In last Friday’s post, I outlined aspects of the private cause of action for fraudulent information returns under Section 7434, and specifically discussed some case law on whether or not an intentionally incorrect form could give rise to fraud under Section 7434 or if there had to be a fraudulent amount stated on the form. The current trending opinion on this matter is that the amount must be fraudulent, not just the form, and the primary holding in this area is Liverett. Today’s post will discuss the specific rationale in Liverett, and why I think the statute may be open to other interpretations.
In Liverett, the specific facts are not that important. A worker thought she should have been an employee, but was treated as an independent contractor by her employer and issued a Form 1099-Misc. The worker brought a Section 7434 claim against the employer, and also brought wage and overtime claims under the Fair Labor Standards Act. The Liverett Court noted the prior cases in this area, but stated there was not an exhaustive analysis of the statute.
In reviewing the statute, the district court found the language of Section 7434 was ambiguous, stating:
This statute, at first glance, appears quite simple and straightforward. But, a more careful reading reveals that it harbors a significant ambiguity, the resolution of which impacts this case.
The source of the ambiguity in [Section] 7434(a) is the phrase “with respect to payments purported to be made to any other person.” Simply put, there is ambiguity as to what the phrase “with respect to…” modifies. On the one hand, [Section] 7434(a) may refer to an “information return with respect to payments purported to be made to any other person” that is “fraudulent.” On this reading, “with respect to…” describes “information return,” and such an information return that is false or misleading in any respect aimed at obtaining something of value is “fraudulent” and therefore actionable. On the other hand, “with respect to payments purported to be made to any other person” may be read as limiting “fraudulent.” Under this interpretation, the filing of an information return is actionable only if the information return is false or misleading as to the amount of payments purportedly made.
After coming to this conclusion, the court had to attempt to ascertain the meaning of the statute, which it concluded meant that the fraud had to be in the amount of the payment and not the form. It came to this conclusion based on statutory construction, the legislative history, and the fact that the plaintiff had other federal statutes available to make claims under. The court’s rationale is plausible under each, but I think there could be other interpretations.
Before discussing each of the rationales below, I do want to reiterate this review was done because the court concluded the statute was ambiguous. Various courts that previously reviewed this matter did not flag this issue, so it might be possible to argue there is no ambiguity. Most people I have spoken with, upon initial reading of Section 7434, assume it means any fraud related to the information return. For purpose of the remainder of the post, however, I will assume that the statute is ambiguous.
I think the statutory construction rationale provided by the court was the strongest, and I suspect the rationale that convinced other courts to follow suit. The Court noted that the placement of the term “fraudulent” prior to the term “information return” was evidence of a broader interpretation, but said other statutory construction tenets required a more nuanced look. The Court then looked to the definition of “information return” under Section 6724, which is “a statement of the amount of payments to another person”. When that is read into Section 7434(a), the statute reads the private cause of action addresses “a fraudulent [statement of the amount of payments to another person] with respect to payments purported to be made…” The Court concluded that reading the definition into the statute shows that if “with respect to payments” modifies information returns, then the language is redundant.
The court then states, “[i]n other words, an ‘information return,’ by definition, relates to the amount of payments to a person.” It then concludes that if “with respect to payments made” has to modify fraudulent, and not “information return”, and therefore must pertain to an incorrect payment amount.
There are two separate conclusions here, which possibly both could be interpreted differently. First, is the conclusion that “with respect to payments” must modify “fraudulent”; otherwise it is superfluous. This reading ignores that information returns contain information beyond the payment amount, and seems to be based on definition of information return referring to payments. The definition quoted, however, is not the entire definition from Section 6724. After the quoted language above, the section continues to say “required by” and then a list of various Code sections requiring information returns. Those various other Code sections have lots of other requirements of information to be included on the information returns, not just the payment amount. If you read the full language of Section 6724, along with the requirements in the internally referenced Code Sections, then “with respect to payments” acts as limiting language to cause Section 7434 to only apply to the “payment” shown on the information return, which, by definition, has a broad range of other information included. I’m not sure I love that interpretation, because I would rather any fraudulent information on the return be included, but it does show that there are other interpretations of the statute and that the above rationale ignores aspects of the definition.
What I also find troubling is that Section 7434(a) does not reference the “amount” of the payment, but the court concludes it must be an incorrect amount in order to be fraud. Even if you assume “with respect to payment” has to modify fraudulent, it is another substantial step to say that has the same meaning as “fraudulent…with respect to [an incorrect statement of the amount of the] payment.” In every, or just about every, discussion of fraud under the Code, mischaracterization is sufficient to show fraud. This again is based apparently somewhat on the fact that “amount” is included in the definition of information return.
There is one reference to “amount” under Section 7434, which the court believed bolstered its position. Section 7434(e) states, “The decision of the court awarding damages in an action brought under subsection (a) shall include a finding of the correct amount which should have been reported in the information return.”
As a contextual clue, I suppose I can understand finding support for the Court’s position, but there is nothing stating that the Court can only apply Section 7434 when the amount has been misstated. Second, and I think more importantly, if employment income has been mischaractherized as “non-employment income”, then I think the correct amount that should have “been reported in the information return” should be $0. The subsection seems to specifically be referencing the information return that was filed, and not all potential and possible information returns that the information could have been included on.
I’m not sure my arguments are perfect (and the above admittedly rambles), but I think a skilled lawyer could use them for the start of a potentially persuasive argument.
The second rationale the court used was based on the legislative history, which I think is the weakest argument. Enacted in TBOR 2 back in 1996, there is scant legislative history on this Section. The reason for the statute provided in the legislative history was:
Some taxpayers may suffer 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.
Most of the remainder of the legislative history summarizes the statute. There are no additional references to the modifying language in question, or the term “amount”, or anything involving “incorrect amounts.” In general, the language is very, very broad.
The court did note the final paragraph in the legislative history pertains to allowing sanctions for frivolous actions under Section 7434. The court reasoned that if Congress was concerned with frivolous actions, it must have intended to have a narrow statute; however, that reading seems counter to the broad language actually provided by Congress. I think it is safe to say Congress wanted to impose sanctions for frivolous actions, but I do not know that was intended to make a narrow statute (they could have drafted a narrow statute).
The final rationale provided by the Court was that the plaintiff had claims regarding worker classification under the Fair Labor Standards Act, which it stated was a comprehensive manner of handling worker classifications. Since there was already a method of addressing worker misclassification, the Court concluded that Congress would not have intended Section 7434 to apply. I think this is an incorrect conclusion for a number of reasons.
First, there are various provisions in the Code and administrative methods before the IRS for dealing with worker classification issues. Clearly, Congress and the IRS do not view the FLSA as the sole statute dealing with this area.
Second, there are an unlimited number of examples of a civil or criminal dispute that would result in causes of action under various federal statutes. Although FLSA is a comprehensive law dealing with overtime and minimum wage claims, I do not think it precludes a claim based solely on the tax aspects or the fraud and problems created by the employer filing an incorrect form.
This transitions into my third thought on this FLSA argument. FLSA might apply to W-2/Form 1099 issues, but it would not apply to any other correct payment amount but incorrect form issue. I believe if we collectively thought about this, we could probably find many other examples (admittedly, W-2/1099 is the most common though). For instance, what happens if an employee exercises non-qualified stock options but is only given a W-2 showing wages. The amount might be correct, but some portion could be a gain properly reported on a Form 1099-B. Or payments that should have been on a Form 1099-B or 1099-Div, but ended up on a W-2. These are not subject to FLSA claims.
The Liverett court definitely represents the prevailing current rationale of courts; however, no circuits have reviewed this matter, and it will be easy for plaintiffs to make Section 7434 claims relating to this issue when making other claims against employers. Although the Liverett court’s rationale is certainly plausible, I do think it may be possible for other district courts to take a more plaintiff favorable position on future matters.