In today’s post, guest blogger Omeed Firouzi discusses the availability of civil damages for misclassified workers who receive inaccurate information returns from their employer. Christine
One of the most intriguing issues in tax law involves the interpretation of 26 U.S.C. Section 7434. As discussed extensively in various posts here, Section 7434 clearly encompasses situations in which taxpayers are issued income-reporting information returns that intentionally misstate the amount of their income. It is less clear if Section 7434 applies to situations in which a taxpayer is given the wrong kind of information return even if the amount of income is correct. Most courts that have ruled on this issue have found that a taxpayer who is misclassified as an independent contractor – and thus receives a Form 1099-MISC rather than a Form W-2 – does not have a cause of action under Section 7434.
These courts have largely followed the lead of the Liverett court, where the United States District Court for the Eastern District of Virginia undertook a thorough analysis of the statutory language and the legislative history of the law and found that it does not encompass pure misclassification. No circuit court has ruled on the issue but a consensus in the lower courts has emerged. The United States District Court for the District of Maryland recently also followed the lead of Liverett in Alan Wagner v. Economy Rent-A-Car Corp., et al.
Wagner involves a Maryland taxpayer who filed suit under various Maryland employment-related statutes and Section 7434 as he alleged willful misclassification through the fraudulent reporting of payments on a 1099 instead of a W-2. In November 2013, the taxpayer initially signed a contract that agreed to “a fixed monthly salary of $5,000 per month plus commission…based on the value of contracts [he] procured for” the company. Ultimately, the taxpayer became a “full-time…employee” and received a W-2 for several consecutive tax years.
Then in 2016, the taxpayer alleges that his employer “began to pressure” him to accept 1099 classification and “when [he] refused, it is alleged that [the employer] began to withhold his commission payments.” The two parties subsequently entered into a “separation agreement” pursuant to which the taxpayer’s employer agreed to pay him “a ‘net’ sum of $45,000 in three installments ‘in exchange for a non-solicitation agreement.’” These payments were issued on a Form 1099 rather than on a W-2.
However, yet again, the court joined the growing consensus in rejecting the notion that Section 7434 applies here. The court noted that Section 7434 “creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” The court also held that “the first rule of Liverett [is that] … plaintiffs cannot prevail under § 7434 by merely alleging that they have been misclassified as independent contractors, or received the wrong type of information return.”
The court recognized that Greenwald v. Regency Mgmt. Servs., LLC, 372 F. Supp. 3d 266, 270 (D. Md. 2019) carved out an exception such that “if the misclassification causes the underreporting of paid wages,” there may be a 7434 cause of action. The case was distinguishable from Greenwald though in that there was no misstatement in the amount of income in question the taxpayer received; the receipt of the aforementioned $45,000 was never in dispute. The proper classification of this income was the central tenet of the taxpayer’s 7434 claim. Consequently, the court found that “on its face, this is a ‘misclassification’ claim which cannot support a § 7434 action.” As such, the claim was dismissed.
The complexity here lies in the modifiers within 7434, as Stephen Olsen has previously described here. A “fraudulent information return with respect to payments purported to be made” clearly applies to reported compensation but when taxpayers are issued 1099s instead of W-2s, the amounts on those information returns will be different anyway. W-2s include withholding and deductions which typically do not appear on Forms 1099-MISC. If an employer willfully misclassifies a taxpayer as an independent contractor and the employer intentionally disregards obligations to withhold Social Security and Medicare taxes, is that information return not, per se, “fraudulent…with respect to payments”?
Further, that the term “fraudulent” comes before “information return” suggests that the type of information return itself, not just the amount, is relevant. This adjective-based analysis might seem overly simplistic but pre-Liverett case law – which is still good law – made it clear in a straightforward manner. For instance, the U.S. District Court for the Southern District of Florida found in a pair of misclassification cases that that “to establish a claim of tax fraud under 26 U.S.C. Section 7434,” one of the necessary elements was simply that the “information return was fraudulent.” In both Seijo v. Casa Salsa, 2013 WL 6184969 (SD Fla. 2013) and Leon v. Taps & Tintos, Inc., 51 F.Supp.3d 1290 (SD Fla. 2014), the willful issuance of a 1099 rather than a W-2 was sufficient proof for this prong of the claim. Strikingly, the Seijo court found that because a 1099 is a “form used to record payments made to an independent contracto[r] and [the worker] was not an independent contractor,” the intentional misclassification was actionable. It cited Pitcher v. Waldman, 2012 WL 5269060, at *4 (S.D. Ohio 2012) for support of the proposition that even if the “amount of the payment [is] not in dispute…[if] the form used to report that payment and the tax implications that went along with that form” are at issue, there could be a claim.
The specter of the “tax implications” that result from misclassification challenge a Liverett-based analysis like the one the Wagner court adopted. Liverett cited the legislative history of 7434 in that it noted how Congress was concerned with “malcontents who ‘sometimes file fraudulent information returns reporting large amount of income for judges, law enforcement officers, and others who have incurred their wrath.” The tax implications though that arise from such efforts are as similarly harmful for workers as misclassification itself. When a taxpayer is issued an information return that overstates their income, it creates additional, unwarranted tax burdens for them. When a taxpayer is issued an information return that is correct in income amount but wrong in the type of return because they were misclassified, it also creates an additional, unwarranted burden.
Congress was concerned with “significant personal loss and inconvenience” for taxpayers as a “result of the IRS receiving fraudulent information returns.” When taxpayers are willfully misclassified as independent contractors, they lose out on myriad benefits employees enjoy under various laws and they are saddled with a self-employment tax that can be onerous for low-income workers. Though the specific examples described in the legislative history do not exactly mirror misclassification cases, they provide a useful window into the broader purpose of the statute: the protection of taxpayers from fraudulent actors who create unnecessary burdens for them. Misclassification is such a burden. Further, one canon of statutory interpretation that was not advanced in Wagner but could arise in a future 7434 case is the notion that if Congress wanted to explicitly clarify that 7434 applied strictly to amounts, it could have done so in the intervening years. Since the law’s enactment in 1996, various, sweeping tax laws have passed under four presidents and misclassification has only grown as a problem in the meantime. Nevertheless, Congress has not amended 7434 to provide more clarity here. Considering the increasingly salient issue of misclassification, it may be that Congress will soon reexamine this vexing statute.