Intentionally Wrong Form Not Fraudulent Filing of Information Return?

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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.

 

Stephen Olsen About Stephen Olsen

Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.

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