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Business Tax

Both employer and its officer can be liable for fraudulent information return damages

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

Czerw v. Lafayette Storage & Moving Corp, (DC NY 11/09/2018) 122 AFTR 2d ¶ 2018-5416

A district court has ruled on several aspects of Code Sec. 7434‘s damages for fraudulent filing of information returns, including that both the entity required to file the return and its officer or other agent can be liable for the damages.

Background. Under Code Sec. 7434(a), if any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, the purported payee may bring a civil action for damages against the person so filing such return.

Facts. Lafayette was a moving company. Mr. Ferrentino was the company’s president and exercised operational control over the company’s day to day functions.

Mr. Czerw began his employment at Lafayette in’ 93, working as a mover. Lafayette and Ferrentino (Defendants) structured his work in a manner consistent with that of an employee.

In May 2014, Defendants started paying Czerw irregularly, and the paychecks that Defendants issued often bounced. Then, beginning in September 2014, Defendants printed out employee paychecks but would not issue them to employees. Czerw alleged that Defendants “did not make, keep and maintain payroll records accurately reporting the wages paid to him.” Despite these problems, Czerw continued to work for Defendants until March 2015, when “it became clear that [Defendants] were not going to pay [him].” In 2015, Czerw only received $4,000 in wages from Defendants. These wages came in the form of two $2,000 checks that Ferrentino mailed to Czerw.

In January 2016, Defendants issued a 2015 Form 1099-MISC to Czerw, which reported “$5,500.00 in non-employee compensation.”  The payer was listed as “Lafayette Storage Moving.” Ferrentino was the person who caused the form to be filed on Lafayette’s behalf.

In all previous years during Czerw’s employment, Defendants had reported Czerw’s income with a W-2 tax form. Czerw repeatedly requested that Defendants properly classify him as an employee, but Ferrentino refused to correct the tax forms.

Czerw sued Defendants for damages under Code Sec. 7434, alleging that Defendants willfully and fraudulently filed the false Form 1099-MISC as part of a scheme “to defraud state and federal taxing authorities… by lessening Lafayette’s tax obligations and the amount of its worker’s compensation insurance premiums.”

Defendants were liable for Section 7434 damages. The court concluded that Defendants were jointly and severally liable to Czerw for damages under Code Sec. 7434. In arriving at its conclusion, the court noted:

A cause of action under section 7434 has three elements. The court held that a cause of action under Code Sec. 7434 has the following three elements: (1) the defendant issued an information return; (2) the information return was fraudulent; and (3) the defendant willfully issued the fraudulent information return.

Both the entity and its agent can be liable. The court concluded that both the entity required to file the return and its agent, e.g., an officer of the entity, can be liable for the penalty.

The court noted that several courts have come to the opposite conclusion, namely that only the party identified as the payer on the form can be liable. These cases find support in some of the statutory language, which provides that a civil action may be brought “against the person so filing such return.” (Code Sec. 7434(a)) Thus, those cases argue that the Code provides a cause of action only against the person who files the allegedly fraudulent return. See, for example, Vandenheede v. Vecchio, (CA 6 2013) 112 AFTR 2d 2013-6309.

The court here noted that other courts have rejected that narrow reading, concluding that a person who causes a fraudulent return to be filed, whether on his own behalf or on behalf of another, may be liable under Code Sec. 7434. These courts focus on other language in the statute: “any person [who] willfully files a fraudulent information return” may be held liable. Those courts reason that this interpretation is consistent with the legislative history, which indicates that Code Sec. 7434 is intended to address the loss and inconvenience caused by “persons intent on either defrauding IRS or harassing taxpayers.”  Furthermore, these courts note that a more limited construction would exempt from liability otherwise culpable agents, contrary to common-law principles of corporate officer liability and legislative intent. See, for example, Angelopoulos v. Keystone Orthopedic Specialists, (DC IL 2015) 115 AFTR 2d 2015-1867.

The court here said that, in light of the statute’s plain language and the anomalous results of a contrary interpretation, it was persuaded by those courts that have interpreted Code Sec. 7434 to impose liability on any person who willfully causes a fraudulent information return to be filed.

The court concluded that the first of the three elements was satisfied as to both Lafayette and Ferrentino, noting that Ferrentino caused the Form 1099 to be issued and filed with IRS on Lafayette’s behalf.

The second and third elements were also satisfied. The court also concluded that the second and third elements for a cause of action under Code Sec. 7434 were satisfied.

As to the second element, the court noted that Lafayette, through Ferrentino, mailed Czerw two checks totaling $4000 and Defendants thereafter filed a form 1099 which stated that Lafayette made payments to Czerw totaling $5500.

As to the “willfully” element, the court said that Czerw had to show that Defendants, aware of the duty purportedly imposed by Code Sec. 7434, specifically intended to flout the statute.

The court noted that while the evidence in this case was limited, the plausibility of Czerw’s claim of willful fraud was bolstered by the fact that Defendants misclassified Czerw for the 2015 tax year – despite treating him as an employee for the entirety of his employment – as well as by the facts suggesting that Defendants were facing business woes starting in May 2014.

References: For civil damages for fraudulently filing an information return, see FTC 2d/FIN ¶S-4470United States Tax Reporter ¶74,344.

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