Employer's Inclusion of Reimbursed Expenses on Form 1099 Was Not Fraudulent.

(Parker Tax Publishing December 2021)

A district court granted summary judgment to an employer with respect to a claim against the employer that it violated Code Sec. 7434 by misclassifying a worker as an independent contractor and by including reimbursed business expenses in the Form 1099 issued to that independent contractor. The court concluded that the misclassification of an employee does not constitute a violation of Code Sec. 7434 and the inclusion of reimbursed expenses on Forms 1099 was not fraudulent. Austin v. Metro Development Group, LLC, 2021 PTC 377 (M.D. Fla. 2021).

Background

Jen Austin performed marketing work for Metro Development Group, LLC (Metro), and entities supported by Metro between June 2014 and April 2020. According to Austin, she was originally hired by Metro as an employee but after she started work there, Metro's CEO, John Ryan, told her that if she wanted to continue working there, she needed to be an independent contractor and form her own limited liability company (LLC). As a result, Austin created Austin Marketing, LLC (Austin Marketing) solely for the purpose of working for and collecting compensation from Metro. Austin claimed she was fired in April of 2020 during a private meeting with Ryan although Ryan denied this. According to Austin, her final paycheck was delayed and Metro still owed her a bonus of $6,668, expenses of $2,796, and accrued unused vacation pay.

Austin and Austin Marketing subsequently filed suit in a Florida district court alleging, among other things, that Metro violated Code Sec. 7434 when it willfully misclassified it as an independent contractor rather than an employee and issued Forms 1099, Miscellaneous Income, with incorrect amounts for some of 2017, and all of 2018 and 2019. As a result of the misclassification of her employment status, Austin claimed that she was damaged (1) when she did not receive certain benefits (including health insurance and a 401k) that Metro employees received, and (2) when Metro failed to deduct all applicable employment taxes from her earnings and failed to make payments towards her FICA tax liability. Austin and Austin Marketing also claimed that the information returns Metro filed were fraudulent because they inflated Austin Marketing's income by including reimbursed expenses.

Metro countered that an individual claim previously filed by Austin, which stated that Metro improperly filed Forms 1099, had been dismissed by the court and that Austin Marketing could not state a claim based on misclassification because the statute limits relief to information returns that include fraudulent information about the payments made to the recipient and Austin, not Austin Marketing, was the recipient of the payments. Metro also argued that there was nothing legally improper about including business expense reimbursements as part of "gross income" on the Form 1099. Metro pointed to Code Sec. 61 and Reg. Sec. 1.6041-1(f)(1) for support for the fact that nothing prohibited the inclusion of reimbursed expenses on Forms 1099. Austin argued that Metro discontinued this practice after Austin and Austin Marketing filed its lawsuit as evidence that Metro knew it should not have included such expenses on the Form 1099.

To prove a claim under Code Sec. 7434, Austin and Austin Marketing were required to establish (1) that Metro issued information returns; (2) the information returns were fraudulent; and (3) Metro willfully issued the returns. Metro moved for summary judgment on the basis that misclassification does not give rise to a claim under Code Sec. 7434, that it was not fraudulent or inaccurate to include reimbursements in the Forms 1099 to Austin Marketing, and that Austin Marketing failed to put forward sufficient evidence of willfulness.

Analysis

The district court granted Metro summary judgment after concluding that, as a matter of law, the misclassification of an employee does not constitute a violation of Code Sec. 7434. Further, the court said, Metro's inclusion of reimbursed expenses on the Forms 1099 was not a fraudulent act. According to the court, even if the inclusion of reimbursed expenses is not permitted as a matter of law, Austin and Austin Marketing failed to put forward sufficient facts that would allow a reasonable jury to find by clear and convincing evidence that Metro acted willfully in including those reimbursed expenses in Austin Marketing's income.

The district court also held that gross income that is reported on Forms 1099 may include expenses, even if those expenses are later deducted. The court found the language of Reg. Sec. 1.6041-1(f)(1) to be ambivalent on this issue, because it does not say exactly when such expenses should or should not be included in a Form 1099. The court found that Austin and Austin Marketing's evidence that there was fraud in this situation to be so scant that no reasonable jury could find by clear and convincing evidence in its favor. With respect to Metro's discontinuance of the practice of including reimbursed expenses in a recipient's Form 1099, the court said Metro's change in practices could have happened for a number of reasons such as (1) Metro knew it was violating the law by including such amounts in a recipients Form 1099 and ceased the practice because it was under legal attack; (2) Metro thought that, although permitted, the law did not require including the expenses and it was preferable to avoid additional exposure to litigation; or (3) Metro thought they could include reimbursed expenses before but learned later that the law did not permit it and thus stopped violating the law in good faith.

With respect to reimbursed expenses being included in the income amounts on the Form 1099 issued to Austin Marketing, the court stated that, whether the law permits inclusion of reimbursed expenses as gross income on Forms 1099 so as to make the Forms 1099 fraudulent is a question of law. Because the Forms 1099 issued to Austin Marketing must include all gains, profits, and income it received from Metro, the court said this raised the question of whether reimbursed expenses may be considered "income" for this purpose.

In the absence of Austin Marketing providing any legal analysis to support its position, the court concluded that nothing clearly prohibited nor required Metro to include reimbursed expenses in gross income on Form 1099 and thus it cannot be considered materially misleading or fraudulent to include such amounts. The court thus agreed with Metro that Austin Marketing failed to establish that the inclusion of reimbursed expenses for the tax years at issue made them materially misleading as a matter of law.

For a discussion of when an individual is considered an independent contractor versus an employee, see Parker Tax ¶210,110. For a discussion of information reporting penalties and civil damages for fraudulent filing of information returns, see ¶262,130.

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