On March 5, 2019, the U.S. District Court for the District of Maryland determined that an employee was potentially entitled to relief under section 7434(a) of the Internal Revenue Code when an employer purposefully reports a portion of their wages on Form 1099-MISC as income from self-employment rather than on the Form W-2.  In Greenwald v. Regency Mgmt. Svcs., LLC, a memorandum opinion, the court allowed the case to proceed to discovery based on the plaintiffs allegations.

The plaintiffs in the case are former employees who were employed as commissioned sales associates.  The plaintiffs did not allege that any hourly wages were reported or withheld upon improperly during the course of their employment, but instead alleged that the defendants failed to withhold on and reported post-termination commission payments on Forms 1099-MISC rather than Forms W-2, forcing the plaintiffs to pay SECA tax.  The plaintiffs alleged that willfully reporting the post-termination commission payments on Form 1099-MISC entitled them to damages under section 7434(a), as well as other claims under state law.

Citing case law in other U.S. District Court cases, the defendants argued that section 7434 provides no remedy for a person who is incorrectly classified as an independent contractor or unless the employer willfully  misstates the payee’s income. Although the court acknowledged the decisions of other courts, it rejected the defendant’s argument.  The court distinguished the other cases because the plaintiffs alleged that the defendants willfully underreported the amount of the plaintiffs’ wages by reporting post-termination commissions payments on Forms 1099 instead of Forms W-2 to avoid paying employment taxes.  The plaintiffs also alleged the defendants “willfully underreported the amounts on their W-2s, 1099s, or both in an effort to defraud tax authorities by reducing their tax obligations.”

 The court’s finding provides that, while no violation of section 7434 may be found where an employer has merely issued a Form 1099 instead of a Form W-2 in paying the total amount of an employee’s compensation, the correct reporting of wages on Form W-2 and erroneous reporting of wages on a Form 1099 to the same employee will give rise to a violation of section 7434.  The court’s finding, despite relying on the holdings of a number of other district courts, appears formalistic.  Although the court drew much from the allegations of the employer’s nefarious intent for purposes of analyzing the motion to dismiss, distinguishing between cases holding that worker misclassification is outside of the purview of section 7434(a) and the case before the court in which the employer misclassified the worker with respect to only a portion of the worker’s wages seems like an inconsequential distinction.

Although pursuing a remedy under section 7434 was more economically more appealing to the plaintiffs (damages under the statute are equal to the greater of $5,000 or the sum of actual damages, the costs of the action, and reasonable attorney fees), it is noteworthy that the plaintiffs had administrative alternatives to dispute the employer’s reporting by filing Form 4852 or Form 8919 with their federal individual income tax returns to identify the employer’s reporting failures to the IRS and seek the correct tax treatment.  These approaches would have extinguished their obligation to pay SECA tax on the amounts reported by the employer on a Form 1099-MISC.  Alternatively, the plaintiffs could possibly have filed a Form SS-8 to request that the IRS determine their status as employees if they believed the employer had improperly classified them as independent contractors.