Tax Lawyers Can Fight the Coronavirus Crisis with the Internal Revenue Code

Today, we welcome guest blogger Bob Rubin. Bob practices in Sacramento, California as a partner in Boutin Jones, Inc. While he primarily focuses on tax procedure in both federal and state matters, he gets involved in other tax issues as well. Today, he writes about a possible use of one of the disaster provisions passed by Congress at an earlier time to protect workers today. He and I started working in the same branch of Chief Counsel, IRS 43 years ago this month. Keith

Under section 139, gross income does not include any amount received by an individual as a qualified disaster relief payment. A qualified disaster relief payment is one of four types of payments made to, or for the benefit of, an individual, but only to the extent any expense compensated by the payment is not otherwise compensated for by insurance or otherwise. The first and most relevant type of payment is any amount paid to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster. President Trump’s Stafford Act Declaration for New York, California and Washington made section 139 applicable.

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The section 139 grants are not income to the employee/grantees, are not subject to employment taxes, are deductible by the employer/grantor and are not subject to information reporting under section 6041. The section 139 plan cannot discriminate based upon length of service or position. The grant cannot be in the nature of income replacement.

Besides section 139, see J. Comm. on Taxation, Technical Explanation of the Victims of Terrorism Relief Act of 2001, JCX-93-01 (Dec. 21, 2001) and Revenue Ruling 2003-12.  This is situation 3 in the revenue ruling:

Situation 3. Employer R makes grants to its employees who are affected by the flood described in Situation 1. The grants will pay or reimburse employees for medical, temporary housing, and transportation expenses they incur as a result of the flood that are not compensated for by insurance or otherwise. R will not require individuals to provide proof of actual expenses to receive a grant payment. R’s program, however, contains requirements (which are described in the program documents) to ensure that the grant amounts are reasonably expected to be commensurate with the amount of unreimbursed reasonable and necessary medical, temporary housing, and transportation expenses R’s employees incur as a result of the flood. The grants are not intended to indemnify all flood-related losses or to reimburse the cost of nonessential, luxury, or decorative items and services. The grants are available to all employees regardless of length or type of service with R.

Section 139 allows employers to assist employees who cannot meet their personal living expenses such as rent, mortgage payments or car payments on a tax-efficient basis. There should be a section 139 plan document that provides the benefits are payable without regard to length of service or position. The plan should require some type of modest substantiation such as a copy of a lease and a signed statement providing that the grantee cannot afford to pay $X of the rent.

California conforms to the income tax provisions of section 139. Employment taxes in California are administered by the California Employment Development Department (“EDD”). EDD Information Sheet State of Emergency or Disaster provides that section 139 grants are not subject to Personal Income Tax Withholding, but are subject to Unemployment Insurance contributions, the Employment Training Tax and State Disability Insurance contributions.

Many employees are being furloughed because they cannot work from home. Others are being furloughed due to a decline in economic activity. Section 139 is a tax-efficient tool employers can use to soften the blow on employees.

In addition to Bob’s thoughts on this subject, we have also gathered thoughts from Omeed Firouzi. Omeed is an ABA Tax Section Christine Brunswick fellow who works with Philadelphia Legal Aid specializing in employment tax issues of low income taxpayers. He prepared this for people working with individuals who receive Form 1099 wages summarizing the FFCRA provisions. Keith

SICK LEAVE for 1099 worker

The credit for COVID-19-related sick leave is 100% of the self-employed person’s “sick-leave equivalent amount” if they themselves are self-quarantined/diagnosed. It is 67% of the SE person’s “sick-leave equivalent amount” if the SE taxpayer is “taking care of [their] child following the closing of the child’s school.”

The “sick-leave equivalent amount” = *to take care of yourself,* the lesser of 1) your average daily SE income or 2) $511 per day for up to 10 days (up to $5,110 in total) OR to *care for a sick family member or your child following the child’s school closure,* $200 per day for up to 10 days ($2,000).

Daily self-employment income in FFCRA is defined as the net earnings for the year divided by 260 (i.e. 260 days).

FAMILY LEAVE for 1099 worker 

The COVID-19-related “emergency family-leave credit” – eligible for up to 50 days – is 100% of the SE taxpayer’s “qualified family leave equivalent.”

The “qualified family leave equivalent” = the lesser of 1) $200 or 2) the average daily SE income for the taxable year per day. As MarketWatch put it, “the maximum total family-leave credit would be $10,000 (50 days times $200 per day).” The House Appropriations Democrats summarized it such that “in calculating the qualified family leave equivalent amount, an eligible self-employed individual may only take into account those days that the individual is unable to work for reasons that would entitle the individual to receive paid leave pursuant to the Emergency Family and Medical Leave Expansion Act.”

Further, there is no “double benefit” allowed for both of these credits. So these credits are “proportionally reduced for any days that the individual also receives qualified sick leave wages from an employer,” so this is especially relevant for our clients who work both W-2 and 1099 jobs simultaneously. (https://appropriations.house.gov/sites/democrats.appropriations.house.gov/files/Families%20First%20Summary%20FINAL.pdf). The statute specifically states that in such a scenario, “your self-employed equivalent benefit ‘shall be reduced (but not below zero) to the extent that the sum of the amount described…exceeds $2,000 ($5,110 in the case of any day any portion of which is paid sick time described in paragraph).”

Working Through an Employer’s Failure to File Form W-2 or 1099 with the IRS

We welcome guest blogger Omeed Firouzi to PT. Omeed is a Christine A. Brunswick public service fellow with Philadelphia Legal Assistance’s low-income taxpayer clinic, and he is an alum of the Villanova Law Clinical Program. His fellowship project focuses on worker classification. In this post, Omeed examines a recent case where the taxpayer unsuccessfully sought relief under section 7434 for her employer’s failure to report her compensation to the government at all. Litigation in this area is likely to continue. Christine

Tax season is upon us so I would be remiss if I did not cite fellow Philadelphian Ben Franklin’s famous maxim that “in this world nothing can be said to be certain, except death and taxes.” But whether you are filing your return as soon as possible or at 11:59 PM on April 15, there is one thing that is uncertain for many taxpayers: whether your employer filed an information return.

As we have seen in our clinic at Philadelphia Legal Assistance and more broadly, employers are increasingly not filing income reporting information returns with the Social Security Administration (SSA) and the Internal Revenue Service (IRS). The Internal Revenue Manual, at IRM 21.3.6.4.7.1, describes the proper procedure for IRS employees to follow should a taxpayer not receive an information return. The IRS website also provides tips and tools for how taxpayers should proceed in such situations.

Under the Internal Revenue Code and regulations promulgated under the Code, employers could be held liable – and subject to penalties – for failure to file correct information returns. However, the IRC and its accompanying regulations lack a clearly defined legal recourse for individual taxpayers when the employer fails to file any information return at all. No explicit cause of action exists for workers in this predicament. Recently, a taxpayer in New York unsuccessfully tried to make the case that 26 U.S.C. Section 7434 encompasses this situation.

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The statute states, in part:

If 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.

This statute has been the subject of several previous Procedurally Taxing posts. As these posts described in detail, courts are in consensus that the statute at least encompasses an employer’s willful misstatement on an information return of the amount of money paid to a worker. The legislative history of Section 7434 reveals that when Congress drafted the legislation in 1996, its authors were concerned with the prospect of “taxpayers suffer[ing] 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.” 

The case law is split on whether misclassified taxpayers can use Section 7434 to file suit against their employers for fraudulently filing a 1099-MISC rather than a W-2, if the dollar amount reported is correct. No circuit court has ruled on the issue but most courts have followed the lead of the U.S. District Court for the Eastern District of Virginia and its Liverett decision that found that Section 7434 does not apply to misclassification.

However, one aspect of Section 7434 where there is judicial consensus is that the statute does not encompass the non-filing of an information return.

The U.S. District Court for the Eastern District of New York recently joined the chorus of courts on this issue. In Francisco v. Nytex Care, Inc., the aforementioned New York taxpayer argued that her former employer, NYTex Care, Inc., violated Section 7434 by “failing to report payments made” to the taxpayer and other workers. The facts of the case are straightforward. Taxpayer Herlinda Francisco alleged NYTex Care, a dry cleaning business, “fail[ed] to identify [her] and other employees as employees” by failing to file information returns for tax years 2010, 2011, 2012, 2013, 2014, 2015, and 2016. Francisco filed suit under Section 7434 alleging that NYTex “willfully and fraudulently filed false returns…by failing to report” employees’ income.

The court principally cited Second Circuit precedent, set in Katzman v. Essex Waterfront Owners LLC, 660 F.3d 565 [108 AFTR 2d 2011-7039] (2d Cir. 2011) (per curiam), in dismissing the case. Katzman established that Section 7434 “plainly does not encompass an alleged failure to file a required information return.” In Nytex, the employer “did not report payments made” to the taxpayer and other employees but the court found that Section 7434 was not the appropriate remedy.

More broadly, the Nytex court examined the plain language of Section 7434, its legislative history, and other relevant case law in foreclosing this claim. The plain text of the statute, the court noted, necessitates a filing by definition; there must be a filed information return in order for it to be fraudulent. The court also looked to Katzman’s parsing of congressional intent for guidance; in Katzman, the Second Circuit ruled explicitly that “nothing in the legislative history suggests that Congress wished to extend the private right of action it created to circumstances where the defendant allegedly failed to file an information return.”

Further, the court even relied upon another case the same plaintiffs’ attorney brought in the Southern District of New York. In Pacheco v. Chickpea at 14th Street, Inc., the plaintiff there also brought suit under Section 7434 on the basis of the failure of their employer to file information returns but the Southern District “found [that situation] was not covered by the statute.” Ultimately, the Nytex court granted the Defendants’ motion to dismiss for failure to state a claim upon which relief can be granted because the court found no cognizable claim for alleged failure to file an information return under Section 7434.

The result in Nytex leaves it frustratingly unclear what remedies exist for workers who find themselves in this taxpayer’s predicament. Had the employer here actually filed a 1099-MISC with the IRS, a potential argument could’ve been made about misclassification and whether that is encompassed by Section 7434. There is more division in the courts about that issue as opposed to the question posed in Nytex. Had the employer willfully overstated the amount the taxpayer was paid, the court could’ve found a clear Section 7434 violation, based on the reporting of a fraudulent amount.

Of course, neither of those things happened here. Instead, there is an aggrieved taxpayer ultimately unable to rely on a statute that is both ambiguous and seemingly limiting all at once. Practically, she is left with no clear way to sort out her own tax filing obligations when no information returns were filed. The court interestingly does not identify an alternative course of action, or judicial remedy, the taxpayer could seek.

In relying on congressional intent, the court leaves the reader wondering if Congress ever envisioned that an employer’s failure to file an information return could cause “significant personal loss and inconvenience” to the worker. If it means a frozen refund check as part of an IRS examination, there is certainly loss and inconvenience there. As Stephen Olsen described at length previously, courts have deeply examined the statutory language in terms of whether the phrase “with respect to payments made” only modifies “fraudulent” or if the information return itself could be fraudulent even if the payment amount is correct.

That discussion raises an interesting question as it relates to Nytex: if a court found an actionable claim for non-filing under section 7434, how would it determine whether the failure to file was fraudulent or whether there was willfulness in the non-filing? Since there would be no information return, would the court be forced to look at what kind of regular pay the taxpayer got to ascertain what the information return likely would’ve been?

Then, the court would have to find that there was “willfulness” on the part of the employer, not merely an inadvertent oversight. To make matters more complex, the court would have to likely wrestle with how there could be a willful act in a case where the employer did not even act at all. If a court found willfulness, a potential argument could be that a non-filing is analogous to filing an information return with all zeroes on it thus leading the court to say it is, in effect, fraudulent in the amount.

For now though: what can a taxpayer do in such a situation? When employers fail to provide or file information returns, the IRS recommends that workers attempt to get information returns from their employers. If that fails, the IRS advises workers to request letters on their employer’s letterhead describing the pay and withholding. Should an employer not comply with these requests, the IRS can seek this information from an employer while taxpayers can file Substitute W-2s attaching other proof of income and withholding – such as bank statements, paychecks, and paystubs. If a taxpayer got an information return but the employer never filed it with the government, that might ease the burden on the taxpayer but the IRS will still seek additional verification.

Even then, taxpayers could get mired in lengthy audits and examinations all while waiting for a critical refund check they rely on to make ends meet every year. We have seen this pattern play out in our own clinic and I suspect as it befalls more taxpayers, there may be either a congressional or judicial reexamination of Section 7434 or another effort to address the problem of non-filing of information returns.