TIGTA’s Report on the Growing Gig Economy

Today we welcome guest blogger Joseph C. Dugan. Joseph is a 2015 graduate of Indiana University Maurer School of Law. During law school, he coordinated IU’s IRS VITA program and worked part-time at a Low-Income Taxpayer Clinic. After graduating, Joseph clerked on the U.S. District Court for the District of Maryland and the U.S. Court of Appeals for the Seventh Circuit before assuming his present position as a trial attorney with the Federal Programs Branch of the Department of Justice, Civil Division. Joseph lives in Maryland with his wife and four-month-old son. Joseph writes in his individual capacity and does not purport to represent the views of the Department of Justice or any of its components.

 This post originally appeared here on the Surly Subgroup blog. We highly recommend adding it to your regular blog reads. Christine

On February 14, 2019, the Treasury Inspector General for Tax Administration (TIGTA) released a Valentine’s Day treat: a comprehensive report following a TIGTA audit concerning self-employment tax compliance by taxpayers in the emerging “gig economy.”

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As Forbes noted last year, over one-third of American workers participate in the gig economy, doing freelance or part-time work to supplement their regular incomes or stringing together a series of “gigs” to displace traditional employment. Popular gig services include ride-sharing giants Uber and Lyft; arts-and-crafts hub Etsy; food delivery services GrubHub and Postmates; and domestic support networks Care.com and TaskRabbit. Even Amazon.com, the second-largest retailer in the world and a traditional employer to many thousands of workers in Seattle and at Amazon distribution centers worldwide, has gotten in on the gig economy with its Amazon Flex service. And for those interested in more professional work experience to pad their resumes, Fiverr connects businesses with freelance copywriters, marketers, and graphic designers. The power of smartphones and social media, coupled with flat wage growth in recent years, makes the digital side hustle appealing and, for many households, necessary.

From a tax revenue perspective, the gig economy is great: it is creating billions of dollars of additional wealth and helping to replenish government coffers that the so-called Tax Cuts and Jobs Act (TCJA) has left a little emptier than usual. From a tax compliance perspective, however, the gig economy presents new challenges. Gig payers generally treat their workers as independent contractors, which means that the payers do not withhold income tax and do not pay the employer portion of FICA. Instead, the contractor is required to remit quarterly estimated income tax payments to the IRS and to pay the regressive self-employment tax, which works out to 15.3% on the first $128,400 in net earnings during TY2018, and 2.9% to 3.8% on additional net earnings. That self-employment tax applies even for low-income freelancers (i.e., it cannot be canceled out by the standard deduction or nonrefundable credits).

While the proper classification of gig workers is a legal question subject to some debate, platforms hiring these workers generally treat them as independent contractors. Taxpayers new to the gig economy and unfamiliar with Schedules C and SE may not be aware of their self-employment tax obligations. If they are aware, they may not be too eager to pay, especially if back-of-the-envelope planning during the tax year failed to account for this additional, costly tax.

In light of this emerging economic narrative and evidence that the portion of the Tax Gap attributable to self-employment tax underreporting is on the rise, TIGTA undertook an audit. TIGTA identified a population of 3,779,329 taxpayers who received a Form 1099-K (an information return commonly used by gig economy payers, as discussed below) from one of nine major payers between TY2012 and TY2016. The audit found that 25% of those taxpayers did not report income on either Schedule C (where self-employment income should be reported) or Form 1040 line 21 (where self-employment income is often incorrectly reported). The TIGTA audit further found that, after adjusting for taxpayers who filed Schedule C with a profit of less than $400 (who may not owe self-employment tax) and taxpayers who earned less than $400 on combined Forms 1099-K received by the IRS, 13% of taxpayers did not file a Schedule SE and did not pay self-employment taxes.

These TIGTA findings are revealing. As Leandra Lederman and I discuss in a forthcoming article, Information Matters in Tax Enforcement, there is a host of evidence that information reporting increases tax compliance. As a suggestive starting point, according to IRS statistics, the voluntary individual compliance rate for income subject to substantial information reporting is 93%, while the voluntary individual compliance rate for income subject to little or no reporting is under 37%. TIGTA’s report does not provide percentages that permit a direct comparison with overall IRS compliance estimates. However, the high rates of complete failure to report income tax and employment tax by gig workers receiving a 1099-K seem to suggest that the 1099-K requirement is not as effective as its drafters hoped. Given the transparency of the earnings to the IRS, a likely explanation for this failure is that some gig workers simply do not understand their tax obligations.

But there’s another problem: a substantial amount of gig income is not clearly subject to an information reporting requirement at all. Back in the day, if a payer hired an independent contractor and paid the contractor over $600 during the tax year, the payer was required under Code section 6041(a) and IRS guidance to file Form 1099-MISC, an information return that put both the IRS and the taxpayer on notice of the income. In 2008, however, Congress enacted Code section 6050W, which, upon its effective date in 2011, required “third-party settlement organizations” (TPSOs) to report payments on what is now Form 1099-K, subject to a generous $20,000/200 transaction threshold. A tiebreaker rule set forth in Treas. Reg. § 1.6041-1(a)(1)(iv) provides that a payer subject to reporting requirements under both Code section 6050W and Code section 6041(a) should comply with the former provision only. As a practical matter, this means that payers who consider themselves to be TPSOs (the definition of which is ambiguous and obviously drafted without reference to the emerging gig economy) can report payments for their higher-earning contractors while leaving contractors with under $20,000 or under 200 transactions invisible to the IRS. What are the chances that an Uber driver who earns a few hundred bucks a month in compensation for rides might genuinely, or conveniently, forget to report those receipts come tax time if she hasn’t received a 1099? Pretty good, if prior Tax Gap research is any indication.

My coauthor, Leandra Lederman, presaged some of the problems with Code section 6050W and Form 1099-K reporting in a 2010 article, in which she identified factors that inform the determination whether additional information reporting might be successful. As Leandra and I observe in Information Matters, Form 1099-K held little promise from the outset. And the problems inherent in the TPSO reporting regime have only worsened as the worker economy has transitioned more and more toward lean, diversified gigs.

As if all of this weren’t concerning enough, TIGTA also found serious problems with the way the IRS goes about assessing self-employment tax compliance. Due to resource constraints, the IRS’s Automated Underreporter (AUR) program, the first line of offense against noncompliant taxpayers subject to information reporting, only selects and works a fraction of returns flagged for discrepancies by the Information Reporting and Document Matching Case Inventory Selection and Analytics (IRDM CISA) system (an acronym that only a bureaucrat could love). The idea is for AUR examiners to focus on cases that may yield the highest assessments while also pursuing repeat offenders and providing balanced coverage across AUR inventories. Yet, even as the discrepancy rate involving Forms 1099-K issued by the nine gig economy companies at the center of the TIGTA study increased by 237% between 2012 and 2015, the AUR program selected just 41% of these cases for review.

That review is not necessarily robust. TIGTA found that, for TY2011 through TY2013, 57 percent of all self-employment cases selected to be worked by AUR examiners were screened out—that is, closed without further action. Yet for cases not screened out, 45% were assessed additional self-employment tax; and TIGTA estimates that about $44 million in further self-employment tax could have been assessed during TY2013 alone if the screened-out cases had been worked and resolved similarly to those that were not screened out.

TIGTA also found that, while the IRS has implemented several tiers of quality review within the AUR program, little action is being taken to identify and correct error trends, and the review processes themselves are prone to error and mismanagement due in part to a lack of centralized coordination. One unfortunate consequence of these shortcomings in the AUR program is that gig workers who are already confused about their obligations are receiving inaccurate CP 2000 notices (the standard notice that informs a taxpayer of an error detected through AUR). In fact, TIGTA estimates that the AUR program sent taxpayers 23,481 inaccurate CP 2000 notices about their self-employment taxes in FY2017. That error rate is not only bad for taxpayers, it is bad for the government: if self-employment tax is inadvertently omitted from a CP 2000 notice, as a matter of policy the IRS is generally unable to correct that omission even if the IRS later detects the mistake. That additional revenue is simply forfeited.

So, despite all its wonderful potential to increase both economic opportunity for hard-working Americans and access to valuable services for those willing to pay for them, the gig economy has created some new challenges for tax administration. Gig workers are unsure of (or noncompliant with) their self-employment tax obligations; gig payers are unsure of (or taking advantage of) their status as TPSOs; and the AUR program is not keeping up with the changing times. TIGTA proposes a host of corrective actions in the February 14 report, most of which the IRS has endorsed. Among these corrective actions, three that strike me as particularly important are Recommendation 3 (revise the Internal Revenue Manual to clarify those circumstances in which an AUR examiner should enter a note justifying a screen-out decision); Recommendation 10 (develop IRS guidance on how taxpayers should classify themselves under Code section 6050W); and Recommendation 11 (work with Treasury to pursue regulatory or legislative change regarding the Code section 6050W reporting thresholds). The IRS disagrees with Recommendation 10, asserting that the problem is better addressed through a Treasury Regulation than IRS guidance and complaining that the IRS is preoccupied with issuing guidance under the TCJA and reducing regulatory burdens pursuant to E.O. 13,789. That may well be the case, but revenues are being lost every year that gig payers and workers misunderstand, or misapply, their reporting and payment obligations. There is no reason to suppose that the gig economy will start contracting any time soon, so it would be prudent for the IRS and Treasury to allocate resources to address this problem expeditiously. (Yes, I appreciate that the IRS is chronically underfunded and forced to make very difficult choices about how to staff projects. This is a problem that Congress largely created and Congress alone can fix.)

Ultimately, the best course here might be for Congress either to tailor the definition of TPSOs to a narrower subset of payers for whom the higher thresholds actually make sense (e.g., platforms like eBay, whose casual sellers may not net any income through their online rummage sales) or to lower those thresholds to make gig earnings more transparent to the IRS. So long as we maintain the regressive self-employment tax, we ought to ensure that all taxpayers liable for the tax—even tech-savvy taxpayers Ubering their way through the emerging economy—pay their fare share.

Oral Persuasion: Taxpayer Testimony and the Burden of Proof

We welcome guest bloggers John A. Clynch, Managing Director, and Scott A. Schumacher, Faculty Director, of the University of Washington School of Law Federal Tax Clinic. John and Scott take us behind the scenes on a recent case where they successfully shifted the burden of proof and convinced the Tax Court that their client did not have income despite its appearance on a Form 1099-MISC. The facts of this case are unusual in several respects, but information return disputes are a regular issue in tax controversy practice and on this blog. Keith collected several previous PT posts here last July. Christine

Unreported income cases are a staple of low-income taxpayer clinics. Low-income individuals often have several jobs of shorter duration, move their residence more often than the general population, and may not be the most adept at recordkeeping. Handling these cases is generally straightforward – obtain the wage and income information from the IRS and match it to the return. These cases can be more challenging if the taxpayer was a victim of identity theft, and the taxpayer must prove they did not receive the income listed in the W-2 or 1099.

But what if there is no dispute that the taxpayer received the money but there is no indication of what payment is for? In Park v. Commissioner, T.C. Summ Op. 2018-46, the Tax Court decided the rather unique question of not whether the amount was received or by whom, but rather what the amount paid was for and thus whether the amount was taxable.

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The taxpayer, Jin Park, is an immigrant from South Korea, who served in the U.S. Army. Mr. Park purchased a home in 2008 and took out mortgages with Bank of America. He was paying both principal and interest on the mortgages in 2012 while on military deployment overseas.

In 2014, Mr. Park received a $13,508 check from BOA. Included with the check was a letter that provided, “based on a recent review of your account, we may not have provided you with the level of service that you deserve, and are providing you with this check.” The letter further stated that Mr. Park might wish to consult with someone about any possible tax consequences of receiving the funds, included a number for him to call if he had any questions. The letter concluded by thanking him for his military service. Mr. Park called the phone number provided on several occasions, but he was unable to obtain any further information. He filed his 2014 Federal income tax return without including the $13,508.

The IRS received a Form 1099-MISC from BOA, reporting other income of $12,789 and a Form 1099-INT from BOA, reporting interest income of $719. The IRS duly issued a Notice of Deficiency, and Mr. Park, now represented by the Federal Tax Clinic at the University of Washington, submitted a Tax Court Petition on his behalf.

In preparing the case for trial, the clinic first sought information from BOA by phone. After what appeared to be a successful telephone contact with BOA, all future calls were met with a brick wall. No one at BOA was able (or willing) to provide any information regarding the payments. The clinic subsequently served a subpoena for records on BOA. The bank declined to produce any records, even after being ordered by the Court. In response to the subpoena, BOA stated, “the bank is unable to locate any accounts or records requested with the information provided.” This is quite surprising, especially given that the Bank Secrecy Act requires banks to maintain records for at least five years.

The case proceeded to trial without any further information from BOA. The issue for the Tax Court to decide was whether any part of the $13,508 received by Mr. Park was income. At trial, the IRS relied on the general presumption of correctness afforded a Notice of Deficiency and on the Form 1099-MISC. At trial, Mr. Park presented testimony that he had been making payments to BOA of interest and principal and that the check received from the bank could be a non-taxable return of overpayment of principal.

The case thus, as in many cases like this, turned on the burden of proof. As readers of PT know, section 7491 places the burden of proof on the IRS, subject to several very important conditions, including the requirement that the taxpayer introduce “credible evidence” to dispute the factual issue. Section 6201(d) further provides that if a taxpayer asserts a “reasonable dispute” with respect to any item of income reported on an information return, the IRS has the burden of producing “reasonable and probative information” concerning the deficiency, over and above the information return.

The specific question before the Court was whether Mr. Park produced “credible evidence” that raised a “reasonable dispute” as to the accuracy of the Form 1099-MISC. The Court held that Mr. Park met his burden. The Court held that his testimony “was subjected to cross-examination and was both plausible and credible.” Further, the Court held that BOA’s letter admitted it was correcting a wrong it had committed regarding Mr. Park’s accounts and was returning his money and the interest that had accrued on it. The Court further noted that the IRS did not offer any argument to the contrary and appeared instead to rely on the presumption of correctness. The Court accordingly held that the $12,789 received from BOA was a nontaxable return of principal.

The facts of Park are unique and are unlikely to repeat, although with banks, one never knows. However, the larger lesson from the case is that credible testimony from the taxpayer can be effective in meeting the burden of proof or shifting it to the IRS. Oftentimes it is the only evidence.

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.