Fifth Circuit Says 1040 plus 1099 equals 945, Reversing District Court’s Calculation of What is a Return

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In Quezada v. IRS, No. 19-51000 (5th Cir. 2020) the Fifth Circuit determined that the Form 1040 filed by the Quezadas and the Forms 1099 issued by his business to its workers started the running of the statute of limitations for backup withholding. The decision reverses the district court which had reversed the bankruptcy court. We discussed those decisions here and here, respectively. You can read the prior posts for background on what is a hotly contested matter with significant monetary implications for the Quezadas as they seek to emerge from bankruptcy and for the IRS as it tries to prevent consequential adverse precedent regarding what constitutes a return.

I plan to follow this post tomorrow with a victory for the IRS in another circuit rendered just a few days after Quezada.  I don’t know if this decision has enough administrative importance for the IRS to warrant consideration of a cert petition or if there is a sufficient conflict in the circuits but I expect the IRS and DOJ will give the matter more than glancing thought.  The IRS very much wants a per se rule because of its desire for ease of administration.  It does not want to triangulate documents on the wrong forms or submitted to the wrong place in order to make a judgment whether a taxpayer has effectively filed a return.  Decisions like Quezada act like sand in the efficient running of its return processing machinery.  The decision also raises questions concerning why the IRS took so long to act on what were clearly deficient Forms 1099.

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The issue presented here arises as a statute of limitations question. Did Mr. Quezada file a return that started the running of the statute of limitations, or rather, since we know he did not file the specific return at issue, did he file other returns or other documents that could take the place of the required return? In some ways this case takes the court into the type of analysis it would use in an informal claim case. Although Mr. Quezada makes no claim for a refund, he argues that he provided the IRS with enough information to trigger a running of the statute of limitations, just as an informal claim would trigger a satisfaction of the statute of limitations for filing a claim without actually using the process prescribed by the IRS.

Mr. Quezada ran a stone mason business.  He had a number of individuals working for him at various times during the years at issue.  These individuals were treated as subcontractors and not as employees and the case does not question that designation.  In 2014 the IRS assessed deficiencies against him dating back to 2005 for his failure to backup withhold for 2005 through 2008.  The court explains why the IRS made the backup withholding assessment:

A Form 1099 shows the name and address of the payee and how much he was paid. Each payee for whom a payor files a Form 1099 must provide a “Taxpayer Identification Number” (TIN). See 26 U.S.C. § 3406(a). A personal identifying number, like a social security number, can serve as a TIN. 26 C.F.R. § 301.6109-1(a)(1)(i). The payor must list the payee’s TIN on the Form 1099. Id. § 301.6109-1(c). If “the payee fails to furnish his TIN to the payor in the manner required,” the payor must withhold a flat rate for all payments to the payee and send the withholdings to the IRS. 26 U.S.C. § 3406(a). This is called “backup withholding”; the flat rate the payor withholds acts as a “backup” in case the payee fails to pay taxes on the underlying payments.

Mr. Quezada reported the payments he made to subcontractors working for his business but almost all of the Forms 1099 he filed reporting those payments failed to include the individuals TIN as required by the statute and regulations. In each of the years almost all of the Forms 1099 he issued were deficient in this way. For reasons not explained, the IRS did not make an assessment against Mr. Quezada for the failure to engage in backup withholding with respect to the deficient Forms 1099 until more than three years after the filing of his income tax returns and the Forms 1099 for the four years in question. At issue concerns an assessment against him of over $1.2 million.

The purpose of backup withholding is to prevent individuals the IRS cannot identify from the Form 1099 from avoiding payment of their taxes with no practical way for the IRS to check whether they paid or not.  Here, it is unknown whether the subcontractors actually paid their taxes meaning that the assessment against Mr. Quezada would result in a windfall to the IRS or whether the assessed amount would allow the IRS to recover taxes it would otherwise lose because of the poor quality of the Forms 1099.

In his bankruptcy case Mr. Quezada contested the timeliness of the assessment of backup withholding. The Fifth Circuit sets out its view of the IRS argument:

Form 945 is thus the “return required to be filed by” a taxpayer who, like Quezada, is required to backup withhold. 26 U.S.C. § 6501(a). Quezada failed to file a Form 945. So, the argument goes, he never filed “the return,” and the limitations period never began to run under § 6501(a)‘s “[g]eneral rule.” The IRS thus contends the analysis ends here: Form 945 is the only document that can constitute “the return,” and Quezada failed to file it. Appeal concluded. In support of its argument, the IRS invokes Lane-Wells, which the IRS construes to create a per se rule requiring the taxpayer to file the return designated for the tax liability at issue; if the taxpayer does not file that specific return, the limitations clock never begins to run.

The court rejects the per se rule finding that Lane-Wells did not create such a rule not only finding that Lane-Wells did not create the per se rule the IRS argues that it held but citing to several circuit court decisions it says support the filing of a return based on other returns or documents.  The Fifth Circuit says it aligns itself with these other circuits and holds that:

‘the return’ is filed, and the limitations clock begins to tick, when the taxpayer files a return that contains data sufficient (1) to show that the taxpayer is liable for the tax at issue and (2) to calculate the extent of that liability.

Having decided that Mr. Quezada need not have filed Form 945 in order to start the clock ticking, in order words that there exists an “informal return” doctrine, the court then looks at what he did file to determine if the returns filed sufficiently met the test it stated.  The court decides that the Forms 1040 and 1099 did provide the IRS with enough information to create an informal Form 945.  The forms filed contained enough data to show he had a backup withholding liability.  The Forms 1099 showed the amount paid and the person paid thus allowing the IRS to calculate the amount of backup withholding that Quezada should have made.  Case over.

The case obviously matters to businesses that fail to make proper backup withholding when they lack the payees TIN. Does the test adopted by the Fifth Circuit create principles that will assist taxpayers in other circumstances? If so, what are those circumstances and how broadly could this test apply.? No doubt, there will be taxpayers out there willing to test the limits of this opinion.

Tomorrow, in a different context but with the same ultimate question of whether a return was filed, we will look at a case that came out the other way.

Comments

  1. Robert Kantowitz says

    The recent decision is correct both on the law and as matter of policy.

    Several observations that I had when I saw this case a few days ago:

    1. Back-up withholding is an important back-stop, but it is only that. There may be no way for he payer to know whether the individual contractors paid taxes, but the inequity of the government’s getting a windfall should be borne in mind. The IRS should at least be required to make whatever effort they can to ascertain whether they collected the tax due before going after the payor. As years go by, systems and matching abilities improve, but I recall an instance as far back as 1980 (not reported as it was on oral argument) in which an appellate court had little sympathy for the IRS’s argument that they had satisfied the criterion of not being in possession of information on 1099s because once they get it it gets placed in a warehouse and there is no way to retrieve it.

    2. IRS forms and their instructions are confusing to tax lawyers and accountants, let alone to others, and the forms often do not provide adequately for situations that may arise. (E.g., if the IRS proposes an adjustment based on an omitted W-2, they provide a letter explaining the adjustment including credit for taxes withheld. Do they confirm that there was no overreporting relative to another W-2? No. Do they send a copy of the entire W-2 or provide what all the boxes say so that a taxpayer who had never received his copy can fulfill the obligation to notify state taxing authorities? No. How many people can explain in a cogent way which TIN a single-member disregarded entity uses, and why, when it files a W-9?) In this case, the taxpayer can be excused for believing that by sending 1099-MISCs to contractors and to the IRS has has done the necessary. The instructions for the 1099-MISC & 1099-NEC run 13 pages and I did not see any reference to an obligation to file a Form 945.

    3. The 1099-MISC is an official form, and as the court pointed out, once the IRS got them, it had all the information it needed. The 945 would not have provided more.

    4. IRC § 6103(b)(1) provides:

    The term “return” means any tax or information return, declaration of estimated tax, or claim for refund required by, or provided for or permitted under, the provisions of this title which is filed with the Secretary by, on behalf of, or with respect to any person, and any amendment or supplement thereto, including supporting schedules, attachments, or lists which are supplemental to, or part of, the return so filed.

    So it would appear that a Form 1099-MISC is a “return.”

    5. This is not a case where a proper return was sent to an IRS office that might not have known what to do with it (e.g., to “US Treasury, Wash. DC”), or where an individual created his own form or letter, which the IRS could legitimately argue was too confusing or irregular for it to treat it as a return.

    6. This can, and will, come up again in other contexts. I also wonder: does anyone else has information on whether states treat as a “return” a copy of the federal 1040 that someone sent in, on the basis that it gives the state enough information to know the taxpayer’s state liability? New York used to accept a copy of a federal request for an extension if no tax was due; now New York demands that in all instances its own form be filed. Does anyone know whether they would still respect the federal form it it were filed? (New York also now requires taxpayers using software to do their returns to file returns and extension requests online — one cannot even find the extension request form on the state’s website to download to paper — but that is a separate issue.)

  2. Cindy Macdonald says

    And how would this kind of incomplete 1099 information return not be ‘frivolous’ in the IRS’s Eyes?

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