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imposing the $5,000 statutory penalty for each violation of Section 7434
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Case No. 1:11-cv-148-HJW
03-28-2014
KENNETH B. PITCHER, and MICHAEL ENDERS, Plaintiffs, v. LAWRENCE WALDMAN, and WALDMAN & COMPANY CPA's, P.S.C. Defendants
ORDER
This Court held a bench trial on July 16-17, 2013, at which the individual parties and several opinion ("expert") witnesses testified. The plaintiffs and defendants have respectively filed "Proposed Findings of Fact and Conclusions of Law" (doc. nos. 129, 130), as well as highlighted versions indicating any disputed facts and law (doc. nos. 134, 135). They have also filed "Supplemental Proposed Findings" and "Second Supplemental Proposed Findings" (doc. nos. 144, 145, 168-1). At the close of trial, the parties requested, and were granted, permission to submit additional closing briefs. The Court has carefully considered all of the trial testimony, the oral arguments of counsel, and the extensive written record, including the trial exhibits (doc. nos. 177-180) and the additional closing briefs (doc. nos. 184-186). Based on applicable authority and the evidence and testimony presented, the Court finds as follows:
I. Background
This case arises from the acrimonious break-up of the successful accounting firm Waldman, Pitcher, and Co., P.S.C. The individual parties in the present case were formerly partners in that firm. The break-up has spawned numerous related lawsuits, various audits by the Internal Revenue Service ("IRS"), numerous complaints of improper conduct to various professional oversight groups, and protracted contentious litigation of the present case. The facts have been exhaustively set forth by the parties in their briefs, in their competing versions of the proposed findings, in their "Supplemental Joint Final Pretrial Order" (doc. no. 141, stipulated facts), and at trial. The relevant facts will be summarized here as succinctly as possible.
The Court takes judicial notice of related litigation, which is relevant for purposes of context and to shed light on the parties' intent and state of mind.
Defendant Lawrence Waldman became a CPA in 1972, worked for a large firm for four years, and then founded his own firm "Waldman & Company, CPAs." He hired Kenneth Pitcher and Michael Enders ("plaintiffs") as associate accountants, respectively in 1985 and 1987. In time, both plaintiffs acquired ownership interests in the firm, which changed its name to "Waldman, Pitcher & Company, P.S.C." In 2005, Waldman, Pitcher and Enders signed employment contracts with the firm. Those contracts included a formula for annual compensation, a schedule for deferred compensation upon termination of employment, and a "non-compete" clause that would preclude them from performing any accounting work for the firm's clients for three years after termination of employment. As of 2009, Pitcher had 25 shares in the firm, and Enders had 15 shares in the firm, out of a total of 97 shares (Plaintiff Ex. 21, W000791, 821). Together, Pitcher and Enders had a 41% stake in the firm.
Pitcher and Enders sought to leave the firm in 2009. Waldman, who had been having health issues and who had returned to work in September, did not agree to their proposed terms. Pitcher and Enders sued for dissolution in state court. See Pitcher, et al v. Waldman, et al, Case No. 09-CI-1491 (Campbell Cty. Circuit Ct.). Through counsel, the parties negotiated a settlement, and on October 22, 2009, entered into the "2009 Settlement and Stock Redemption Agreement" (Jt. Ex. I, "2009 Agreement"). They terminated the 2005 employment contracts, divided the client lists, and formed separate accounting firms. The parties agreed that Pitcher and Enders would relinquish their stock in the original firm and that certain account receivables ("AR") and work in progress ("WIP") would be assigned to their new firm "KPE Services, Inc. ("KPE"). The amount of AR to be assigned to KPE was $111,535 for Pitcher's clients and $13,260 for Enders' clients (for a total of $124,795). Defendants paid $27,755.00 to KPE for amounts received from Pitcher and Enders' clients during October 6-21, 2009, and paid $60,000.00 to plaintiffs' attorneys at Greenebaum (Plaintiff Ex. 21, W000792, 800, copies of checks). The 2009 Agreement specified that Waldman & Co. would pay Pitcher "a purchase price in the amount of $833.00" for his shares and pay Enders "the amount of $500.00" for his shares.
Waldman, Pitcher & Company became "Waldman & Company, CPAs, PSC," and Pitcher and Enders formed a new firm known as "KPE Services, Inc., which later became "Pitcher, Enders & Drohan, CPAs, Inc." (doc. no. 141 at 7, ¶¶ d, e).
In their state complaint, Pitcher and Enders had alleged that Waldman was "engaged in fraudulent, unethical, and illegal billing practices" and had been "overbilling" clients (Plaintiff Ex. 21, W000773 at ¶¶ 7-9). Waldman insists that this was untrue and was merely a ploy by the plaintiffs to obtain rescission of their 2005 employment contracts. In any event, the 2009 Agreement included a "non-disparagement" clause. Unfortunately, this settlement did not conclude matters between the parties, and the non-disparagement clause later became the subject of litigation between the parties. According to Waldman, Pitcher subsequently told a client (Gerald Robinson) that Waldman had been overbilling him. Waldman testified he was "pretty angry" and "intended to fight" because "no one pushes me around" (doc. no. 182 at 13, 18, Trial Transcript). Waldman told Robinson on December 30, 2009, that he was "going to war" (Plaintiff's Ex. 35, transcript of audio recording played at trial).
In January 2010, Waldman & Co. issued 1099-MISC forms to Pitcher and Enders personally for tax year 2009, for non-employee compensation in the amount of $111,535.00 for Pitcher and $13,260.00 for Enders (Plaintiff Ex. 2-3). It is undisputed that Waldman and his company had not collected any of the AR/WIP money reflected on those 1099 forms (doc. no. 134, ¶¶ 18-19). Waldman was admittedly angry at Pitcher and Enders and has repeatedly characterized their departure as effectively "stealing" two million dollars from him. As a prominent and experienced CPA, Waldman was familiar with the matching program of the IRS and knew that issuing these 1099s to Pitcher and Enders personally would likely result in IRS audits of their personal income tax returns. Waldman & Co. benefitted by taking a corresponding tax deduction for the reported amounts. Plaintiffs did not declare any of the AR, WIP, or the $60,000.00 payment to Greenebaum as income on their personal 2009 tax returns (doc. no. 141 at 8, ¶ o).
Waldman was selected as a "Top 100 CPA" by Money magazine (doc. no. 182 at 25).
In February and March of 2010, Pitcher and Enders complained to the IRS's Office of Professional Responsibility ("OPR") that Waldman had issued 1099s containing information that Waldman knew to be inaccurate (Def. Ex. B-C). They asserted that Waldman had done this "to exact a revenge that he couldn't otherwise exact during our negotiations" (doc. no. 135, ¶ 28). They filed similar complaints with the Accountancy Board of Ohio and Ohio Society of CPAs (Def. Exs. F-H, J, L). Those groups declined to take disciplinary action against Waldman.
Waldman countered by suing Pitcher and Enders in May 2010, alleging that they had "defamed" him by filing the complaints with those groups. See Waldman, et al, v. Pitcher, et al, Case No: A1004877 (Ct. of Comm. Pleas for Hamilton Cty., Ohio). He also alleged that Pitcher and Enders had violated the 2009 Agreement in various ways. He contended that the plaintiffs had improperly withheld certain contractual payments (i.e. "Robinson payments") in order to offset costs the plaintiffs had incurred in connection with "due date monitoring" software (Plf. Ex. 21 at W000384). Plaintiffs counter-claimed, asserting that although Waldman had expressly agreed in Section 3.12 of the 2009 Agreement to make the software available to them, Waldman had refused to do so (W000403). The parties entered into a protective order prohibiting them from disclosing information designated "confidential" to third parties.
In addition to the "defamation" suit, Waldman (individually and as Trustee) and his firm also filed suit against Pitcher as Co-Trustee, seeking to recover "excessive administrative costs" of $810.52, plus attorney's fees, for Pitcher's administration of the firm's 2002 Plan and Trust Agreement. See Waldman, et al, v. Pitcher, et al, Case No: 10-cv-7526 (Hamilton Cty. Mun.Ct.), removed to federal court on the basis of ERISA jurisdiction, as OHSD Case No. 1:10-cv-238 (J. DLott).
Waldman complained that although he had demanded that Pitcher resign as trustee in November 2009, Pitcher had not resigned until February 24, 2010. Waldman later moved to voluntarily dismiss, indicating he had developed cancer which caused him to "reevaluate his resources and priorities." The Magistrate Judge recommended granting dismissal. Pitcher objected, contending that Waldman should pay Pitcher's attorneys fees of over $30,000 as a condition of dismissal. The Court overruled the objections and dismissed the case without prejudice on September 15, 2011.
On July 22, 2010, Waldman asked the IRS for an informational letter determining that his tax characterization of the 2009 transactions was correct (Plaintiff Ex. 21 at W000529). On August 23, 2010, he requested a "Determination Letter" as to whether the amounts paid to plaintiffs in the 2009 transactions were reportable on Form 1099-MISC or W-2. Waldman also asked the IRS to pursue action against the plaintiffs for allegedly engaging in a "tax avoidance scheme." The IRS denied Waldman's requests in November and December of 2010. The IRS informed Waldman that "issuance of a Determination Letter or an Information Letter is not an appropriate response to your request" (W000434), that his request was "being declined on the basis that it deals with issues which should have been submitted as a request for a Private Letter Ruling" (W000441, 448), and that "the fact that the return for the period in question has already been filed precludes this possibility" (W000434). Waldman acknowledges the IRS informed him that he was seeking a letter on "a closed transaction" and that the IRS would only provide such letters for "proposed transactions" (doc. no. 182 at 41). The IRS declined to give an opinion on how Waldman & Co. should have reported the sums and advised that the issue now is "how the former employees should treat the compensation [on] their returns" (W000448).
Waldman then hired a tax attorney, Howard Richshafer, to review the 2009 transactions and offer an opinion on the manner in which Waldman & Co. had reported them to the IRS (doc. no. 182 at 44, advising that "I am planning to use your letter to justify part of my claim"). The record reflects that Waldman indicated to Richshafer that he did not need to consider the fair market value of the firm. Waldman's letter to Richshafer described "[w]hat I need from you to confirm my case" (Id. at 47). Based on the incomplete information and assumptions urged by Waldman, Richshafer indicated in a "limited" opinion that certain "income" should have been reported on W-2 forms to the plaintiffs.
In February 2011, Waldman & Co. issued "corrected" 2009 1099s to the plaintiffs, reflecting "zero" for their nonemployee compensation. At the same time, he issued "corrected" W-2s to Pitcher and Enders reflecting increased amounts in Box 1 (Jt. Exs. II-III). For Pitcher, an additional $199,290.00 of reported income was included, reflecting the $111,535.00 for the accounts receivable assigned to KPE, $27,755 for the amount paid to KPE by Waldman & Co., and $60,000.00 for attorney fees paid by Waldman & Co. to plaintiffs' attorneys at Greenebaum. For Enders, an additional $13,260.00 was included, consisting of $13,260.00 for the accounts receivable assigned to KPE. Waldman & Co. took a tax deduction for the increased amounts listed on the corrected W-2s, even though such returns indicated that no federal income taxes had been withheld. In a February 12, 2011 letter, Waldman sent plaintiffs copies of the Corrected 2009 1099s and W-2s and demanded payment for alleged back-taxes, interest, and penalties, amounting to approximately $9,000.00, citing the indemnity clause of the 2009 Agreement.
On February 17, 2011, Waldman filed a whistleblower complaint against Pitcher and Enders, asking the IRS to investigate matters including: 1) whether the treatment of AR and WIP and the assignment of "income" in the 2009 transactions was appropriate, 2) whether Pitcher and Enders had possible I.R.C § 409A tax liability, 3) whether Pitcher and Enders had engaged in gross negligence with regard to the 2009 transactions, and 4) whether Pitcher and Enders had violated Treasury Dept. Circular 230 or were subject to penalties, censure, and disbarment. Waldman asserts that this IRS whistleblower complaint was based in part on the "covered letter" tax opinion he had obtained from Richshafer. Such letter indicates on its face that it was only a "limited scope" tax opinion (doc. no. 182 at 7, 62-63).
On March 9, 2011, Pitcher and Enders filed the present action, Pitcher et al v. Waldman, et al, OHSD Case No. 1:11-cv-148, asserting that defendant Waldman and his firm had willfully filed fraudulent information returns to the plaintiffs in violation of 26 U.S.C. § 7434, resulting in adverse tax consequences and IRS audits of both plaintiffs.
On April 4, 2011, Waldman obtained a civil protection order against Pitcher for an allegedly threatening comment made at a deposition concluded two months earlier in conjunction with the then-ongoing state court litigation (doc. no. 182 at 74-77; Plf. Ex. 39). Waldman also filed a criminal complaint against the plaintiffs with the Treasury Department in the summer of 2011 (doc. no. 182 at 78). Pitcher and Enders were not prosecuted.
At trial, Waldman testified that Pitcher had said "I'm going to thump you" (doc. no. 182 at 76-77). The record reflects that when Waldman sought the civil protective order, the only example of a purportedly threatening comment was that Pitcher had allegedly said at deposition "I'm going to bust him."
On January 31, 2012 (after three days of trial in state court), the parties settled their Hamilton County lawsuit (doc. no. 141 at 4, 9, ¶ aa; Plf. Ex. 11). This "2012 Agreement" provided that all future communications between the parties must be through their legal counsel and that Waldman would cause his insurer, Farmers Insurance Company ("Farmers") to pay $75,000.00 to plaintiffs' attorneys (Dinsmore & Shohl).
On February 28, 2012, Pitcher (individually and as Co-Trustee of "The Waldman, Pitcher and Co., CPA's Profit Sharing Trust") filed suit against Waldman (as Trustee) and the Trust, after Waldman refused to indemnify him for fees and costs (which had allegedly risen to over $45,000) incurred in successfully defending Waldman's "$810 Trust Litigation." See Pitcher v. Waldman, et al, Case No: A1201601 (Ct. of Comm. Pleas for Hamilton Cty., Ohio), removed to federal court as OHSD Case No. 1:12-cv-215.
In that case, the Court noted the "extreme" and "well-documented" level of personal animosity between the parties and pointed out that "the amount of attorney's fees expended by both parties in this case and the multitude of related cases quite obviously exceeds any type of benefit that could be achieved by either party, had either employed a cost-benefit analysis" (OHSD Case No. 1:12-cv-215, doc. no. 44 at 4, fn. 4).
After Pitcher and Enders learned that Waldman had voluntarily disclosed information designated as confidential to the IRS, they filed another suit against Waldman on October 5, 2012, alleging that Waldman had violated the non-disparagement clause of the 2009 Agreement and the confidentiality provisions of a Protective Order issued on August 20, 2010. See Pitcher, et al. v. Waldman, Case No: A1207858 (Ct. of Comm. Pleas for Hamilton Cty., Ohio).
Several related lawsuits were also filed by insurance companies drawn into the fray over the duty to defend the parties under commercial liability policies. See Acuity Mutual Insurance. Co. v. Waldman, et al, OHSD Case No. 1:11-cv-913 (J. Beckwith); Assurance Co. of Am. v. Waldman, et al, OHSD Case No. 1:13-cv-179 (J. Beckwith) (case settled and dismissed with prejudice).
During 2012, the IRS conducted audits of the 2009 personal tax returns of both Pitcher and Enders. On November 9, 2012, the IRS determined that, contrary to the information returns issued by Waldman & Co., the amounts reported on the 2009 1099s and corrected W-2s did not constitute "non-employee compensation" or "wages" (Def. Ex. N, IRS Audit Findings; see also, doc. no. 135, ¶ 50). The IRS characterized the amounts of AR and WIP assigned to KPE as "a stock distribution, reportable as capital gain income" to Pitcher and Enders. They paid the capital gains tax to the IRS (Def. Ex. N, copies of checks).
In January 2013, Waldman issued 1099s for tax year 2012 to each plaintiff, reflecting non-employee compensation in the amount of $37,500.00 for each plaintiff (doc. 141 at 9, ¶ z). He sent them directly to plaintiffs and attached Post-It notes on which he wrote "tax cheat thief" to Pitcher and "you are going to hell" to Enders. Based on Farmer's payment of $75,000 to plaintiffs' attorneys at Dinsmore, Waldman attributed $37,500.00 to each plaintiff. After receiving these 2012 1099s, Pitcher and Enders asked defendants for an explanation of the basis for the 1099s, but defendants refused to explain. Plaintiffs then amended their complaint in the present case and asserted two additional violations of IRC § 7434 based on the 2012 1099s for $37,500 issued to each plaintiff.
After contentious discovery, this case proceeded to trial in July of 2013. The individual parties all testified and spent considerable time disputing the proper characterization of the funds reported by defendants in the information returns. Both sides presented opinion witness testimony. Lynn Nichols, CPA, and Richard Ferguson, testified for the plaintiffs; tax attorney Howard Richshafer testified for the defense. Ferguson gave opinion testimony regarding economic valuation of the firm's shares.
II. Issues Presented
The Court must determine whether Waldman and his company violated 26 U.S.C. § 7434 ("I.R.C. § 7434") by willfully filing fraudulent information returns with respect to payments purported to be made to the plaintiffs. Specifically, the Court must determine whether the defendants are liable for separate violations of § 7434 based on their issuance of the 2009 1099s, corrected W-2s, and 2012 1099s. The parties primarily argue about whether the defendants had a duty to issue those information returns, whether the defendants were actually the "payor" of the amounts on the returns, and the various ways in which the returns were false.
III. Relevant Law
I.R.C. § 7434 is entitled "Civil damages for fraudulent filing of information returns" and was enacted in 1996 as part of the "Taxpayer Bill of Rights 2," Pub.L. No. 104-168, 110 Stat. 1452. The Report of the House Committee on Ways and Means states that § 7434 was enacted to address the fact that "[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." H.R. Rep. 104-506, at 37, reprinted in 1996 U.S.C.C.A.N. 1143, at 1158 (Mar. 28, 1996). The Committee also cautioned that it did not intend "to open the door to unwarranted or frivolous actions or abusive litigation practices." Id.
Section § 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 so filing such return." The parties agree that to establish a claim of tax fraud under 26 U.S.C. § 7434, plaintiffs must prove: (1) that the defendants issued "information returns"; (2) that the information returns were fraudulent; and (3) that defendants willfully issued fraudulent returns (see doc. no. 141 at 15, "Agreed Applicable Propositions of Law"); see also, Richardson v. C.I.R., 509 F.3d 736 (6th Cir. 2007); Cavoto v. Hayes, 2010 WL 2679973 (N.D. Ill.) (citing Granado v. C.I.R., 792 F.2d 91 (7th Cir. 1986)). The parties also agree that plaintiffs must prove each of these elements by clear and convincing evidence (doc. no. 141 at 16); see also, Cavoto, 2010 WL 2679973; Smith v. C.I.R., 926 F.2d 1470, 1475 (6th Cir. 1991) (fraud must be proven with clear and convincing evidence); Rogers v. C.I.R., 111 F.2d 987, 989 (6th Cir. 1940) ("Fraud cannot be lightly inferred, but must be established by clear and convincing proof"). Fraud may be proven by circumstantial evidence. Traficant v. C.I.R., 884 F.2d 258 (6th Cir. 1989) (citing Biggs v. C.I.R., 440 F.2d 1, 5 (6th Cir. 1971)).
With respect to the tax code, "willfulness" is generally defined as the voluntary, intentional violation of a known legal duty. Cheek v. U.S., 498 U.S. 192, 201 (1991); U.S. v. Pomponio, 429 U.S. 10, 12 (1976). "[W]here willfulness is a statutory condition of civil liability, we have generally taken it to cover not only knowing violations of a standard, but reckless ones as well." Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 57 (2004) (observing that "[t]his construction reflects common law usage, which treated actions in 'reckless disregard' of the law as 'willful' violations") (citing W. Keeton, D. Dobbs, R. Keeton, & D. Owen, Prosser and Keeton on Law of Torts § 34, p. 212 (5th ed.1984)).
IV. Discussion
A. Whether the Defendants Willfully Filed Fraudulent 2009 1099s and Corrected 2009 W-2s
Statutory interpretation "begins where all such inquiries must begin: with the language of the statute itself." U.S. v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989). Here, the language of I.R.C. § 6041 is plain and unambiguous, and "the sole function of the courts is to enforce [a statute] according to its terms." Id. Courts generally give terms their "ordinary meaning." See, e.g., Ransom v. FIA Card Services, 131 S.Ct. 716, 726 (2011) (indicating that such reading should be consistent with a statute's text, context, and purpose).
I.R.C. § 6041 and the corresponding regulation only require reporting of payments of salary, wages, or other compensation for services rendered. I.R.C. § 6041(a); Treas. Reg. § 1.6041-1(a)(1)(i)(A),(b)(1),(e). Although the defendants argue that they had a legal duty to issue the 2009 information returns, Form 1099-MISC is used primarily to report income, not stock redemptions. In its audit findings, the IRS determined that the AR and WIP sums assigned to KPE were stock distributions taxable to plaintiffs as capital gains, not as ordinary income. As Lynn Nichols, CPA, clearly and persuasively testified, the defendants had no duty to issue an information return for a minority shareholder stock redemption. In his testimony, he pointed out that defendants were confusing two separate issues, i.e. the statutory reporting requirements and the taxability of the amounts at issue. Although the plaintiffs ended up owing some capital gains tax, the defendants had no duty to issue the 2009 1099s and corrected W-2s under such statute and regulation. An experienced CPA like Waldman knew (or should have known) that he and his firm had no duty to issue the 2009 1099s to plaintiffs in connection with stock redemptions.
Nichols is a federal tax specialist with over 40 years of experience. He authors and teaches federal tax courses for CPAs on a national level (doc. 182 at 93-95).
Plaintiffs point out that, as confirmed by the IRS' audits of plaintiffs' 2009 tax returns and as explained by Nichols, the transactions under the 2009 Agreement were stock redemptions, and thus, defendants should not have characterized the $111,535 for Pitcher and the $13,260 for Enders as non-employee compensation. In doing so, the defendants misrepresented the nature of the transaction to the IRS. Defendants benefited because they were able to take a deduction for those amounts. Waldman acknowledged at trial that if the sums were characterized as compensation, he could take a tax deduction (doc. no. 182 at 35). Waldman also knew he would create a matching problem for Plaintiffs in the IRS's matching program, and as intended, the IRS did in fact audit the plaintiffs' 2009 tax returns. Plaintiffs assert that the defendants issued the corrected W-2's in an attempt to retroactively legitimize their improper issuance of the 2009 1099s, retain an improper tax deduction, and continue harassing plaintiffs.
Although Waldman attempted to rely on Richshafer's limited tax opinion as evidence that he did not willfully file fraudulent 2009 information returns, plaintiffs point to evidence that Waldman had directed Richshafer toward a particular conclusion while withholding accurate information of the fair market value of Waldman & Co. at the time of the 2009 Agreement (doc. no. 184 at 16, fn.2, indicating a "Total Value Range" of $1,492,964.25 to $2,488,273.75 even though Waldman had discouraged Richshafer from investigating the firm's FMV). Waldman did this in order to steer his witness to the conclusion that the corrected W-2s were properly issued. In fact, Richshafer testified that with appropriate information, he would reach the same conclusion as Nichols and the IRS that the 2009 transactions were stock redemptions. Waldman knew the tax implications of the proper characterization (doc. no. 182 at 55, Q: [I]f Mr. Richshafer rendered an opinion to you that this was a stock redemption transaction, then Waldman & Co. would lose its deduction, correct? A. Correct.).
Ferguson testified that the $833 and $500 were not the FMV of the shares repurchased by Waldman & Co. from plaintiffs, and that those shares had been worth an estimated $614,000 to $1,200,000 in 2009.
While a mere mistake would not satisfy I.R.C. § 7434's prohibition of willfully filing fraudulent information returns, plaintiffs argue that Waldman's issuance of the corrected information returns in reliance on a "fraudulently obtained" legal opinion further confirms that the defendants knew they improperly issued the 2009 1099s (doc. no. 184 at 17).
Waldman has acknowledged that he knew it was incorrect to file the 2009 1099s. He testified he "put it on a 1099 because the negotiations were that I would not put it on W-2s, as demanded by Pitcher and Enders" (doc. no. 182 at 37). He testified that "Pitcher and Enders demanded in October 2009 that I not put it on a W-2 or they wouldn't sign the agreement . . . So I had to go under Plan B" (Id. at 31-32, Q: So what you're telling me is you knew it was supposed to be a W-2 back in October of 2009, but you put it on something different because of what Ken and Mike told you to do? A: As a part of our negotiation.). As a CPA should well know, the "employer's obligation to report payments in excess of $600 is imposed by law, not by agreement of the parties." IRS Information Letters, 2008-0041, 2008 WL 4378537 (IRS-INFO).
"In our complex tax system, uncertainty often arises even among taxpayers who earnestly wish to follow the law, and it is not the purpose of the law to penalize frank difference of opinion or innocent errors made despite the exercise of reasonable care." U.S. v. Bishop, 412 U.S. 346, 360-361 (1973) (quoting Spies v. U.S., 317 U.S. 492, 496 (1943)) (internal marks omitted); Rogers, 111 F.2d at 989 (observing that "it is conceivable that . . . owing to different or contradictory theories of tax computation, [taxpayers may] calculate returns which differ greatly in result"). Waldman cannot accurately justify the 2009 1099s and corrected W-2s as an innocent difference of opinion. He was a sophisticated tax professional who was well aware of the implications of his reporting on the information returns. He demonstrated great animosity toward his former partners (who likewise displayed great animosity toward him). Although Waldman testified to his belief that Pitcher and Enders "were attempting a tax fraud scheme" in the 2009 Agreement (doc. no. 182 at 31-32), this does not justify his own filing of information returns that he knew were incorrect and which mischaracterized the 2009 transactions. See U.S. v. Aaron, 590 F.3d 405, 408 (6th Cir. 2009) ("a good-faith motive for willfully committing tax fraud has never constituted a proper defense"). Waldman filed a whistleblower suit and was aware of how to proceed in that manner.
B. Whether the Defendants Willfully Filed Fraudulent 2012 1099s
Section 6045 and its implementing regulation only require reporting by a person who actually pays an attorney for services rendered, unless that reporting would otherwise be covered under I.R.C. § 6041. I.R.C. § 6045(f); Treas. Regs. §§ 1.6041-1(a)(1)(ii)(iii), 1.6045-5(a),(c)(4),(d). The regulation defines a "payor" as "a person who makes a payment if that person is an obligor on the payment." Treas. Reg. § 1.6045-5(d)(3) (emphasis added). The regulation specifically defines a "payor" as "[a] person who pays a settlement amount" and "[that] person's insurer if the insurer pays the settlement amount." Id. § 1.6045-5(d)(3)(i)-(ii). Here, defendants' insurer, Farmers Insurance Group f/b/o Assurance Company of America ("Farmers") paid plaintiffs' lawyers at Dinsmore & Shohl ("Dinsmore"). Farmers was the "payor" with the reporting obligation and did in fact submit the appropriate information return to Dinsmore. Although this concluded the reporting duty for that payment, Waldman issued 1099s for tax year 2012 to each plaintiff, reflecting non-employee compensation in the amount of $37,500.00 for each plaintiff (doc. 141 at 9, ¶ z). He attached Post-It notes on which he wrote "tax cheat thief" to Pitcher and "you are going to hell" to Enders.
The 2012 1099s issued by the defendants mischaracterized the nature of the $75,000 payment made by Farmers because they do not accurately reflect what actually happened. By filing the 2012 1099s, the defendants represented to the IRS that they were "payors" of the payments and that each of the plaintiffs received a payment of $37,500 (doc. no. 182 at 99; doc. 183 at 100). In fact, Farmers paid a single lump sum of $75,000 to Dinsmore. Defendants had no duty to issue the 1099s for the payment by Farmers (doc. no. 182 at 107). Dinsmore alone had the right and duty to report it. Defendants did not actually make the payment and had no duty to issue the 2012 1099s under either statute or the regulations because defendants were not the "payor" of the attorneys fees. Although defendants contend that they could be deemed a "payor" because Waldman was an "obligor," the Court rejects such argument because it contradicts the unambiguous statutory language.
The 2012 1099s issued by the defendants mischaracterized to the IRS that they had paid $37,500 to each of the plaintiffs. As to the stated amount, Richshafer acknowledged at trial that "it was probably not correct to split the $75,000" and that "the amount should be correct." Defendants admitted they never made any such payments to plaintiffs in 2012. As Nichols testified, Waldman did not qualify as "payor" because he did not pay anything. Farmers wrote the check with its own money, i.e. it was not a mere ministerial act. Plaintiffs have pointed out that the case was settled and no "indemnity" for a judgment was ever triggered.
In sum, the evidence establishes that the defendants filed false information returns with the IRS in order to harass the plaintiffs, not to meet a non-existent duty. As a result, the Court finds that the defendants willfully filed fraudulent 2012 1099s and are therefore liable for violation of I.R.C. § 7434.
C. Conclusion
Plaintiffs have shown that the defendants did not have a duty to issue any of the information returns in this case. As for whether the defendants "willfully" filed them, the evidence reflects that Waldman is an experienced, intelligent, sophisticated tax professional who harbored great animosity toward the plaintiffs. Given his education, knowledge, and business experience as a CPA, he could not have reasonably believed that these information returns were proper to file. He filed these information returns "willfully" in order to obtain tax benefits and harass the plaintiffs. Despite having "settled" a previous lawsuit over the plaintiffs' departure from the firm, Waldman was dissatisfied and stubbornly believed the plaintiffs had "stolen" two million dollars from him by leaving his firm with clients. In taking on the role of whistleblower, he deliberately misused the IRS reporting system. While Waldman may have believed that the plaintiffs had under-stated their taxable income to the IRS, that was a matter for the IRS to determine.
When Waldman and/or his company issued the information returns to plaintiffs, defendants mischaracterized the nature of the transactions and benefited from mischaracterizing these transactions to the IRS. The Court finds that the defendants willfully filed fraudulent information returns, thereby violating Section 7434(a) with respect to each of the information returns at issue, i.e. the 2009 1099s, the corrected W-2s, and the 2012 1099s.
D. Damages
Having found the defendants liable, the Court must determine damages. Section 7434(b) provides that:
[T]he defendant shall be liable to the plaintiff in an amount equal to the greater of $5,000 or the sum of --Section 7434(e) also provides that "the decision of the court awarding damages in an action brought under subsection (a) shall include a finding of the correct amount which should have been reported in the information return." Here, there is no "correct amount" that should have been reported, because the defendants had no duty to file the information returns in the first place.
(1) any actual damages sustained by the plaintiff as a proximate result of the filing of the fraudulent information return (including any costs attributable to resolving deficiencies asserted as a result of such filing),
(2) the costs of the action, and
(3) in the court's discretion, reasonable attorneys' fees.
The Court will impose the $5,000 statutory penalty for each violation, as the evidence reflects that such amount is greater than the sum of § 7434(b)(1-3) factors. The actual damages asserted by plaintiffs consist largely of their defense of the IRS audit triggered by the defendants' issuance of the 2009 information returns. Actual damages would also include plaintiffs' costs and, in the Court's discretion, attorneys fees in bringing this suit. Of course, the IRS audit of plaintiffs' 2009 returns concluded that although the plaintiffs were not taxable for the AR and WIP as "nonemployee compensation" or "wages," the plaintiffs did in fact owe capital gains tax for their stock redemption (albeit at a lower tax rate than for ordinary income). The Court is not prepared to deem properly owed taxes as "damages," as that would be an absurd result.
The statute provides the Court with discretion whether to award reasonable attorney fees. In light of the unusually hostile litigation history between the parties, the Court observes that plaintiffs have certainly played a significant role in creating the bitter circumstances of this case. This case has also been marked by needlessly contentious discovery battles, repetitive briefing, and unfortunate personal attacks. In view of the animosity between the parties, the Court in its discretion declines to award attorneys' fees to the plaintiffs. The Court is aware that, absent such an award, this may be a Pyrrhic victory for plaintiffs. Nonetheless, the Court is convinced that this is a just result under the unusual circumstances of this case.
The term "Pyrrhic victory" refers to the ancient Greek King Pyrrhus, whose army suffered great losses while winning battles against the Romans in 279-280 BC during the Pyrrhic War. Given those losses, the "victory" was tantamount to defeat. See, e.g., Beauharnais v. Illinois, 343 U.S. 250, 275 (1952) (dissent by Justice Black, advising the prevailing parties to "consider the possible relevancy of this ancient remark: 'Another such victory and I am undone.' ").
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Accordingly, judgment is hereby GRANTED against the defendants in favor of plaintiff Kenneth B. Pitcher in the amount of $15,000.00 and in favor of plaintiff Michael Enders in the amount of $15,000.00, on their claims pursuant to 26 U.S.C. § 7434 for the defendants' issuance of the 2009 1099 forms, the "corrected" W-2 forms, and the 2012 1099 forms. The parties shall each bear their own costs of this action. In its discretion, the Court declines to award attorneys fees to plaintiffs.
IT IS SO ORDERED.
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Herman J. Weber, Senior Judge
United States District Court