Misclassified “Independent Contractor” Succeeds in Using Tax Code to Get Damages from Employer

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We have nearly finished information return filing season. This is the time of year when Americans get their W-2s and 1099s, stuff them in folders and drawers, and hope that when it comes time to prepare their tax return they remember where the papers are. Information returns often lie forgotten until it’s time to answer questions from software prompts or from long-suffering preparers who play detective to ferret out a taxpayer’s economic life.  Some taxpayers can access their information returns seamlessly, but for most this is still a 20th century process that contributes to the huge costs of filing compliance. To be sure, information returns are the backbone of “voluntary” compliance—it is no surprise that when income is not subject to reporting taxpayers have a tendency to not include those items on their 1040s—and that will be true whether the 1040 is postcard size or in the form of a Hallmark Valentine’s Day card professing the IRS’s undying love for taxpayers who file and pay timely.

I digress—today’s post is about people who intentionally file incorrect information returns.

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We have discussed this issue before, and Stephen and I have just heavily tweaked this issue in the Saltzman and Book IRS Practice and Procedure treatise. The cases tend to crop up when someone seeks to make someone else’s life miserable by fling a phony return to generate IRS attention in the form of underreporting letters and possible tax assessments. What could be more middle-finger flipping then sending the IRS an information return showing a former partner or significant other with all kinds of income supposedly but not really earned?

To deal with this, Congress added Section 7434 which provides that

[i]f 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.

There are a surprising number of interesting legal issues that spin off this provision. One of the issues concerns whether the statute provides a remedy for someone who is truly an employee but is treated as an independent contractor and who then receives a 1099-MISC rather than a W-2. The cases are split, some saying that the statute only provides a remedy when an improper amount is reported, and other courts holding that the statute provides a remedy for any fraudulent action in connection with the information return, including filing the wrong form. Another key issue that the courts are wrestling with is whether liability is limited to the person who was required to file the information return under federal law. For example, some courts have declined to find personal liability if the filer was not the party required to file the information return. See e.g., Vandenheede v. Vecchio, a 2013 case from a federal district court in Michigan declining to hold liable two co-trustees who prepared and caused a false information return to be filed on another’s behalf.

This takes us to a case from last year that I read as I prepare the updates for the next round of the treatise. The case is Czerw v Lafayette Moving and Storage. In the case, a federal district court in NY considered the claims of Joseph Czerw, who worked over twenty years as a mover for the same employer. In prior years, Czerw received W-2s and was treated as an employee, which was consistent with his actual arrangement with the employer. In 2015 his employer had major financial difficulties, with checks bouncing. Unlike in past years, when he got W-2s, for that year Czerw received a 1099-MISC for over $5,000. Not only was the information return the wrong type, but Czerw had only been paid about $4,000. Even though Czerw contacted his employer to get him to treat him as an employee and reflect the proper amount he was paid, his employer declined to fix things.

Czerw sued his corporate employer and Matthew Ferrentino, the corporation’s sole owner and president, alleging that his employer and Ferrentino had actual knowledge that a W-2 form was the correct form to submit and that the 1099-MISC reflected the wrong amount he received. Czerw alleged that the defendants willfully, purposely, and fraudulently filed the false Form 1099-MISC as part of a scheme “to defraud state and federal taxing authorities . . . by lessening [] Lafayette’s tax obligations and the amount of its worker’s compensation insurance premiums.” The complaint sought $5,000 in damages—the statutory amount provided in the absence of actual damages or discretionary legal fees.

The defendants defaulted, but before the court granted damages it had to explore whether the statute provided for relief in Mr. Czerw’s situation. The first issue the court considered was whether liability extended not only to the corporation but also to Ferrentino individually. The order briefly explores the split in cases on the issue, and lines up squarely with the cases that extend liability “on any person who willfully causes a fraudulent information return to be filed.” Thus it found that Ferrentino in his individual capacity was also potentially on the hook for damages.

As to whether section 7434 can be used in misclassification cases in the absence of an incorrect amount reported, the order notes that the law is developing on this issue. The court was able to avoid coming down on any side because the 1099-MISC that was filed overstated the amount that Czerw received:

As Plaintiff concedes, however, some courts have held that “§ 7434(a) creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” Liverett v. Torres Advanced Enter. Solutions LLC, 192 F. Supp. 3d 648, 653 (E.D. Va. 2016) (emphasis added). Under that interpretation, the statute “provides no remedy for a person incorrectly classified as an independent contractor.” Tran, 239 F. Supp. 3d at 1298. But because Plaintiff alleges that the Form 1099-MISC incorrectly states the amount paid to him, the second element is satisfied regardless, and the Court need not address whether the alleged misclassification supports a claim under § 7434.

Conclusion

Employee misclassification is a major issue. Employers who misclassify employees are failing to provide unemployment insurance and workers’ compensation. Those employers can also leave workers with large employment tax liabilities. Advocates who work in this field have Section 7434 as a possible mechanism to ensure fair treatment for workers and punish those who do the wrong thing. The Czerw order is helpful but as briefly reflected in this post there are some key legal issues that await further development.

 

 

 

 

 

 

Leslie Book About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. BILL NEMETH EA says

    I strongly endorse having the IRS allow early access to their file of information returns.
    My clients “edit” their tax docs before they give them to me.
    My preferred way to work with these clients is to do a Pro Forma prior to April 15 and file an extension so I can have access to IRS W&I in August (when W&I are usually completely developed). If they owe, I ask them to send in a payment when we file the extension.

    New Development – the IRS has moved the W&I Available Date past the due date of April 15th, likely to reduce Tax fraud.
    I offer the following commentary on when the IRS makes the taxpayer Wage & Income Transcripts available.
    May 8, 2018 2017 IRS Wage and Income Transcripts available
    March 30, 2017 2016 Wage and Income Transcripts available
    Early April 2016, 2015 Wage and Income Transcripts available.

    We have determined that the Account Transcripts are “flagged” for Unreported Income 4-6 months before the IRS AUR Unit sends the CP2000 Notice. We file a 8821 on every tax client, monitor the transcripts every 2 weeks, and “see” the CP2000 flag 4-6 months BEFORE the CP2000 is sent. This gives us time to analyze, create and file a complete and accurate amended return BEFORE the CP2000 Notice is sent, saving the taxpayer some interest and eliminating the 20% Accuracy-Related Penalty.

    It is a Win-Win in that the IRS gets additional revenue without expending any real resources (the computer-matching program generates the Code 922 Unreported Income Flag without human intervention).

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