer and the IRS to unwind the bad information provided.

The Horejs case also raises an interesting jurisdictional issue regarding a refund to an intervenor.

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Citibank sent a Form 1099-C to Mr. Horejs, his wife Mary Baldwin and the IRS indicating that Mr. Horejs and Ms. Baldwin had income resulting from the cancellation of debt. Mr. Horejs told the IRS, presumably during the audit phase though the description of the timing is not perfectly clear, that the “Form 1099-C was incorrect, referring respondent (the IRS) to litigation between petitioner (Mr. Horejs) and Citibank.” The IRS asked for more information about the dispute which Mr. Horejs did not provide. Specifically, the IRS asked him to contact Citibank to obtain a corrected Form 1099-C and send it a copy.

While it would be nice if Citibank would oblige, in situations like this Citibank and the taxpayer usually have a broken relationship. The fact that Mr. Horejs sued Citibank about the debt suggests that he will probably struggle to convince Citibank to send him a new form. Mr. Horejs alleges in his case with the IRS that it was wrong for the IRS to ask him to do this and wrong for the IRS to rely on the Form 1099-C sent to it by Citibank. I sympathize with Mr. Horejs and I also sympathize with the IRS because it’s trying to resolve a problem it did not directly create. Because of the impasse regarding the Form 1099-C at the audit stage, the IRS issued a notice of deficiency. This is an easy way for the correspondence auditors to kick the problem upstairs.

Of course, sending the notice of deficiency not only prolongs the problems for the taxpayer and the IRS but also brings another innocent party into the situation, the Tax Court. The parties before the court and the court itself generally do not possess the information necessary to resolve the case and the system does not create a mechanism to make the issuer of the Form 1099 a party to the case over which the court would have power to issue orders and over which it could impose sanctions. Perhaps we should build a better mousetrap with respect to information return cases and make the issuer of the information return a party, get everyone in front of the court at the same time and assign “blame”, including the imposition of penalties against the issuer of a bad information return or against the taxpayer. If the information return issuer were a party to the litigation, the IRS would have almost no work to do because it would be up to the information return issuer to come forward with information to support the basis for issuing the information return and up to the taxpayer to respond when the information return issuer came forward with solid evidence to support the issuance.

But that’s not the system we have.

When the IRS sent the notice of deficiency, Mr. Horejs filed a Tax Court petition. Mary Baldwin did not. Since she did not file a petition, the IRS assessed the proposed deficiency against her. She paid the liability while Mr. Horejs’ Tax Court case was still pending. Then she filed Notice of Intervention and the Court issued an order amending the caption and allowing her to intervene. I do not recall seeing this before but maybe I just have not paid enough attention to parties trying to intervene.

Meanwhile, the IRS made contact with Citibank to request support for the information return it issued. Citibank responded by sending the IRS a corrected Form 1099-C reporting that petitioner had not received cancellation of indebtedness income in 2014. Based on this change of heart by the issuer of the information return, the IRS prepared a decision document conceding the deficiency in the case. The order indicates that Mr. Horejs and Mary Baldwin signed the decision document as did the IRS attorney; however, neither Mr. Horejs nor Ms. Baldwin were happy.

Mr. Horejs filed a motion for summary judgment asking for his $60 filing fee, $500 for time and expenses dealing with the matter, a refund of the money paid by Ms. Baldwin, a letter of apology from the IRS and damages from Citibank for issuing a false document. At the hearing on the motion, the Court explained it did not have jurisdiction to order the IRS to apologize or to order damages against Citibank. The IRS stated at the hearing that it would issue a refund to Ms. Baldwin at the conclusion of the case and the parties filed a stipulation showing her statement of account.

Steve wrote a two part post last fall on 7434 generally for anyone interested in the relief available there.

So, Mr. Horejs wins his case. Does not receive an apology, does not receive compensation for his time and effort or his outlay of funds for the filing fee, does not receive, at least in the Tax Court, a recovery of damages from Citibank and may feel pretty empty as a winner since winning in Tax Court is often not as much winning as avoiding losing. I am sure he is still unhappy and frustrated. Still, an interesting thing happens in this case in that Ms. Baldwin, who did not timely file a Tax Court petition and now comes into the case as an intervenor, gets all of her money back (plus interest). The result shows that intervenors can obtain a recovery of an overpayment in a Tax Court case and creates an interesting aspect of Tax Court jurisdiction of which I was previously unaware. Hat tip to Carl Smith for noticing this unusual wrinkle in a Tax Court case. Maybe more non-petitioning spouses will come into the Tax Court after being assessed and use this refund forum.

 

 

 

What to Do if You Receive a Form 1099-C with Which You Disagree

Guest bloggers and I have written before about issues created by “bad” Forms 1099. A post exists on Faulty Information Returns written by my former colleague at the Legal Services Center Caleb Smith; on Offset of a Tax Refund to Pay Student Loans written by my current colleague at the Legal Services Center Toby Merrill who heads the Project on Predatory Student Lending; on Proving a Negative and Cash for Keys by me. These posts generally deal with the situation of someone receiving a Form 1099 that may not be accurate and trying to deal with the consequences of the issuance of the form.

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As Caleb discussed in the post about faulty information returns, this issue creates a significant burden in situations in which a class of individuals have their loans forgiven as a result of government enforcement litigation or private class action litigation attacking the debt provider or a debt buyer. In these situations, several hundred thousand people may have their debt forgiven as a result of litigation but the lender may feel compelled to issue a Form 1099-C to all of the members of the group or class obtaining relief. Frequently, the information return comes to low-income individuals not well equipped to cope with the tax consequences of receiving a Form 1099-C. The issuance of the Form 1099-C to hundreds of thousands of people who may have one or more defenses to the inclusion of the amount on the form as income also puts a strain on the IRS, which must cope with the resolution of the issue on an individual basis with each of the recipients rather than with the class.

In a couple of cases, the IRS issued guidance essentially telling the lender not to issue the Form 1099-C because the IRS could see that the issuance would create a train wreck for the individuals and the system; however, the IRS does not have an easy mechanism for issuing rulings that will stop the issuance of the Form 1099-C to a group or class of individuals. Several recent cases, including Corinthian, ITT, and Aequitas, involving student loan disputes highlight the circumstances that can lead to the issuance of massive numbers of Form 1099-C.

If the Form 1099-C goes out, then the IRS computers react like Pavlov’s dog. They scour the taxpayer’s account for a return reporting the amount on the information return. If the computers do not find the income from the information reported on a return filed by the taxpayer, the computers spit out an automated underreporter notice and the controversy is off to the races.

What to do on your tax return

One of the tough situations for low income taxpayers receiving a Form 1099-C is that the existence of this form places their returns “out of scope” for free income tax assistance at a Volunteer Income Tax Assistance (VITA) site. The tax clinic at Harvard refers qualifying individuals to VITA sites to have their returns prepared because the VITA volunteers generally do a great job and because they prepare the return for free. The combination of good quality and free makes these sites the perfect place to refer our clients; however, on this issue it does not help. Low income taxpayer clinics do not prepare current year returns because they focus on tax controversy, and return filing is not controversy. So, free assistance in preparing the return may be difficult or impossible to obtain. This is an issue, however, where paying money to get it right at the outset could save a lot of headaches (and money) in the future, so find a good professional to assist with the return if you can afford it and are not totally confident.

The guide discussed below helps people to understand how they can report the characterization of the amount on the Form 1099-C on their return. Because it’s hard to stop the issuance of Form 1099-C in most of the cases involving a class of individuals contesting the validity of a debt, and because no good way yet exists to warn individuals receiving the form who disagree with the amount on the form, the Legal Services Center created a brief guide for individuals who find themselves in this situation. The guide is not legal advice and is no substitute for professional advice on how to treat an item on a return, but might assist individuals struggling to come to a basic understanding of what the receipt of a Form 1099-C requires of them if they do not simply agree with the amount and characterization of the debt forgiveness. There can be more than one basis for excluding from income an amount reported on a Form 1099-C, which is why they are outside the scope of VITA volunteers’ services. So, using the guide should help a taxpayer start the process of reporting the information on a Form 1099-C but should not necessarily be the ending point. Having the return professionally prepared may save many downstream problems. The guide offers up two primary bases for taking the position that the debt is excluded – disputed debt and insolvency of the individual at the time of forgiveness. Others may exist and not all preparers may be equipped to make a proper evaluation. So, choose the preparer wisely.

What to do if the return gets audited

Even individuals who follow the guide to report information from a 1099-C may wind up in the correspondence audit process. The guide does not instruct individuals who wind up in the correspondence audit process on what to do, but for many individuals who file a return that the computer identifies as deficient in reporting the information on the Form 1099-C, understanding what to do in audit can also be important. Again, the information in this post is no substitute for professional advice, and low income taxpayer clinics can assist qualified individuals in the audit process to respond to the correspondence received from the IRS. The critical action in the correspondence audit is alerting the IRS to the dispute over the amount and characterization of the event on the Form 1099-C so that the individual can invoke IRC 6201(d) if the matter moves from the examination phase to the Tax Court.

If the individual who has received a Form 1099-C that they believe is mistaken as to the amount or characterization of the debt, and if that individual notifies the IRS during the examination, then it is possible to reverse the normal burden of producing evidence. That burden normally rests with the taxpayer because the taxpayer normally controls the evidence. Form 1099-C, however, is generated by a third party and not by the taxpayer. Therefore, Congress has provided in IRC 6201(d) that when the taxpayer has alerted the IRS to a problem with a Form 1099-C and has cooperated during the examination phase of the case, the burden of production concerning the accuracy of the Form 1099-C shifts to the IRS. So, responding to the notice of examination of the return can prove critical in an information return case.

Conclusion

It appears that large numbers of individuals are poised to receive Forms 1099-C. Addressing the form when filing the tax return could head off additional problems. If addressing the form on the return does not solve the problem, the taxpayer must respond to the notice of examination and alert the IRS to the dispute regarding the information on the form sent to the taxpayer.

Can Intentionally Filing an Improper Information Return Justify a Claim for Damages Under Section 7434?…Part II

In last Friday’s post, I outlined aspects of the private cause of action for fraudulent information returns under Section 7434, and specifically discussed some case law on whether or not an intentionally incorrect form could give rise to fraud under Section 7434 or if there had to be a fraudulent amount stated on the form.  The current trending opinion on this matter is that the amount must be fraudulent, not just the form, and the primary holding in this area is Liverett.  Today’s post will discuss the specific rationale in Liverett, and why I think the statute may be open to other interpretations.

In Liverett, the specific facts are not that important.  A worker thought she should have been an employee, but was treated as an independent contractor by her employer and issued a Form 1099-Misc.  The worker brought a Section 7434 claim against the employer, and also brought wage and overtime claims under the Fair Labor Standards Act.  The Liverett Court noted the prior cases in this area, but stated there was not an exhaustive analysis of the statute.

In reviewing the statute, the district court found the language of Section 7434 was ambiguous, stating:

This statute, at first glance, appears quite simple and straightforward. But, a more careful reading reveals that it harbors a significant ambiguity, the resolution of which impacts this case.

The source of the ambiguity in [Section] 7434(a) is the phrase “with respect to payments purported to be made to any other person.” Simply put, there is ambiguity as to what the phrase “with respect to…” modifies. On the one hand, [Section] 7434(a) may refer to an “information return with respect to payments purported to be made to any other person” that is “fraudulent.” On this reading, “with respect to…” describes “information return,” and such an information return that is false or misleading in any respect aimed at obtaining something of value is “fraudulent” and therefore actionable. On the other hand, “with respect to payments purported to be made to any other person” may be read as limiting “fraudulent.” Under this interpretation, the filing of an information return is actionable only if the information return is false or misleading as to the amount of payments purportedly made.

After coming to this conclusion, the court had to attempt to ascertain the meaning of the statute, which it concluded meant that the fraud had to be in the amount of the payment and not the form.  It came to this conclusion based on statutory construction, the legislative history, and the fact that the plaintiff had other federal statutes available to make claims under.  The court’s rationale is plausible under each, but I think there could be other interpretations.

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Before discussing each of the rationales below, I do want to reiterate this review was done because the court concluded the statute was ambiguous.  Various courts that previously reviewed this matter did not flag this issue, so it might be possible to argue there is no ambiguity.  Most people I have spoken with, upon initial reading of Section 7434, assume it means any fraud related to the information return.  For purpose of the remainder of the post, however, I will assume that the statute is ambiguous.

I think the statutory construction rationale provided by the court was the strongest, and I suspect the rationale that convinced other courts to follow suit.  The Court noted that the placement of the term “fraudulent” prior to the term “information return” was evidence of a broader interpretation, but said other statutory construction tenets required a more nuanced look.  The Court then looked to the definition of “information return” under Section 6724, which is “a statement of the amount of payments to another person”.  When that is read into Section 7434(a), the statute reads the private cause of action addresses “a fraudulent [statement of the amount of payments to another person] with respect to payments purported to be made…”  The Court concluded that reading the definition into the statute shows that if “with respect to payments” modifies information returns, then the language is redundant.

The court then states, “[i]n other words, an ‘information return,’ by definition, relates to the amount of payments to a person.”  It then concludes that if “with respect to payments made” has to modify fraudulent, and not “information return”, and therefore must pertain to an incorrect payment amount.

There are two separate conclusions here, which possibly both could be interpreted differently.  First, is the conclusion that “with respect to payments” must modify “fraudulent”; otherwise it is superfluous.    This reading ignores that information returns contain information beyond the payment amount, and seems to be based on definition of information return referring to payments.  The definition quoted, however, is not the entire definition from Section 6724.  After the quoted language above, the section continues to say “required by” and then a list of various Code sections requiring information returns.  Those various other Code sections have lots of other requirements of information to be included on the information returns, not just the payment amount.  If you read the full language of Section 6724, along with the requirements in the internally referenced Code Sections, then “with respect to payments” acts as limiting language to cause Section 7434 to only apply to the “payment” shown on the information return, which, by definition, has a broad range of other information included.  I’m not sure I love that interpretation, because I would rather any fraudulent information on the return be included, but it does show that there are other interpretations of the statute and that the above rationale ignores aspects of the definition.

What I also find troubling is that Section 7434(a) does not reference the “amount” of the payment, but the court concludes it must be an incorrect amount in order to be fraud.  Even if you assume “with respect to payment” has to modify fraudulent, it is another substantial step to say that has the same meaning as “fraudulent…with respect to [an incorrect statement of the amount of the] payment.”  In every, or just about every, discussion of fraud under the Code, mischaracterization is sufficient to show fraud.  This again is based apparently somewhat on the fact that “amount” is included in the definition of information return.

There is one reference to “amount” under Section 7434, which the court believed bolstered its position.  Section 7434(e) states, “The decision of the court awarding damages in an action brought under subsection (a) shall include a finding of the correct amount which should have been reported in the information return.”

As a contextual clue, I suppose I can understand finding support for the Court’s position, but there is nothing stating that the Court can only apply Section 7434 when the amount has been misstated.  Second, and I think more importantly, if employment income has been mischaractherized as “non-employment income”, then I think the correct amount that should have “been reported in the information return” should be $0.  The subsection seems to specifically be referencing the information return that was filed, and not all potential and possible information returns that the information could have been included on.

I’m not sure my arguments are perfect (and the above admittedly rambles), but I think a skilled lawyer could use them for the start of a potentially persuasive argument.

The second rationale the court used was based on the legislative history, which I think is the weakest argument.  Enacted in TBOR 2 back in 1996, there is scant legislative history on this Section.  The reason for the statute provided in the legislative history was:

Some taxpayers may suffer significant personal loss and inconvenience as the result of the IRS receiving fraudulent information returns, which have been filed by persons intent on either defrauding the IRS or harassing taxpayers.

Most of the remainder of the legislative history summarizes the statute.  There are no additional references to the modifying language in question, or the term “amount”, or anything involving “incorrect amounts.”  In general, the language is very, very broad.

The court did note the final paragraph in the legislative history pertains to allowing sanctions for frivolous actions under Section 7434.  The court reasoned that if Congress was concerned with frivolous actions, it must have intended to have a narrow statute; however, that reading seems counter to the broad language actually provided by Congress.  I think it is safe to say Congress wanted to impose sanctions for frivolous actions, but I do not know that was intended to make a narrow statute (they could have drafted a narrow statute).

The final rationale provided by the Court was that the plaintiff had claims regarding worker classification under the Fair Labor Standards Act, which it stated was a comprehensive manner of handling worker classifications.  Since there was already a method of addressing worker misclassification, the Court concluded that Congress would not have intended Section 7434 to apply.  I think this is an incorrect conclusion for a number of reasons.

First, there are various provisions in the Code and administrative methods before the IRS for dealing with worker classification issues.  Clearly, Congress and the IRS do not view the FLSA as the sole statute dealing with this area.

Second, there are an unlimited number of examples of a civil or criminal dispute that would result in causes of action under various federal statutes.  Although FLSA is a comprehensive law dealing with overtime and minimum wage claims, I do not think it precludes a claim based solely on the tax aspects or the fraud and problems created by the employer filing an incorrect form.

This transitions into my third thought on this FLSA argument. FLSA might apply to W-2/Form 1099 issues, but it would not apply to any other correct payment amount but incorrect form issue.  I believe if we collectively thought about this, we could probably find many other examples (admittedly, W-2/1099 is the most common though).  For instance, what happens if an employee exercises non-qualified stock options but is only given a W-2 showing wages.  The amount might be correct, but some portion could be a gain properly reported on a Form 1099-B.  Or payments that should have been on a Form 1099-B or 1099-Div, but ended up on a W-2.  These are not subject to FLSA claims.

The Liverett court definitely represents the prevailing current rationale of courts; however, no circuits have reviewed this matter, and it will be easy for plaintiffs to make Section 7434 claims relating to this issue when making other claims against employers.  Although the Liverett court’s rationale is certainly plausible, I do think it may be possible for other district courts to take a more plaintiff favorable position on future matters.

Can Intentionally Filing an Improper Information Return Justify a Claim for Damages Under Section 7434?…Part I

As Les blogged last week, he moderated a panel on Friday dealing with Section 7434 private causes of action for the issuance of fraudulent information returns.  Les was good enough to invite me to participate and bring down the esteem of the panel which otherwise consisted of him and the wonderful Mandi Matlock.  Mandi, by the way, was a presenter extraordinaire, participating in three presentations at the ABA Joint Meeting in Austin. I don’t know how she did it, as I could barely do one coherently.   The materials from the conference and the audio of the panel can be found here.  Professor Bryan Camp was in attendance, and had kind words to say about the presentation in a brief post he did earlier this week on TaxProfBlog.

During the panel, Les outlined the general requirements for claims under Section 7434, and then presented various interesting questions regarding the interpretation and use of the statute to me and Mandi.  All of the questions were interesting, but I purloined the most interesting question, which was if a fraudulently filed incorrect information return, which states the correct payment amount, is sufficient for a claim under Section 7434.

This post will focus on that question, and try to flesh out my somewhat off-the-cuff arguments in the presentation on why a fraudulent incorrect information return with the correct payment amount could allow for a valid claim under Section 7434. This area is evolving, so I would love for our readers to comment on this post and indicate why I am completely incorrect, or add additional points or arguments in favor of my position.

I previously framed this issue in the prior post aptly titled “Intentionally Wrong Form Not Fraudulent Filing of Information Return?”   Although the title was not riveting, I think this is a really interesting issue, and I think all tax lawyers (business lawyers), and tax preparers should know about the Section.

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To get into this, let’s start with the statutory language in question:

In general. If any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, such other person may bring a civil action for damages against the person so filing such return.

The question revolves around what must be “fraudulent” under the statute.  Is it sufficient that the information on the return is correct, but the filer fraudulently selected the wrong information return, or does the filer need to have fraudulently included an incorrect amount on the form?  And, perhaps another wrinkle, does the fraud have to be pertaining to the payment or specifically to the amount of the payment.

The most, by far, frequently seen area where this comes up is in the worker classification arena.  In these situations, a worker believes she is an employee but the employer issues a Form 1099-Misc.  That form states the correct amount of the payment, but misclassifies the compensation as “non-employment” compensation (or possibly “other income”).

The initial cases that looked at this (largely from the Southern District of Florida) determined that an incorrect form was sufficient to make a claim under Section 7434, but did not provide much in terms of analysis.  For instance, in Seijo v. Casa Salsa, 2013 WL 6184969 (SD Fla. 2013), a dance instructor challenged her classification as an independent contractor and the court stated the dance instructor “produced evidence from which a reasonable factfinder could conclude that  Casa Salsa violated [Section 7434] by filing Form 1099-Misc’s for the payments it made to her” because the instructor was not an independent contractor.   This was followed by two other cases from the Southern District, including Leon v. Taps & Tintos, Inc., 51 F.Supp.3d 1290 (SD Fla. 2014), which involved a similar issue with bar tenders/waiters, where the court again stated, “Plaintiff has sufficiently alleged that Defendant issued Form 1099-MISC…and that the issued form violated Section 7434 where Plaintiff could properly be classified as an employee rather than an independent contractor.” Very clear statements that the incorrect form was sufficient to make a Section 7434 claim.  Links to these cases can be found in my prior post, which is linked above.

More recently, Riordan v. ASAP Expert from the District of Kansas in May of 2017 entered a default judgement under Section 7434 for a plaintiff on this same W-2/1099-Misc issue.  In Riordan, however, the defendants did not defend the case, which likely makes it not very influential.

Before getting into the other newer holdings on this matter, I think it is important to note that Riordan highlights an issue in these cases, which is that these cases are between two private parties that are taking these as one-off cases.  There is no litigation strategy overall, and no common positions being taken.  This means the varied arguments contribute to the courts taking a less coherent approach than many tax cases involving IRS as a party, and that it may be incumbent on the defendants to raise the issue discussed herein.  Although this leads to uncertainty, it also is an opportunity for plaintiffs, as the responding lawyer may know nothing about this area of tax law.

Starting in 2016, courts began looking more closely at claims under Section 7434 with regard to this incorrect form issue.  Liverett v. Torres Adv. Ent. Sols., LLC, 192 F.Supp.3d 648 (ED Va. 2016), is turning into the seminal district court holding on this matter.  Liverett has been followed by Derolf v. Risinger Bros, which I wrote about before, and Tran v. Tran, 239 F.Supp.3d 1296 (MD Fla. 2017).  And, the Southern District of Florida has changed its tune, and stated that it did not adequately consider this matter in the past cases and will now be following Liverett. See Vera v. Challenger Air Corp, 2017 WL 2591946 (SD Fla. 2017) (seriously, if you are an aerospace company in Florida, is Challenger the best name-I’m still scarred from watching the ’86 incident).

So, is this issue done?  I don’t think so.  Most people making these claims will be making other claims about the incorrect forms, so it will be easy enough to tack on a Section 7434 cause of action, and I think the Liverett court’s rationale is not air tight.  Part 2 of this post next week will talk about Liverett and why I think there is some opportunity for a different conclusion than that court reached.

Summer Reading: Tax Compliance And Small Business Taxpayers

The Wall Street Journal ran an interesting article last week, Number of Americans Caught Underpaying Some Taxes Surges 40% [$]. The main point in the story is that with the increase in the gig economy many more Americans are left on their own to pay estimated taxes. Many are not complying. The WSJ reported that from 2010 to 2015 there was an increase of about 40% in the number of people penalized for underpaying estimated taxes.

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It is easy to understand why. Without the benefit of withholding that comes with traditional paychecks and in many cases also without information reporting that can remind people that Uncle Sam is looking, there are many challenges to staying on the right side of the tax law.

A report last year from the American University Kogod Tax Policy Center called Shortchanged: Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy gives the issue a deep dive.

The Kogod Report is terrific. It is well researched. It provides background on the rapid growth of this segment of the economy, with companies like Uber, Airbnb, Etsy and many others pushing Americans into the uneasy tax perch of small business owners. One of the main points in the study is that the tax code is a 20th century code poorly matched with the 21st century economy. Add to the mix a 20th century mode of tax administration and many Americans are ill-equipped to keep records and understand how the law applies to their situation. This all leads to a major tax administration headache.

What I found most interesting in the report is the survey it conducted of about 50 small business owners. While the survey is not meant to be a statistically reliable sample (and in fact may reflect a greater sophistication as all responders were in the National Association of Self Employed) it did provides some insight into many challenges this group faces:

At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. Approximately one- third of our on-demand platform operator survey respondents didn’t know whether they were required to pay quarterly-estimated payments and almost half were unaware of any available deductions, expenses or credits they could claim to offset their tax liability. These taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income. Compounding this problem is inconsistent reporting rule adoption that results in widespread confusion among taxpayers

I tip my cap to one of the headings in the report (They Got 1099 Problems and Withholding Ain’t One). The Report and the WSJ article tell of one of the main shortfalls in the US tax reporting system for platform players. Essentially reporting is only required if payments are made via credit card or debit card, and the aggregate number of transactions to one service provider exceeds 200 and the payments exceed $20,000. Absent exceeding both requirements then companies that process credit card payments on behalf of individuals in the gig economy are not required to issue a 1099. Of course, the absence of a 1099 does not mean that the service provider does not have to report income but the absence of reporting leads to either mistakes or intentional non reporting.

Some of the platform players in the economy, like Uber, issue a 1099 even if the service provider does not meet both the 200/20K tests (an earlier WSJ article talks about this; see The Blind Spot in a Sharing Economy: Tax Collection $).

As the report discusses, employment and income tax liabilities, with penalties, can snowball. Not surprisingly, the National Taxpayer Advocate has been on this issue; for example, her testimony last year before the House Committee on Small Business touches on these issues, and lots more, including employee classification issues. She also adds a number of proposals to increase compliance, including changing estimated tax and backup withholding rules for taxpayers with poor compliance history and an increase in IRS education efforts to get people on the right path.

Tax administrators, scholars and legislators have taken note. IRS has put up the Sharing Economy Tax Center on its web page, and there are legislative proposals to change the 200/20,000 rule to trigger mandatory reporting at lower thresholds. UC Hastings Law Professor Professor Manoj Viswanathan has a new article called Tax Compliance in a Decentralizing Economy that addresses some of these issues (I have not yet read though am looking forward to it). Our blogging colleague BC Law Prof Diane Ring at Surly Subgroup also discusses the sharing economy in a post today highlighting worker classification issues. With her BC colleague Shu-Yi Oei Diane co-authored Can Sharing Be Taxed, an article that was in Wash U Law Review last year that also looked at the sharing economy, including reviewing some of the compliance problems implicated in today’s post.

As the Kogod Center reports, it is likely that this part of the economy will grow rapidly in the next few years so one can expect a great deal more attention on the issue.

 

 

Intentionally Wrong Form Not Fraudulent Filing of Information Return?

When a taxpayer receives an accidentally wrong information return, it is natural for that person to be frustrated.  It creates filing problems, and usually it is impossible to get a corrected return.  When a taxpayer receives an intentionally incorrect information return, they usually freak out.  Cases coming out of Section 7434, which allows a taxpayer to make civil claims against the issuer of an information return for fraudulent filing of information returns, usually have entertaining fact patterns.  They often revolve around business partners (sometimes family members) seeking retribution against one and other for perceived wrongdoing. One angry person will issue an information return indicating huge amounts of money were paid as compensation to the other angry person.  Often there is other litigation going on over a business divorce. This post involves Section 7434, but the fact pattern is unfortunately pretty boring, as is the primary holding.  The Court did, however, make an interesting statement (perhaps holding) that intentionally issuing an incorrect information return with correction information would not constitute the fraudulent filing of an information return.  No Circuit Courts have reviewed this issue, and it was a matter of first impression for the Central District of Illinois.

In Derolf v. Risinger Bros Transfer, Inc., two truck drivers brought suit under Section 7434 against their employer for issuing them Form 1099s for the compensation they received from the employer, Risinger Bros, believing they were employees and should have received Form W-2s instead.  There are like absolutely no interesting facts in the summary.  No Smoky and the Bandit hijinks, or lurid lot lizard tails (don’t ask).  The plaintiffs were long haul truckers, who entered into “operating agreements” and “leases” with the trucking company.  Those agreements provided significant flexibility in how the truckin was accomplished.  The primary holding of the case was that the truckers were, in fact, independent contractors, and the trucking company was correct in issuing Form 1099s to them for the work instead of Form W-2s.

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That pretty well nips the Section 7434 issue in the bud, as Risinger Bros acted properly, but the District Court for the Central District of Illinois still addressed the potential issuance of a fraudulent information return.  In general, under Section 7434, the person receiving an incorrect information return can bring a civil suit against the issuer if the issuer willfully files a fraudulent information return as to payments purported to be made to any other person.  This provides a remedy for someone who receives false information returns that the issuer was using commit tax fraud or to create issues for the person receiving the return.  This requires a showing of bad faith or deceit, which is often the main issue in these cases, and why you get all the juicy details.

The Court in Derolf stated no misclassification occurred, but that it found the claim that the wrong information return resulted in a fraudulent filed information return to be “not cognizable as pled.”  The Court noted that “there appears to be a split amongst the district courts, and no authoritative precedent as to whether the nature of the fraud pertains solely to the pecuniary value of the payments at issue or whether the scope of the fraud encompasses broader concepts.”  In the case, the plaintiff cited to two cases from the Southern District of Florida, and a case from Maryland  for the proposition that it was not solely the amount that had to be fraudulent.  The Court in Derolf dismissed those cases as failing to actually address the issue (sort of a weak split).  In one of those three, Leon v. Tapas & Tintos, Inc., the court did state that where a Form 1099 was issued instead of a proper W-2, “that the issued forms violated Section 7434 where Plaintiff could properly be classified as an employee rather than an independent contractor,” but did not spend any time discussing that issue.   The plaintiff in Leon failed to properly plead bad faith, so the matter was tossed without further discussion.

The Court in Derolf instead focused on two other district court cases, Liverett v. Torres Adv. Ent. Sols. LLC and Tran v. Tran, which both stated the fraud had to be due to a misstatement in the amount.  Liverett had a very similar fact pattern, and did a deep dive into the statutory language and the legislative history on the matter.  In Liverett, the District Court for the Eastern District of Virginia found Section 7434 was ambiguous and it wasn’t clear if the fraud was on the payment amount or the information return itself, but based on statutory construction and legislative history that the fraud had to be on the amount.  I won’t go into great detail about the analysis, but I think aspects are open to other interpretations.  For instance, the Court relies on legislative history stating the rationale for enacting the statute as “some taxpayers may suffer significant personal loss and inconvenience as the result of the IRS receiving fraudulent information returns, which have been filed by persons intent on either defrauding the IRS or harassing taxpayers.”  H.R. Rep. No. 104-506, at 35 (1996).  This doesn’t seem like a slam dunk in showing Section 7434 applies only to incorrect dollar amounts and not incorrect forms.  Perhaps the most convincing aspect of the holding was that the plaintiffs in these types of cases have other avenues of redress, specifically the Fair Labor Standards Act (although, in theory, this type of claim could arise with other forms not included under a FLSA claim, such as a Form 1099-Misc being issued when a Form 1099-B was appropriate).  Keith also mentioned this tactic seemed like potential self-help by the plaintiff in skirting the normal process for worker determination achieved by filing the SS-8.  This can be a slow process; taking many months.  It seems possible that the defendant or the Service could take the position that if the plaintiff has not sought such a determination, it has not exhausted its administrative remedies (then what happens if the plaintiff has, but the defendant still issues a Form 1099 when a W-2 would be appropriate –probably still no Section 7434 relief based on this case).

Overall, I think the statute and legislative history could be read to allow Section 7434 claims based on the filing of incorrect information returns, and not just incorrect dollar amounts on information returns.  For now, there is somewhat of a split, but most District Courts that have taken a hard look at this have come down on the side that the fraud must be in the amount reflected on the information return and not on the type of return filed.  Since 2015, there have been at least five or six cases looking at this issue, so I suspect more courts will deal with it in the coming months.

 

Procedure Round Up(date):   Regulations, Mount Up! & State Law SOL Issue When Suing Promoters.

This will be a short post that touches on some temporary and final regulations that were issued in the last quarter of last year that impact tax procedure, specifically information reporting and the preparer due diligence rules, which we have previously covered.  The second portion of the post will deal with a state law statute of limitations issue from a tax shelter participant suing the promoter.

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Regulation Update

What is Keno?

Back in March of 2015, I wrote about the temporary regulations dealing with reporting of winnings from bingo, keno, and slot machines.  The Service has finalized those regulations, which can be found here.  I believe the final regulations are similar to the temporary regulations (although aspects regarding electronic slot machines were not included in the final regs). These rules peg the required reported winnings at $1,200 for bingo and slot machines (but $1,500 for keno).  Anyone have any idea why those amounts are different (or what keno is, I don’t go to casinos much)?  The information on the information reporting must include the name, address, and EIN of the payee, along with a description of the two types of ID used to verify the payee’s address.

Discharge Reporting- Buy Now, Three Years, No Payments!

I thought I had written up the proposed regulations from 2014 relating to the rules on discharge of indebtedness reporting when a borrower had not paid for more than three years, but I cannot find the post (very possible I just read about it and found it interesting).  Under Section 6050P, prior regulations treated nonpayment of debt for 36 months as an “identifiable event”, which indicated formal discharge of indebtedness and required the issuance of a Form 1099-C.  This caused many borrowers to believe the debt had been discharged, but it was simply an IRS reporting requirement.  Tax professionals, lenders and borrowers did not like the rule.  The final regulations can be found here.  The regulations eliminate the passage of that time frame as a reportable event, which is a good result.  This change may have come from discussions started in the ABA Tax Section, Low Income Taxpayer Committee.

Preparer Due Diligence Regs Updated.

The Government has issued temporary/proposed regulations regarding the preparer due diligence rules, which can be found here.  We’ve talked about preparer due diligence repeatedly on the blog, including one of our first posts (and most popular), where Les extensively discussed peeing in pools.  That was re-posted earlier this year, and can be found here.  In both 2014 and 2015, Section 6695 dealing with preparer due diligence was amended.  The penalty was indexed for inflation, and the due diligence requirements were expanded to include the Child Tax Credit, the Additional Child Tax Credit, and the American Opportunity Tax Credit.  The proposed regulations update the provisions to take into account these changes.

Information(less) Returns

In late December 2016, the Service issued guidance (Notice 2017-9) regarding the new de minimis safe harbor provisions enacted under the PATH act.  In general, failure to include all required information on an information return or payee statement will result in a penalty being imposed on the issuer.  The penalty is dependent on various factors, including the amount incorrectly reported, when it was not reported, how quickly it is rectified, and potentially other factors.

The penalty under Section 6721 can be reduced or eliminated in certain circumstances.  There is a de minimis exception to Section 6721, which allows the penalties to be waived if the error is corrected on or before August 1st in the year it is filed.  This is limited to the greater of ten returns or .5 percent of the information returns filed.  For returns required to be filed after December 31, 2016, there is a safe harbor that applies, where, if the information return has an error of $100 or less, or involves less than $25 of withholding, then the safe harbor applies, and no corrected return is required.  The notice is clear that this does not apply for intentional acts or intentional disregard.  It also indicates that regulations will be forthcoming regarding the safe harbor.

The de minimis safe harbor will not apply, however, if the payee elects out of the safe harbor.  Under Section 6721(c)(3)(B) and Section 6722(c)(3)(B), the payee can make an election and the payor has thirty days to furnish a corrected payee statement to the payee and the IRS.  If it is not done within thirty days the penalties will apply (it is possible for additional time in limited circumstances).

The payor must provide the manner for making such an election, which can be any reasonable manner including by writing, electronically or by telephone.  The payee must be told in writing the fashion in which the election can be made.  The notice goes on to indicate the timing of when the election must be made, and indicates the election must: 1) clearly state the election is being made; 2) the payee’s name, address, and TIN; 3) the type of statements and account numbers; and 4) the years in which the election should apply.

So, if you are super angry that Gigantor Bank and Lack of Trust Company misstated your 1099 by $4.37, you now have your avenue for redress.

Shelter Participant SOL Against Promotor Runs From Final Tax Court Ruling, Not Notice of Tax Deficiency

I initially saw this suit, and thought some aspect pertained to federal law claims against the tax shelter promoter, but the claims were state law based.  It is, however, still an interesting statute of limitations issue, that could impact future rulings based on state law.

In Kipnis v. Bayerische Hypo-Und Vereinsbank, AG, the Eleventh Circuit, following direction from the Florida Supreme Court, has reversed the district court in holding the statute of limitation on state based claims against a tax shelter promoter by a participant were not time barred.

The particular holding is for a relatively straightforward issue.  After the defendant admitted fault, the IRS issued a notice of deficiency to the plaintiff for his involvement in the shelter.  This occurred in October of 2007.  On November 1, 2012, there was a final tax court order disposing of the case (90 days thereafter appeal rights expired).  On November 4, 2013, plaintiff filed suit against the defendant alleging various state law claims including fraud from the promoting and selling of the transaction.

The defendants moved to have the case thrown out as being outside of Florida’s four and five year statute of limitations for the claims made.  The issue was appealed to the Eleventh Circuit, which sought guidance from the Florida Supreme Court on the issue, specifically:

Under Florida law and the facts in this case, do the claims of the plaintiff taxpayers relating to the CARDS tax shelter accrue at the time the IRS issues a notice of deficiency or when the taxpayer’s underlying dispute with the IRS is concluded or final.

The Florida Supreme Court, which the Eleventh Circuit followed, determined that the claims accrued at the time the tax court order became final, which was ninety days after the order was issued when the appeals period had passed. See Kipnis v. Bayerische Hypo-Und Vereinsbank, AG 202 So. 3d 859 (Fla. 2016).  I think this is inline generally with what the federal law would be in most analogous situations, but would invite others to comment on this aspect if they have thoughts.