Search Results for: improper payments

Senate Again Takes Aim at Improper Payments in Federal Programs

Last week the Senate Finance Committee held a hearing on reducing improper payments in federal programs. The hearing considered not just tax. It covered 124 programs across the federal government in FY 2014 that have resulted in about $124.7 billion misspent, though the IRS got special attention as the EITC, along with Medicare and Medicaid, account for about 75% of the government-wide improper payments. The only witness at the hearing was GAO Comptroller Gene Dodaro, a graduate of Lycoming College, the alma mater of the great Stephen Olsen.

The hearing highlights the continued IRS emphasis on EITC, with Dodaro testifying that EITC claimants are twice as likely to get audited as non-claimants and that about 45% of all IRS correspondence audits focus on EITC. Moreover, Dodaro believes that the two most important legislative fixes Congress could do to help IRS administer EITC would be to give it authority to regulate unenrolled preparers and to accelerate the time to file information returns.

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The hearing itself is good theater and also informative. Senator Hatch kicks it off at the 35 minute mark, noting the importance of the issue and framing the severity of the problem with what could be done with the money if it were not misspent (e.g., the improper payments would be enough to buy every American an Ipad or a year’s worth of meals at Chipotle, or on a more serious level health insurance for every person in Florida). Senator Wyden’s opening remarks starts off at the 42 minute mark, framing the discussion by noting that there are two key defining issues: one, that improper payments include payments that are too big, too small or documented in some wrong way. The second issue is out and out fraud. Senator Wyden notes that conflating fraud and improper payments generally is wrong.

GAO Comptroller Dodaro’s testimony starts at the 51 minute mark. His written testimony has lots of data and graphs and charts. He goes into EITC in great detail on page 13, and it looks at IRS compliance trends and that how in FY 14 IRS reported EITC program payments of $65.2 billion and estimated that about 27.2% or $17.7 billion in those EITC payments were improper.

Despite that attention-grabbing number, the GAO written testimony (page 33) describes the most significant source of the tax gap for individuals not as errors with credits such as EITC, but small business individual income underreporting:

Individual income tax underreporting accounted for most—about $235 billion—of the underreporting tax gap estimate for tax year 2006. Of that amount, IRS reported that over half—$122 billion—comes from individuals’ business income, including income from (1) sole proprietorships (persons who own unincorporated businesses by themselves), (2) partnerships (a group of two or more individuals or entities, such as corporations or other partnerships, that carry on a business), and (3) S-corporations (corporations meeting certain requirements that elect to be taxed under subchapter S of the Internal Revenue Code).

In his written testimony he summarized GAO’s view on the tax gap as follows and how IRS and Congress can reduce it as follows:

Addressing the estimated $385 billion net tax gap will require strategies on multiple fronts. Key factors that contribute to the tax gap include limited third- party reporting, resource trade-offs, and tax code complexity. For example, the extent to which individual taxpayers accurately report their income is correlated to the extent to which the income is reported to them and the Internal Revenue Service (IRS) by third parties. Where there is little or no information reporting, such as with business income, taxpayers tend to significantly misreport their income. GAO has many open recommendations to reduce the tax gap. For example, GAO recommended in 2012 that IRS use return on investment data to reallocate its enforcement resources and potentially increase revenues. Since 2011, GAO also recommended improvements to telephone and online services to help IRS deliver high-quality services to taxpayers who wish to comply with tax laws but do not understand their obligations. Other strategies GAO has suggested would require legislative actions, such as accelerating W-2 filing deadlines. Additionally, requiring partnerships and corporations to electronically file tax returns could help IRS reduce return processing costs and focus its examinations more on noncompliant taxpayers. Further, a broader opportunity to address the tax gap involves simplifying the Internal Revenue Code, as complexity can cause taxpayer confusion and provide opportunities to hide willful noncompliance.

At about the 58 minute mark, a good snapshot of the GAO position on EITC was in Dodaro’s response to questioning from Senator Hatch when the Senator described the EITC as “one of the most poorly administered federal programs” and asked if Dodaro agrees with that characterization. There Dodaro deflects from IRS bashing and notes that the EITC is difficult and complex to administer based on the challenges it faces in determining family arrangements and often its lack of information about income. Dodaro again emphasizes that IRS needs legislation to help it administer the program successfully. In particular, as I mention above, Dodaro believes that the two most important legislative proposals would be giving IRS authority to regulate paid preparers and accelerate the filing of information returns.

For those interested in the issue of regulating preparers, at about 1:01 is where GAO’s Dodaro gives his endorsement of legislation regulating preparers, including references to Oregon, one of the handful of states that has its own mandatory education and testing regime.

Parting Thoughts

There are many other specific proposals in the GAO testimony, including expansion of math error authority that I have many reservations about (and discussed previously), and a general call for simplifying the laws. For many reasons, Congress will always focus on errors in transfer programs such as the EITC. Given that the administration has proposed extending the prior expanded levels of EITC and has with some bipartisan support also called for expanding the EITC for childless workers it seems likely that the issues surrounding EITC compliance will receive an even greater amount of Congressional attention in the months ahead.

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

We welcome back guest blogger Omeed Firouzi, who works as a staff attorney at the Taxpayer Support Clinic at Philadelphia Legal Assistance, for a discussion of the latest case involving an information return with improper information.  The question of how far the statute goes in order to protect recipients continues to play out in the district courts with recipients struggling to gain traction through IRC 7434.  Keith

I, among other tax practitioners, have written on this blog several times about 26 U.S.C. Section 7434. Specifically, we’ve written about the debate in district courts as to whether pure misclassification of an employee as an independent contractor is actionable under Sec. 7434.

A central question in courts’ analysis here is how to interpret the language, “with respect to payments purported to be made to any other person.” § 7434(a). At issue in all these cases, including the one below, is whether willful filing of a fraudulent information return covers only payment amounts themselves or whether it can also encompass misclassification itself.

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On December 1, 2021, the U.S. District Court for the Middle District of Florida, Tampa Division, handed down a decision granting summary judgment in favor of a firm that the plaintiff accused of fraudulent misclassification per Sec. 7434. As such, this court joined the (so far) majority of district courts in ruling that misclassification per se is not actionable under Sec. 7434 (although it was a notable departure from other recent Florida cases).

The case revolves around taxpayer Jen Austin and her experience with Metro Development Group. The case also involved an interesting issue as to whether reimbursed expenses can be included on a Form 1099-NEC and questions of state law. For our purposes though, it is important to look at the relevant 7434 aspect of this case. Austin says she was hired as an employee by Metro in 2014 but then she was actually paid as an independent contractor. Notably, Austin herself formed an LLC (Austin Marketing, LLC) for these 1099 payments though she also alleges she complained several times about her classification to no avail. For his part, the defendant, John Ryan, “testified in his deposition that he did not remember Austin asking to be an employee.” Austin worked for Metro until April 2020; she says she was fired “in a private meeting with Defendant Ryan [but] Ryan claims he never fired her.”

Two months later, Austin and her LLC, Austin Marketing LLC, filed suit against Metro and CEO John Ryan in federal district court. Austin and Austin Marketing, LLC sought, among other claims for relief, damages under Sec. 7434. Though the Court dismissed part of the complaint on the grounds that “Austin was not individually injured by any fraudulent tax standing,” the Court did allow Austin Marketing’s claim to be heard. Ultimately, the defendants moved for summary judgment on the matter of Section 7434, partly “on the basis that misclassification does not give rise to a claim under Sec.7434” – and they won.

In an order written by U.S. District Judge Kathryn Kimball Mizelle, who recently earned national attention with her injunction against the CDC’s federal air and public transit mask mandate order, the Court plainly stated that “only claims for fraudulent amounts of payments may proceed” under Sec. 7434. Judge Mizelle wrote that the plain text of the statute supports this conclusion because “with respect to payments” makes clear that a fraudulent information return must be one that has an incorrect amount on it. Mizelle cites not only U.S. Supreme Court interpretation of the phrase “with respect to,” from an unrelated 2021 case involving the Federal Housing Finance Agency, but also the litany of federal district court cases that also found misclassification per se as outside 7434.

Mizelle also focuses on the next part of the statute, specifically “payments purported to be made.” She writes that the phrase “’payments purported to be made’ clarifies that actionable information returns are ones only where the return fraudulently-that is, inaccurately or misleadingly- reports the amount a payer gave to a payee.” Finally, on this specific matter, Mizelle cites the Liverett case, the Eastern District of Virginia case that most courts have followed to rule misclassification out of bounds of 7434. In citing Liverett, Mizelle argues that because Sec. 7434 defines “information return” as “any statement of the amount of payments [Court’s emphasis added],” the statute thus “only gives liability for” fraudulent payments and “not for any willful filing of an information return instead of a W-2.”

Further, Mizelle also finds that, because Austin herself did not have standing as an individual and because the only case before her now is from Austin Marketing, technically Austin Marketing is not a person to whom W-2s could even be issued. She also finds that the Form 1099s “properly included reimbursements for business expenses” and that “even if the law required exclusion of the reimbursed expenses,” there was no willfulness on the part of the defendants. Mizelle writes that “Austin Marketing’s evidence is…scant [and] amount to mere speculation.”

The Austin case is now one of many, that we have analyzed here, that delve into the frustrating question of whether “fraudulent” describes just payment amounts. Even so, even if one were to take a strictly textualist view of the statute, it is not entirely clear that pure misclassification is not compatible with the statute.

As I have noted here before, even a textual reading of the statute could support the notion that misclassification could give rise to a cause of action under this law. When someone is fraudulently misclassified as a 1099 worker when they should have received a W-2, they receive a form that is, in several ways, different in numbers, format, and details than what is appropriate. Notably here, if a misclassified person was hypothetically reclassified as a W-2 worker, it is possible the taxable gross wages that are reported on line 1 of the W-2 would be different than what their 1099-NEC had shown. That is because of course the taxable wages could exclude some pre-tax deductions whereas it is possible that a 1099 compensation amount wouldn’t account for that. That difference is a difference in amount and if an employer willfully, fraudulently misclassifies as a worker and such a difference is conceivable, the 1099 is arguably also fraudulent in amount.

Further, even if the gross compensation would be the same for a misclassified worker on a 1099 or W-2, the misclassified worker is missing out on federal income tax withholding. As such, the misclassified worker lacks the benefit of such a “payment,” a credit they can use on their tax return where their tax withheld is described by the IRS itself as a “payment.” Therefore, it could credibly be argued that “with respect to payments” could theoretically encompass the “payment” that a federal income tax withholding ultimately is. Judge Mizelle took a strict textualist view to find pure misclassification, when the compensation is not in dispute, to be out of scope for this statute. Another court in the future may take a different view even with the same style of statutory interpretation.

Can IRS Levy Reach Future Rent Payments?

A relatively brief CCA issued this month discusses the IRS’s ability to levy on the right to receive rent payments beyond the date of the levy. The CCA explores the rationale as to why a single levy may have continuous legal effect that will extent to the right to receive future payments, a topic I discussed recently in Levy on Social Security Benefits: IRS Taking Payments Beyond Ten Years of Assessment Still Timely. It also explores whether the IRS is required to use a Form 668-A to effectuate the levy, as it appears that an IRS employee had arguably mistakenly served a Form 668-W. Form 668-W is typically associated with continuous wage levies.

As Keith has patiently explained to me (and readers of both the blog and the Saltzman and Book treatise), there are two types of levies: 1) one-time events and 2) continuous wage levies.  The one time event levies come in two varieties: 1) bank levies where the IRS gets what is in the bank that day or other similar levies where the IRS reaches a static asset and 2) levies that reach an asset with future fixed payments.  Lots of people have trouble distinguishing between continuous wage levies and levies with fixed future payments, and it appears that the mistaken form IRS used reflects some of that confusion.

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The levy involved in this CCA reaches an asset with fixed future payments. As the CCA explains, “rental income is generally subject to a levy with continuous effect meaning that, to the extent that future rental liabilities are fixed and determinable, meaning the terms are provided for in a rental contract, the single levy reaches both current and future rental payments.”

There are a handful of cases that apply this principle in the context of rental income, including United States v. Halsey, Civ. A.  No. 85-1266, 1986 U.S. Dist. LEXIS 24130 (C.D.Ill.1986). One wrinkle in the CCA is that the lease was a month-to-month, but as the CCA explains

that [the] lease was a month-to-month lease does not affect the levy’s attachment to future payments. The levy was effective to reach future payments not by reason of the fact that it continued to operate beyond the time at which it was made, which it does not, but rather because the levy reached Plaintiff’s then existing right to the future payments under the lease, not the future payments themselves.

The CCA concludes that the Service’s use of the Form 668-W (meant for wages and allowing for exemptions under 6334(a)) in the context of rental income does not invalidate the levy, relying on there essentially being no material harm by the use of the improper form and that there is no authority concluding that the Service use a particular form for effectuating the levy.

Levy on Social Security Benefits: IRS Taking Payments Beyond Ten Years of Assessment Still Timely

Dean v US involves a motion to dismiss a taxpayer’s suit alleging that the IRS recklessly disregarded the law by continuing to levy on a taxpayer’s Social Security payments beyond the ten year SOL on collections.  The magistrate concluded that the IRS’s actions were not improper and recommended that the case be dismissed. The district court approved the recommendation and Dean timely appealed to the 11th Circuit, which affirmed the district court.  The case nicely illustrates how the ten-year collection period does not prevent collection beyond the ten-year period when there is a timely levy relating to a fixed and determinable income stream.

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Dean owed over two million dollars for tax years 1997-2005. IRS assessed the liabilities in 2007; IRS recorded a notice of federal tax lien shortly thereafter. In 2013, IRS served a levy on Dean and the SSA for the unpaid tax. Following the levy, SSA began paying over all of the benefits slated for Dean to the IRS. I here note as a tangent that this differs from the federal payment levy program under 6331(h), which authorizes an automatic 15% levy on certain federal benefits, including social security. IRS is not precluded from issuing continuous manual levies, as it did here, where it could take all of the benefits, subject to exemptions that the taxpayer establishes as per 6334(a)(9).

In 2017, with the CSED expiring, IRS filed a certificate of release of federal tax lien stating that Dean had “satisfied the taxes,” that the lien was “released,” and authorized the proper IRS officer to “note the books to show the release of this lien.” IRS also abated the assessments.

Dean at this point believed that the levy on his social security benefits should have stopped. When it did not, he filed a complaint in federal court alleging that the levy was an unauthorized collection action and he sought over $64,000 in damages.

Unfortunately for Mr. Dean, as the magistrate noted, the argument does not “hold water” (allowing me gleefully to link to the great Joe Pesci and Marisa Tomei scene in My Cousin Vinny).

The regs under Section 6331 describe the relationship between a levy and fixed and determinable payments: “[A] levy extends only to property possessed and obligations which exist at the time of the levy.” 26 C.F.R. § 301.6331–1(a). “Obligations exist when the liability of the obligor is fixed and determinable although the right to receive payment thereof may be deferred until a later date.” Id. 

An obligation is fixed and determinable “[a]s long as the events which gave rise to the obligation have occurred and the amount of the obligation is capable of being determined in the future …. It is not necessary that the amount of the obligation be beyond dispute.” United States v. Antonio. 71A AFTR 2d 93-4578], *6 n. 2 (D. Haw. Sept. 24, 1991). Numerous cases establish that Social Security benefits are a fixed and determinable obligation of the SSA and are subject to one-time levies. 

As the lower court opinion discusses, the 2013 levy created a custodial relationship between IRS and the SSA and as such the benefits came into constructive possession of the IRS. The regs under Section 6343 also provide that “a levy on a fixed and determinable right to payment which right includes payments to be made after the period of limitations expires does not become unenforceable upon the expiration of the period of limitations and will not be released under this condition unless the liability is satisfied .” 26 C.F.R. § 301.6343-1(b)(1)(ii).

The Eleventh Circuit also helpfully explains the relationship between the levy and the benefits, directly refuting the claim that the collection occurred after the expiration of the SOL:

Instead, the IRS seized his entire Social Security benefit—that is, his “fixed and determinable right to payment” of his Social Security benefit in monthly installments—immediately upon issuing the notice of levy in June 2013. 26 C.F.R. § 301.6343-1(b)(1)(ii); see Phelps, 421 U.S. at 337. Having seized his entire benefit before the expiration of the collection limitations period, the IRS was not required to relinquish it after the period expired. See 26 C.F.R. § 301.6343-1(b)(1)(ii).

The lower court opinion also nicely discusses the lack of legal significance of the IRS’s abatement of the assessment and issuance of the release of federal tax lien. Both events did not change that Dean owed an underlying tax.  As to the abatement, taxpayers are liable for the tax regardless of whether there has been an assessment. While the release of the federal tax lien affects the IRS’s security interest, it did not release the levy and had no bearing on the underlying tax debt.

TIGTA Releases Report on Improper Payment Rate For Refundable Credits

Last month TIGTA released its annual review of the IRS’s improper payment reporting requirements under the Payment Integrity Information Act  (PIIA). The focus in this TIGTA report is the IRS’s administration of refundable credits. In the pre-COVID time frame (FY 20), OMB determined that the Earned Income Tax Credit (EITC), Additional Child Tax Credit (ACTC), and American Opportunity Tax Credit (AOTC) are high-priority programs that are susceptible to significant improper payments.  

Under applicable executive orders, for any program identified as “susceptible to significant improper payments” the IRS is required to provide the following information for the Treasury Department’s financial report:

  • The rate and amount of improper payments. 
  • The root causes of the improper payments. 
  • The actions taken to address the root causes. 
  • The annual improper payment reduction targets. 
  • A discussion of any limitations to the IRS’s ability to reduce improper payments. 

Rather than focus on the data that the report reveals (as I have done in the few times I have reviewed these reports), in this brief post I will focus on two somewhat surprising developments discussed in the TIGTA report: 1) that the IRS has formally requested that OMB excuse it from reporting erroneous refundable tax credit claims under the PIIA and 2) that the IRS is systemically imposing a two-year ban for ACTC claimants.  The first of these developments is encouraging and the second is alarming. I will briefly discuss each below.

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Possible IRS Carve Out From PIIA

On pages 2 and 3 of the report TIGTA discusses how last fall Treasury and the IRS formally requested that the OMB allow IRS to be excused from meeting the requirements under the PIIA. As TIGTA discusses, Treasury and IRS stated that the tax system is “primarily” a collection system and not a payment program. More substantively the request centered on how IRS directly addresses similar concerns as part of its comprehensive tax gap strategy. As part of its pitch, and as TIGTA summarized, the argument centered on the following points:

  • The refundable portion of tax credits, or outlays, should not be considered separately from the rest of the credit because the IRS and Treasury Department need to view any errors to address them effectively. 
  • Tax credits are embedded into and affected by other provisions of the Federal tax system. Tax Gap estimates and other comprehensive compliance analyses are more effective in helping the IRS identify noncompliance and allocate limited resources effectively.
  • Tax Gap estimates already effectively monitor changes in refundable tax credit errors over time. 
  • Improper payment estimates under the PIIA provide no additional information to the IRS as it administers tax credits and addresses noncompliance. 
  • Refundable tax credit overclaims are largely due to the credits’ statutory design and the complexity taxpayers face when self-certifying eligibility for the refundable tax credits, not internal control weaknesses, financial management deficiencies, or reporting failures. 
  • Tax credits are part of an interrelated tax administration portfolio that the IRS addresses through a comprehensive enterprise risk management program. 

Given that refundable credits comprise a relatively small amount of the overall tax gap, and that special focus on this one small aspect of the gap seems to contribute to additional pressure on IRS to single out relatively low income and low payoff audits, the Treasury and IRS request seems sound. Does this mean that if the request is granted the number of EITC audits will decrease? I am not certain, though I suspect that with additional pressure on IRS to step up audits of higher income taxpayers and lighten the touch on others it would likely give the IRS more flexibility to shift resources and contribute to a relative rebalancing of individual audit coverage.

The other side of the coin is that Congress seems intent on using the tax system to deliver all sorts of benefits, and as the IRS itself more directly acknowledges its role as a benefit administrator, the reasons for exceptional treatment may not be as compelling. According to TIGTA, earlier this year OMB advised Treasury and IRS that it is considering IRS’s request and will respond after the new management team at OMB is in place. It is unclear if the last year’s expanded use of IRS to deliver benefits that seem less tethered to tax collection will have an impact on the OMB decision. Perhaps OMB might press IRS to focus more on certain payments, like the advanced component of the CTC if that is made permanent.   

Systemic Ban and Child Tax Credit

One aspect of the TIGTA report is to evaluate whether IRS is using its existing powers to adequately address refundable credit errors (this is a common refrain; see my post Is IRS Too Soft on People Claiming EITC? Treasury Says Yes and Also Suggests No). One part of the IRS tool kit is the extraordinary power IRS has to impose a two or ten-year ban following a determination that an individual has disregarded credit eligibility rules. TIGTA observes that in its view IRS has failed to effectively use bans, looking at 1.9 million taxpayers from FY 17 and over 3900 of them who were allowed to claim credits despite having some or all of the credits disallowed in the two prior years. Given audit costs (even correspondence audits) TIGTA’s “solution” is for IRS to systemically impose a ban when individuals have had two successive years of disallowed credits.

The report is a little foggy on the details but it appears that IRS pushed back on the TIGTA recommendation. On page 8 the IRS stated that it did not agree to  “modify systemic processes to apply the two-year ban after two audits result in the disallowance of a refundable tax credit “ On the other hand, earlier on the same page the report states that starting in “Processing Year 2021, systemic processes will assess the two-year ban for the ACTC.” 

I read this to mean that for some refundable credits (ACTC and I suspect EITC) IRS will be using a systemic ban following prior disallowances. There are a number of problems with this solution, as the NTA’s 2019 special report on refundable credits highlighted. With Congress at least temporarily buttressing the CTC, and the influx of claims to hit IRS from nontraditional taxpayers, any IRS decision to systemically impose a ban is fraught with risks to taxpayer rights. It seems hard to square bootstrapping a failure to respond with the mental state needed to justify a ban determination.  While I would like to know more about the systemic banning IRS will be imposing I suspect that this means IRS can make a determination that an individual has acted recklessly or intentionally in the absence of any hearing or even direct taxpayer communication. Given that there is no published guidance on the meaning of reckless or intentional disregard for these purposes, and no outward facing guidance on exactly how IRS makes its determinations, this is a relatively obscure but potentially significant part of the IRS’s job in administering benefits.

As I and others have written before (see for example Bob Probasco’s The EITC Ban-Further Thoughts Part 1Part 2 and Part 3) the absence of clear notice and a defined path to administrative and judicial review of a ban determination is inconsistent with taxpayer rights, including the right to be informed, the right to a fair and just tax system, and the right to appeal. As Congress leans on IRS to deliver more benefits, the absence of clarity around these potentially catastrophic ban determinations is likely to generate close judicial scrutiny and highlight how IRS practice is inconsistent with due process protections that surround other nontax based programs. Given the temporary and likely permanent expansion and advanced payment of the ACTC, the stakes are even higher than in past years. 

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

We welcome back guest blogger Omeed Firouzi who brings us up to date on litigation over the scope of section 7434’s cause of action for the fraudulent filing of information returns. Christine

Internal Revenue Code Section 7434 has been the subject of numerous posts here. In the aftermath of the Liverett decision in the Eastern District of Virginia in 2016, courts have largely agreed that while  intentionally wrongful overreporting of income  on an information return constitutes “fraudulent filing,” misclassification itself (actually receiving a 1099-MISC instead of a W-2 with no dispute about the income amount) is not actionable under section 7434.

Nevertheless, a small handful of federal district court decisions very recently have left the door open, at least in the preliminary stages of litigation, to the possibility that Section 7434 could encompass misclassification claims. The United States District Court for the Western District of Washington in September became the most recent court to address the matter.

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The facts in Ranko v. Gulf Maine Products Co. Inc., Et. Al. involve taxpayer William Ranko and his work for seafood processor and wholesaler Gulf Marine. Ranko filed suit in King County Superior Court but Gulf Marine removed the case to the federal district court, on the basis of diversity of citizenship. Mr. Ranko alleges several causes of action, including violations of Section 7434 and various employment-related claims.

With regard to the specific federal tax issue at hand, Mr. Ranko alleged that Gulf Marine misclassified him as an independent contractor in tax years 2016, 2017, and 2018. Mr. Ranko was referred to as an Outside Sales Manager and was treated as an employee, he alleged, yet his employer failed to withhold taxes. As a result of such misclassification, Mr. Ranko owed more federal taxes than he should have. While there is no evidence in the case that Mr. Ranko filed a Form SS-8 to challenge his misclassification before the IRS, the facts alleged do seem to support Mr. Ranko’s contention that he was an employee.

Mr. Ranko attested that such misclassification was itself a violation of Section 7434. Though Mr. Ranko separately claimed nonpayment of wages, he did not allege that the actual amounts on the 1099-MISC filed by Gulf Marine were incorrect. Rather, he alleged that the “fraudulent filing” under 7434 was the wrongful, intentional filing of 1099s rather than the W-2s that he should have received.

Interestingly, unlike several other courts that have analyzed Section 7434 at length, the court here did not engage in an extensive analysis of the Liverett decision and its interpretation of the legislative history behind Section 7434. Rather, the court focused on the intentionality of the employer’s alleged misconduct in allowing Mr. Ranko’s claim to move forward. Indeed, the court noted that “the misclassification enabled Gulf Marine to avoid tax liability by failing to ‘pay one half of the payroll taxes” and that such “allegations are sufficient to raise a reasonable inference that Gulf Marine willfully filed a fraudulent information return with respect to payments purported to have been made to” Mr. Ranko. Consequently, the court denied Gulf Marine’s motion to dismiss this cause of action.

The Ranko court appears to be part of the aforementioned trend of district courts that have refused to dismiss outright the possibility that misclassification on its own is actionable under Section 7434. Part of how the Ranko court got here too relied on the Greenwald v. Regency Mgmt. Servs., LLC decision in the U.S. District Court for the District of Maryland in 2019.

The Greenwald case was brought by Maryland employment attorney Richard Neuworth (who I’ve incidentally had the privilege of getting to know at various ABA Tax Section conferences and who has been a resource on misclassification work) as he has sought to protect wronged employees in such cases. In Greenwald, the workers alleged that their information returns did not include commissions (on which taxes were not withheld) that they received after their employment ended, and so those information returns constituted “fraudulent filing.” The court there agreed there were sufficient grounds for a claim under 7434. But the Ranko court here appears to be going even further in stating that even when there is no dispute at all about the dollar amount reported on the information return, there can be a 7434 claim.

The Ranko court may be helping to break new ground here. Then again, the District of New Jersey recently again ruled the other way on this matter. Ultimately, as discussed extensively on this blog, the issue is one of statutory interpretation. Whether “fraudulent” is an adjective that describes the filing in a broad sense or whether “fraudulent” only relates to “payments” will continue to vex courts for some time to come, absent congressional action. Notably though, the statutory text at Section 7434(a) does not include the words “amount,” “compensation” or “income.”

Rather, the statute states the willful filing must be “with respect to payments purported to be made.” The Ranko court appears to be construing the statute broadly to understand that the phrase, “payments purported to be made,” encompasses any payments and fraud that is present with respect to such payments. In other words, fraud “with respect to [the] payments” is not limited solely to fraud in the amount of the payment reported.

Instead, the argument is that the payments should have been reported or handled differently. This could encompass different specific acts, but the Ranko court is clearly concerned that the employer’s treatment and reporting of the payments as non-employee compensation burdens the employee with taxes they should not owe. This is not only due to the lack of withholding but also simply due to the different FICA/Medicare tax burdens on employees versus non-employees. Should the case move further along, it will be fascinating to see whether the court will find that it was Congress’ intent to protect such individuals from employer misconduct.

Court Rules Against Government in CARES Litigation Challenging Statute’s Denial of Payments to Mixed Status Couples

Earlier this year MALDEF filed a lawsuit in federal district court in Maryland on behalf of US citizens who were denied the COVID stimulus benefits under Section 6428 because they filed a joint return with spouses who use an ITIN. In response to a government motion to dismiss the suit, earlier this week in Amador v Mnuchin a federal district court in Maryland ruled against the government and allowed the suit to proceed to the merits.

The case is one of a handful of lawsuits that is challenging CARES’ failure to benefit mixed status couples and one of a number of other legal challenges to the CARES legislation. [Disclosure: I am co-counsel on two such cases, one challenging the IRS’s failure to rapidly and effectively distribute economic impact payments to the eligible children of parents and caretakers who do not file federal income tax returns and the other challenging the  exclusion of U.S. citizen children from the benefits of emergency cash assistance based solely on the fact that one or both of their parents are undocumented immigrants.] 

All of the cases raise interesting tax procedure issues, and many raise important constitutional law issues. In this post, I will discuss the tax procedure issue relating to sovereign immunity that Amador implicates, and save for another day the standing and the constitutional issues.

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The Amador suit targets CARES identification requirements that effectively deny any EIP or later 6428(a) credit to taxpayers who file a joint return and are married to someone with an ITIN rather than a social security number. The complaint alleges that CARES discriminates against mixed-status couples because it treats them differently than other married couples, in violation of the Constitution, including the Fifth Amendment guarantees of equal protection and due process. The government filed a preliminary motion to dismiss the lawsuit on a number of grounds, including that 1) the government had not waived sovereign immunity, 2) the plaintiffs failed to establish standing, and 3) the plaintiffs’ constitutional arguments failed to state valid claims for relief. The district court ordered an abbreviated and accelerated briefing on the government’s motion.

In Amador, of most immediate relevance for tax procedure was the government’s argument that the plaintiffs’ suit should be dismissed because it failed to establish a waiver of sovereign immunity. Absent a waiver, sovereign immunity shields the federal government and its agencies from suit. In a nutshell the government argued that the plaintiffs had to wait until the filing of a 2020 tax return or separate refund claim and the passage of six months or the denial of the refund claim before bringing suit to challenge Congress’ decision to not allow payments under Section 6428 to US citizens who are married to undocumented immigrants. In other words, the placement of Section 6428 in the Code meant, according to the government, that the taxpayers had to exhaust through normal refund procedures after or with the filing of a 2020 tax return to get a court to pass on the merits of the constitutional challenge. 

In response, the plaintiffs argued that they were not seeking a tax refund, and as a result they did not need to go through the typical refund process. Instead, they argued that their suit seeks injunctive and declaratory relief, with the APA serving as the source for the waiver of sovereign immunity.

Where in the APA is the source for a waiver? 5 U.S.C. § 702 provides that  “[a]n action in a court of the United States seeking relief other than money damages and stating a claim that an agency . . . acted or failed to act . . . shall not be dismissed nor relief therein be denied on the ground that it is against the United States or that the United States is an indispensable party.” 

The government in response argued that 5 USC § 704 provides a backstop against using the APA as a source for challenging the CARES provisions because it authorizes review of agency action under the APA only if “there is no other adequate remedy in a court.”  In other words, what 5 USC § 704 provides is that the APA does not generally displace procedures that provide a specific means to challenge a particular agency action. This, along with the Anti-Injunction Act, is why most challenges to tax law, including allegations that IRS/Treasury failed to comply with APA procedural requirements in rulemaking, have traditionally been shoehorned into the normal baskets of deficiency cases or refund cases (though as we have discussed in PT the Supreme Court in CIC will likely be addressing the AIA’s role in insulating IRS practice from pre-enforcement scrutiny). 

This gets us back to the government’s view in Amador that the individuals had an alternate remedy that served to defeat the APA’s separate source of jurisdiction for the suit. The court disagreed with the government and held that the APA did serve as a waiver of sovereign immunity, looking to the nature of the EIP and the absurdity of requiring exhaustion for a benefit that Congress sought to deliver as rapidly as possible:

Forcing plaintiffs to exhaust their administrative remedies would be an “arduous, expensive, and long” process, Hawkes, 136 S. Ct. at 1815-16, that serves none of the goals underlying § 7422. Before plaintiffs could challenge § 6428(g)(1)(B), they would first have file a 2020 tax return, which they cannot do until 2021. Then, plaintiffs would have to wait until the IRS invariably denies their request for a refund in the amount of the CARES Act payment, because they are ineligible per § 6428(g)(1)(B). Once that happens, plaintiffs would have to file an administrative claim with the IRS, asking it to reconsider its position. But, here too, the IRS will reject plaintiffs’ claim, citing § 6428. Thus, administrative exhaustion under § 7422 is guaranteed to be an exercise in futility because there is no possibility that it could provide plaintiffs with relief. See Cohen v. United States, 650 F.3d 717, 732 (D.C. Cir. 2011) (en banc) (concluding that the § 7422 was not an adequate alternative to APA where administrative exhaustion could not remedy plaintiff’s complaint). This Kafkaesque scenario is at odds with the very purpose of the impact payments—to assist Americans grappling with the economic fallout of a public health catastrophe. (emphasis added)

In addition, the court held Congress did not explicitly create a separate path to challenge the payment of EIP, given that Section 7422 presupposes a recovery of tax that had been previously collected or assessed:

Plaintiffs do not seek the recovery of any monies wrongfully “assessed” because they do not allege that the IRS improperly calculated their tax liability. See Hibbs v. Winn, 542 U.S. 88, 100 (2004) (“As used in the Internal Revenue Code (IRC), the term ‘assessment’ involves a ‘recording’ of the amount the taxpayer owes the Government.”). Nor do plaintiffs complain of taxes wrongfully “collected.” Instead, they challenge the discriminatory effect of a refundable tax credit under the First and Fifth Amendments.

In finding that there was no previous assessment or collection, the court suggested that refund procedures for the EIP itself were likely inappropriate in the first instance:

Certainly, the mismatch between the plain language of § 7422 and the nature of plaintiffs’ suit does not support the finding that Congress intended § 7422 to replace the APA. In fact, if anything, it leaves the Court “doubtful,” Bowen, 487 U.S. at 901, that § 7422 can serve as a statutory basis for plaintiffs to challenge § 6428(g)(1)(B). (citation omitted).

Conclusion

Amador now proceeds to the merits, though the opinion notes that due to the accelerated briefing on the preliminary issues the government may re-raise the procedural challenges later, including at the likely next summary judgment stage.

While this is a preliminary decision and not directly addressing the merits, the Amador district court’s discussion of the relationship between Section 6428(g), Section 7422 and the APA is significant. It reflects a growing judicial recognition that the mere placement of a benefit in the tax code does not mean that procedures ill-designed to accommodate the financial reality of Americans and the actual nature of the Code-based emergency benefits should serve to bar a court’s review of good faith constitutional challenges. The issues that the Amador suit raises are serious and the stakes are very high. Traditional paths for challenges to tax statutes should not serve as a bar to effectively shield suspect legislation from judicial review.

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

In today’s post, guest blogger Omeed Firouzi discusses the availability of civil damages for misclassified workers who receive inaccurate information returns from their employer. Christine

One of the most intriguing issues in tax law involves the interpretation of 26 U.S.C. Section 7434. As discussed extensively in various posts here, Section 7434 clearly encompasses situations in which taxpayers are issued income-reporting information returns that intentionally misstate the amount of their income. It is less clear if Section 7434 applies to situations in which a taxpayer is given the wrong kind of information return even if the amount of income is correct. Most courts that have ruled on this issue have found that a taxpayer who is misclassified as an independent contractor – and thus receives a Form 1099-MISC rather than a Form W-2 – does not have a cause of action under Section 7434.

These courts have largely followed the lead of the Liverett court, where the United States District Court for the Eastern District of Virginia undertook a thorough analysis of the statutory language and the legislative history of the law and found that it does not encompass pure misclassification. No circuit court has ruled on the issue but a consensus in the lower courts has emerged. The United States District Court for the District of Maryland recently also followed the lead of Liverett in Alan Wagner v. Economy Rent-A-Car Corp., et al.

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Wagner involves a Maryland taxpayer who filed suit under various Maryland employment-related statutes and Section 7434 as he alleged willful misclassification through the fraudulent reporting of payments on a 1099 instead of a W-2. In November 2013, the taxpayer initially signed a contract that agreed to “a fixed monthly salary of $5,000 per month plus commission…based on the value of contracts [he] procured for” the company. Ultimately, the taxpayer became a “full-time…employee” and received a W-2 for several consecutive tax years.

Then in 2016, the taxpayer alleges that his employer “began to pressure” him to accept 1099 classification and “when [he] refused, it is alleged that [the employer] began to withhold his commission payments.” The two parties subsequently entered into a “separation agreement” pursuant to which the taxpayer’s employer agreed to pay him “a ‘net’ sum of $45,000 in three installments ‘in exchange for a non-solicitation agreement.’” These payments were issued on a Form 1099 rather than on a W-2.

However, yet again, the court joined the growing consensus in rejecting the notion that Section 7434 applies here.  The court noted that Section 7434 “creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” The court also held that “the first rule of Liverett [is that] … plaintiffs cannot prevail under § 7434 by merely alleging that they have been misclassified as independent contractors, or received the wrong type of information return.”

The court recognized that Greenwald v. Regency Mgmt. Servs., LLC, 372 F. Supp. 3d 266, 270 (D. Md. 2019) carved out an exception such that “if the misclassification causes the underreporting of paid wages,” there may be a 7434 cause of action. The case was distinguishable from Greenwald though in that there was no misstatement in the amount of income in question the taxpayer received; the receipt of the aforementioned $45,000 was never in dispute. The proper classification of this income was the central tenet of the taxpayer’s 7434 claim. Consequently, the court found that “on its face, this is a ‘misclassification’ claim which cannot support a § 7434 action.” As such, the claim was dismissed.

The complexity here lies in the modifiers within 7434, as Stephen Olsen has previously described here. A “fraudulent information return with respect to payments purported to be made” clearly applies to reported compensation but when taxpayers are issued 1099s instead of W-2s, the amounts on those information returns will be different anyway. W-2s include withholding and deductions which typically do not appear on Forms 1099-MISC. If an employer willfully misclassifies a taxpayer as an independent contractor and the employer intentionally disregards obligations to withhold Social Security and Medicare taxes, is that information return not, per se, “fraudulent…with respect to payments”?

Further, that the term “fraudulent” comes before “information return” suggests that the type of information return itself, not just the amount, is relevant. This adjective-based analysis might seem overly simplistic but pre-Liverett case law – which is still good law – made it clear in a straightforward manner. For instance, the U.S. District Court for the Southern District of Florida found in a pair of misclassification cases that that “to establish a claim of tax fraud under 26 U.S.C. Section 7434,” one of the necessary elements was simply that the “information return was fraudulent.” In both Seijo v. Casa Salsa, 2013 WL 6184969 (SD Fla. 2013) and Leon v. Taps & Tintos, Inc., 51 F.Supp.3d 1290 (SD Fla. 2014), the willful issuance of a 1099 rather than a W-2 was sufficient proof for this prong of the claim. Strikingly, the Seijo court found that because a 1099 is a “form used to record payments made to an independent contracto[r] and [the worker] was not an independent contractor,” the intentional misclassification was actionable. It cited Pitcher v. Waldman, 2012 WL 5269060, at *4 (S.D. Ohio 2012) for support of the proposition that even if the “amount of the payment [is] not in dispute…[if] the form used to report that payment and the tax implications that went along with that form” are at issue, there could be a claim.

The specter of the “tax implications” that result from misclassification challenge a Liverett-based analysis like the one the Wagner court adopted. Liverett cited the legislative history of 7434 in that it noted how Congress was concerned with “malcontents who ‘sometimes file fraudulent information returns reporting large amount of income for judges, law enforcement officers, and others who have incurred their wrath.” The tax implications though that arise from such efforts are as similarly harmful for workers as misclassification itself. When a taxpayer is issued an information return that overstates their income, it creates additional, unwarranted tax burdens for them. When a taxpayer is issued an information return that is correct in income amount but wrong in the type of return because they were misclassified, it also creates an additional, unwarranted burden.

Congress was concerned with “significant personal loss and inconvenience” for taxpayers as a “result of the IRS receiving fraudulent information returns.” When taxpayers are willfully misclassified as independent contractors, they lose out on myriad benefits employees enjoy under various laws and they are saddled with a self-employment tax that can be onerous for low-income workers. Though the specific examples described in the legislative history do not exactly mirror misclassification cases, they provide a useful window into the broader purpose of the statute: the protection of taxpayers from fraudulent actors who create unnecessary burdens for them. Misclassification is such a burden. Further, one canon of statutory interpretation that was not advanced in Wagner but could arise in a future 7434 case is the notion that if Congress wanted to explicitly clarify that 7434 applied strictly to amounts, it could have done so in the intervening years. Since the law’s enactment in 1996, various, sweeping tax laws have passed under four presidents and misclassification has only grown as a problem in the meantime. Nevertheless, Congress has not amended 7434 to provide more clarity here. Considering the increasingly salient issue of misclassification, it may be that Congress will soon reexamine this vexing statute.