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.
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.