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When “Any Person” Might Mean Just One Person

Posted on Aug. 28, 2015

Or, Who is Responsible for the Section 7434 Civil Penalty for False Information Returns

Sometimes my wife suggests that someone (any person) should do a specific chore, and I understand the subtext is that I am the person who should take that action.  However, when the Code says “any person” without qualifying the language, I assume Congress isn’t telling just me to mow the lawn, it really means “any person” may be subject to the rest of the Section.

Now, a really bad transition, I’m sure a lot of you hate your partners, whether domestic or professional (this has absolutely nothing to do with my wife, she is absolutely the best person in the world and I am not just writing that because she subscribes to the blog).  The PT readership is a civilized and refined bunch, so I’m certain none would seek retribution against those partners with underhanded tactics, but the rest of the world is nasty and brutish.  Sometimes those nasty and brutish folks attempt to use the Code to seek vengeance by issuing false or fraudulent information returns to their prior partners or others.  The Service does not appreciate such childishness, and imposes a penalty under Section 6721 for incorrect information returns, and those filed with intentional disregard for the rules.  This provides little solace to those who have received the false information return, and had to deal with sorting out the chaos.  In comes Section 7434(a), which states the person receiving the false information return has a right to civil suit for damages against the revenger.  Such suit can be brought against “any person…so filing” the fraudulent information return…but, perhaps not really any person.  Turns out, there is a disagreement between courts as to what “any person” means.  Perhaps, more accurately, there is a disagreement how that term applies to filing the information return; is it just the person (entity) required to file the return, or is it also the person assisting in the preparation or causing the return to be filed.

Angelopolous v. Keystone Ortho Specialists, a District Court case from the Northern District of Illinois, is a recent case dealing with this issue.  Normally, business partners trying to screw each other wouldn’t make it on our pages, but in Angelopolous alleged fake 1099s were issued and allowed the Court to discuss the differing interpretations of who will qualify under the statute as “any person…so filing”.

Some Facts

The specifics may help to flesh out the Section 7434 analysis, and allow us to get on our high horses and claim we would never act so poorly.  The plaintiff, Angelopoulos, was an anesthesiologist who worked for the defendant and related companies.  Keystone and other related entities were effectively controlled by a Dr. Hall.  Dr. Hall and those entities are the defendants.  Plaintiff (and some other doctors working for the practice) alleged that the defendants, specifically Hall, defrauded them by self-dealing and paying his own companies premium rates above FMV.  Plaintiff and other physicians left the employment of Hall’s entities once they suspected the fraud, and Plaintiff claimed that Hall subsequently changed the profit allocations causing a loss to Plaintiff and income to Hall.

Plaintiff also alleged that Hall fabricated debts owed by Plaintiff to the businesses so that Hall could offset the capital contributions owed back to Plaintiff and not repay those amounts to Plaintiff.  When Plaintiff would not agree that the businesses did not owe him anything for those capital contributions, Plaintiff alleged that Hall retaliated by filing false information returns to the IRS in an attempt to create a substantial tax liability for Plaintiff (and a corresponding deduction to one of Hall’s entities).  Specifically, Plaintiff claimed that Hall issued a 1099-Misc overstating earned income by around $110,000 for Plaintiff.  Apparently, the IRS and the Tax Court eventually agreed with Plaintiff, and adjusted his income to the levels indicated by Plaintiff.

Plaintiff then filed his claim for violation of Section 7434 for fraudulently filed information returns against the business and also Hall individually.  Defendants moved to have the count dismissed against Hall, claiming he was not the person filing the returns.  The Court did not agree, but others have succeeded in similar situations.

The Law

Section 7434(a) provides:

“[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.”

As mentioned above, the question before the court was who qualifies as “any person…so filing”.  There are no regulations under Section 7434, and little other IRS guidance.  The case law is fairly sparse, although this can be a very important and impactful Section.  Those cases that have considered this particular issue have come to different conclusions.

In 2013, the Eastern District of Michigan considered this in relation to a revocable trust filing information returns.  In Vandenheede v. Vecchio, the plaintiff Mary Vandenheede filed suit for filing false and fraudulent information returns against the trustees of the Donald J. Chinn Revocable Trust, who were Frank Vecchio and Frank Borschke, along with the trust’s accounting firm and law firm.  The Franks were his lawyer and accountant.  Vandenheede had started dating Mr. Chinn in 1992, and Chinn paid for Vandenheede’s expenses from his revocable trust.  By 2006, Mr. Chinn had unfortunately developed Alzheimer’s disease, and a guardian was appointed.  The revocable trust continued to pay expenses for Vandenheede.   Following the guardianship, the Franks became trustees, and 1099’d Vandenheede for income she earned in a trade or business (the services are not specified in the opinion…let’s go with companionship).  The Service assessed income, penalties and interest based on the information return, and Vandenheede claimed the distributions were instead reimbursements for her living expenses (a gift from Chinn to her).  Vandenheede sued for refund based on the above, and all taxes, penalties and interest were abated.  She then brought suit against the Franks to obtain damages for her costs based on Section 7434(b).  As a side note, if Vandenheede and Chinn were not married, the trustees were probably in a bad situation having made distributions from the trust to an impermissible beneficiary, which the incapacitated Chinn may not have been able to direct.  This “income” play may have been their effort to ensure they would not be held liable for improper distributions – this is all speculation on my part.

The Franks argued that the person “so filing” is the person required by statute to file the return, and not every person involved in preparing the return. Further, they argued the revocable trust was largely ignored for income tax purposes, and Donald Chinn placed all the taxable items on his personal return; therefore, Donald Chinn was the filing the related information returns.

The Court reviewed the statute, and then looked to regulation under Section 6721 because of the lack of guidance under Section 7434.  Regulation 301.6721-1(g)(6) deals with the IRS penalty for failing to file an information return and states the filer is the person “required to file an information return.” This does not extend to the preparer of the return, and possibly not the person directing the filing for an entity.

In Vandenheede, the court followed the argument of the Franks based on the above analysis, and found the “filer” or person who “filed the return” in this case was Donald Chinn, while the trustees (the Franks) prepared and caused the return to be filed.  Since they were not the filers, they could not be responsible for the civil damages under Section 7434.

I think this analysis is open to attack because I’m not sure the regulations under Section 6721 are persuasive on this point.  Section 6721 seeks to force those required to file information returns to file the required return in a timely fashion and correctly.  Section 7434  seeks to prevent the filing of false or fraudulent information returns, but does not clearly tie that to only the person required to file.  Some of my analysis here is borrowed from other cases to be discussed below.  I am uncertain why Congress would have wanted to restrict this to fraud by those required to file and not those without the filing requirement.  The Committee Reports state the reasoning as “[s]ome 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.”  The report does state that Congress is concerned about unwarranted or frivolous actions, but to solve the issue frivolous claims are subject to sanctions under Rule 11.

In addition, under Section 6721(a)(1), the term “by any person” is modified by also requiring a failure under (a)(2), which requires a failure to file an information return.  If you look to the information return provisions to find the required parties, it states something like “all persons engaged in a trade or business and making payment…of $600 or more…”.  That does not extend to the accountant preparing the return (although I think there is an argument to be made that it does apply to the trustee of a trust, even if revocable and ignored for return filing, if the grantor is incapacitated).  Conversely, Section 7434 states “[i]f any person willfully files a fraudulent information return…” and has no other qualifying language.  Clearly, Congress understands that someone other than the person required to file a return may file that return.  If you look to Section 6201(d), you will find provisions regarding the shifting of burden to the IRS if a taxpayer asserts a reasonable dispute with respect to any item of income “filed” by a third party.  The statute does not specify if that third party was required to file the return, and is looked to in third party fraud situations.  In addition, the intent of the statute is arguably more akin to provisions like 18 USC § 286, conspiracy to defraud the government (used to prosecute ID theft) or other related theft provisions, which applies to anyone filing a false claim or document.  I am assuming full research would show other statutes, regulations, and cases that could bolster this position.

Even though I do not agree, the Sixth Circuit sided with the District Court on other grounds, and specifically elected not to address the “filer” issue.  We covered the eventual affirmation by the Sixth Circuit in SumOp here.  Perhaps the Sixth Circuit forgoing the filer analysis is a sign that it did not fully agree with the lower court.  The Western District of Michigan (prior to the 6th circuit affirming) reviewed a similar issue also, and followed Vandenheede.  See Swartwout v. Edgewater Grill, LLC.

In Angelopolous, however, the Northern District of Illinois declined to follow the rationale in Vandenheede.  The Court instead decided to follow the implied position in Pitcher v. Waldman, a 2014 decision out of the Southern District of Ohio (interestingly also affirmed to the 6th Circuit, but again not focusing on the “filer” issue).  The Southern District did not have a significant discussion of the filing requirement, but imposed the civil liability against an accountant and the accounting firm he controlled for false information returns issued by the accounting firm to prior employees, indicated the Court believed the individual preparing and causing a return to be filed could also be liable and not just the entity with the filing requirement.

The Angelopolous Court also did not take that narrow view, and provided slightly more analysis on the matter. It stated the review should really start and end with the statute, as it viewed the term “any person…so filing” as being unambiguous, and applying to any person willfully filling the fraudulent return.  The Court stated the implied holding in Pitcher discussed above was proof that other courts agreed with this analysis.  The Court then noted it did not need to look further, but that the legislative history was consistent with its analysis.  Specifically, the Court found that the person required to file or an agent assisting in filing are both able to cause the some “significant personal loss and inconvenience” to the person receiving the information return.  If that were not the case, it would result in various illogical results.

For the reasons stated above, in Angelopolous, the Court found Hall was a proper defendant for preparing the 1099s and causing them to be filed.  The entities that actually filed the returns were also proper defendants (I will not state the entities that had the filing obligation were also proper defendants, because I doubt anyone is required to file a 1099 for a potentially fabricated amount).

Overall, as stated above, I agree with the Angelopolous court, and do not think the intention of the statute would be to only punish the fraud of those required to file information returns.  It should equally apply to those who file the return without the requirement (until I have to defend one of these cases, and then my tune will change as soon as the retainer clears).  There exist protections against frivolous suits of this nature, and a broad application better advances the purpose of the statute.  I also think the key to protecting those assisting with the filing and those causing the filing is the language under Section 7434 imposing damages on the person who “willfully files a fraudulent information return”.  An unwary accountant, or a clueless company president will likely not be deemed to willfully file a fraudulent return.

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