Tax Theft – What is an Employee to Do?

Lebau & Neuworth staff has often observed that employees working for construction companies, bars and restaurants, landscape companies and other small businesses are often subjected to a tax-fraud scheme that costs them both wages and governmental benefits. The fraud comes in one of three forms: (1) Writing two pay checks – one with taxes taken out for work up to 40 hours a week and one without taxes, usually for overtime hours worked by paying straight time to employees; (2) Deliberate misclassification of employees as independent contractors and not as employees; and (3) Stealing the tax dollars from employees’ paychecks or not sending the taxes to governmental agencies (employees are then issued tax documents at the end of the year that misstate their compensation and tax payments that are genuinely owed).

The result of any of these tax-fraud scenarios is that the employees may lose overtime compensation and will lose important governmental benefits such as Social Security, Medicare, workers compensation and unemployment benefits. In addition, employees are also at risk for higher taxes, interest and penalties from taxing agencies due to the employer’s misconduct.

Fortunately, there are both federal and state protections to combat this type of fraud. The most important of these, 26 U.S.C. Section 7434, was enacted in 1996 and provides a private cause of action for fraudulent filing of tax-information returns against individuals and businesses.

Most notably, the statute stipulates these provisions:

• (a) In general, if any person willfully files a fraudulent information return with respect to payments purported to have been made to any other person, such other person may bring a civil action for damages against the person filing the return.
• (b) Damages: In any action brought under Subsection (a), upon a finding of liability on the part of the defendant, the defendant shall be liable to the plaintiff in an amount equal to the greater of $5,000 or the sum of:
  • (1) Any actual damages sustained by the plaintiff as approximate 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) At the court’s discretion, reasonable attorneys’ fees.

There is no minimum amount that subjects the employer and individuals to the $5,000 penalty, even if the violations are far less than that amount. Furthermore, an employee may sue for multiple penalties for continuing violations that last more than one year. Attorney’s fees are likely to be obtained because the employer’s fraudulent practice may affect all employees, and also taxpayers in general are saved money based on the successful lawsuit.

26 U.S.C. 7434 requires a willful element to prove fraudulent intent. As a result, the action should only be brought against individuals working for the employer engaged in the tax fraud and those acting in the scope of their responsibilities for the employer, not outside accountants and bookkeepers that are unaware of the fraud.

If you have any questions regarding Tax Theft from an employer, the attorneys at Lebau & Neuworth can provide you with answers based on our vast experience with handling tax fraud. Contact us at (410) 296-3030 or lebauneuworth.com/contact-us.