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Worker Not Entitled to Damages Under Tax Code for Alleged Employment Misclassification

(Parker Tax Publishing July 2016)

A district court held that a taxpayer was not entitled to damages under Code Sec. 7434 as a result of an employer allegedly misclassifying him as an independent contractor rather than as an employee. However, the court noted that the taxpayer can seek redress under the Fair Labor Standards Act. Liverett v. Torres Advanced Enterprise Solutions LLC, 2016 PTC 239 (E. D. Va. 2016).

Grant Liverett worked for Torres Advanced Enterprise Solutions LLC (Torres LLC), a government contractor, to provide bid procurement and contract management services. Liverett filed suit in district court alleging that Torres LLC engaged in a scheme to misclassify its employees as independent contractors in order to avoid paying the minimum and overtime wages to which these employees were due under the Fair Labor Standards Act (FLSA). As part of his suit, Liverett said the company was liable for tax fraud because it willfully misrepresented the status of its employees by issuing them Form 1099s instead of Form W-2s. There was no allegation that the amounts reported on the Forms 1099 were incorrect. As a result of the alleged misclassification, Liverett sought damages under Code Sec. 7434(a).

Code Sec. 7434(a) provides that 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 filing such return.

The district court noted that while the provision in Code Sec. 7434(a) appears straightforward, upon a more careful reading it contains significant ambiguity. The source of the ambiguity, the court said, was the phrase "with respect to payments purported to be made to any other person." The ambiguity arises in determining what the phrase "with respect to..." modifies. On the one hand, Code Sec. 7434(a) could refer to an "information return with respect to payments purported to be made to any other person" that is "fraudulent." On this reading, the court said, "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, the court noted, the ambiguous phrase could 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. Thus, the court observed, a Form 1099 that identifies Liverett as an independent contractor when he is in fact an employee is an information return that is false with respect to Liverett's employment status. But, if the Form 1099 accurately reports the amount of wages paid to Liverett, the return is not fraudulent with respect to the amount of the payments made. The district court noted that no appellate court has addressed the ambiguity in Code Sec. 7434(a).

After examining the legislative history of Code Sec. 7434, the district court concluded that "with respect to..." modifies "fraudulent" rather than "information return." The sensible solution to avoid redundancy, the court said, is to read the "with respect to..." language as describing the nature of the fraud, namely fraud as to the amount paid. Thus, the court held that Code Sec. 7434(a) creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid.

Congress's rationale for enacting Code Sec. 7434, the court noted, was that some taxpayers could 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. Congress designed Code Sec. 7434 to afford a damages remedy for victims of that problem. It is entirely consistent with this legislative purpose, the court opined, to read Code Sec. 7434(a) as creating a private cause of action only for the filing of information returns that are fraudulent with respect to the amount paid to another. The fraudulent scheme alleged by Liverett, the court said, fell beyond the scope of the policy problem that Code Sec. 7434 was designed to address.

However, the court continued, Liverett is not without options because Congress intended for claims arising from misclassification of employees as independent contractors to find statutory redress under FLSA. Citing 29 U.S.C. Sec. 216(b), the court said that, to the extent Torres LLC's allegedly willful misclassification harmed Liverett, the FLSA will ensure that Liverett is made whole and that Torres LLC is deterred from future willful misclassifications by the imposition of liquidated damages.

For a discussion of civil damages for fraudulent filing of information returns, see Parker Tax ¶262,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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