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

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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.

Comments

  1. Seems the above could apply when an S corporation fails to declare wages / file W2s for its officer-employees (a virtually unsupportable position…yet it happens, and in such cases, seems difficult in light of the above to say what the fallout exactly would be (thinking specifically about the failure to file W2s).

  2. Kenneth H. Ryesky says

    Very early on, Dear Old Dad showed me that he ALWAYS kept his most recent pay stub until the next one (his pay stubs showed yearly cumulative gross, withholding, and net figures). He explained to me that the cost to do such limited retaining was effectively zero, but the cost could be ruinous if ever a question arose (he had issues with his employer, and once told me that he wouldn’t put anything past them; a stance that was validated years later, after his departure, when the employer got lots of ink on lots of newsprint regarding other issues).

    If, perchance, the employer issued paystubs showing withholding of taxes, then there may well be Section 6672 issues on the employer’s side, which could easily be weaponized by the employee into an inducement to settle.

  3. Code Sections 6721 and 6722 establish penalties for failure to file W-2 forms or to furnish them to employees. The problem is that Congress can lead the IRS to helping taxpayers, but can’t make them enforce the law, especially when resources are not provided. Should employees have a private cause of action to enforce these penalties? That would not be practical without a federal employment court where thousands of cases could be filed.

    For an amusing urban tax fantasy, read the instructions to IRS Form 4852, “Substitute for Form W-2 [etc.]”:
    “If you don’t receive the missing or corrected form from your employer or payer by the end of February, you may call the IRS at 800-829-1040 for assistance. You must provide your name, address (including ZIP code), phone number, social security number, and dates of employment. You must also provide your employer’s or payer’s name, address (including ZIP code), and phone number. The IRS will contact your employer or payer and request the missing form. The IRS also will send you a Form 4852. If you don’t receive the missing form in sufficient time to file your income tax return timely, you may use the Form 4852 that the IRS sent you.”

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