As Neil Sadaka crooned, breaking up is hard to do. And it certainly proved so for an accounting firm. The acrimonious breakup did result in a tax case, this time looking at liability for filing a false information return under IRC §7434.

The Sixth Circuit court of appeals was called by both parties to review decisions of the U.S. District Court in the case of Pitcher and Enders v. Waldman, et al, CA6, Case Nos. 14-3369/14-3392, on appeal from the U.S District Court for the Southern District of Ohio.

IRC §7434 provides a penalty for willfully filing a false information return. [IRC §7434(a)]. The penalty in that case is the greater of $5,000 or the sum of actual damages incurred, the costs of any actions dealing with resolving the deficiency the IRS was lead to believe existed and reasonable attorney fees.

The case at hand involved an accounting firm where minority shareholders decided to leave the firm. The majority owner, Mr. Waldman, opposed this action and so the minority owners (Mr. Pitcher and Mr. Elder) sued for dissolution in state court.

Eventually a settlement was reached that allowed the minority shareholders to leave the firm, taking their clients and related receivables with them. After relinquishing their stock in the new firm they formed a new firm. The old firm was required to assign certain receivables to the leaving members and pay legal fees accrued by the two as officers and directors of the firm.

Mr. Waldman was, to put it mildly, upset by these developments and sought to antagonize his former partners by filing two Forms 1099s for 2009, two corrected W-2s for 2012 and two Forms 1099s for 2012, filings the District Court found fraudulent. Apparently, though, the invective did not flow one way—the District found the minority partners had themselves engaged in conduct that served to inflame tensions.

The original Court decision came down with a ruling that satisfied neither party. The Court found Mr. Waldman had knowingly issued six false information returns (the sets referred to above). However, the Court found that the minority partners’ compensatable damages, though, were less than the $5,000 minimum award under the statute, thus awarding the old members the $5,000 minimum.

In arriving at that conclusion the District Court denied the minority shareholders’ request for attorneys fees, an amount that would have easily pushed them over the minimum damage award amount. The District Court found that the minority shareholders had played “played a significant role in creating the bitter circumstances of this case” and therefore decided that it would not be appropriate to award any legal fees.

Both parties appealed. Mr. Waldman claimed that the District Court erred by finding he had willfully filed fraudulent information returns. Mr. Waldman argued that his expert had determined he was correct in his belief (a belief that the District Court and the appellate panel would not find credible) that he had a filing obligation.

The Court of Appeals found that there was no basis to overturn the District Court’s decision to discount the letter Mr. Waldman had—and that, in fact, the panel indicated that had they been asked to rule they would have also discounted it. The appellate opinion notes:

Even if we were to ignore the deference reviewing courts extend to fact finders on questions of credibility, Waldman’s challenge would fail. Waldman’s expert’s initial assessment was unpersuasive not because of a credibility deficit but because Waldman “had directed [his expert] toward a particular conclusion while withholding accurate information of the fair market value of [the company] . . . in order to steer his witness to the conclusion that the corrected W-2s were properly issued.” When presented with the relevant information, Waldman’s expert reached the same conclusion as the opposing expert as to the nature of the transaction and the resulting reporting obligations. The district court was correct to credit the essentially unanimous opinion of the experts.

The Court also noted that Mr. Waldman, having specific expertise himself in taxes, clearly should have known his filings were not appropriate. As the Court noted:

Given his own tax expertise and his careful deception of his expert, Waldman’s conduct provided sufficient evidence to support the district court’s conclusion that his fraudulent filing was willful. In addition to evidence that Waldman misled his expert to extract a favorably flawed legal opinion, the district court noted Waldman’s direct testimony that “he knew it was incorrect to file the 2009 1099s.” Similarly, Waldman’s expertise made it clear that his decision to file 1099s in 2012 was a willful fraud. Those 1099s falsely claimed that Waldman paid Pitcher and Enders each $37,500. Waldman made no payment. Neither Pitcher nor Enders received one. While a lay person might have accidently characterized the actual transaction—a $75,000 payment by Waldman’s insurer to Pitcher and Enders’s attorney—in this way, Waldman is a tax expert.

The appellate panel also refused to overrule the District Court’s decision regarding attorney’s fees. The panel ruled:

For their part, Pitcher and Enders contend that the district court abused its discretion by declining to award attorneys' fees after finding Waldman liable. When deciding not to award attorneys' fees, the district court described the litigation history between the parties as "unusually hostile" and cited "needlessly contentious discovery battles, repetitive briefing, and unfortunate personal attacks" in the litigation. Pitcher and Enders argue that the district court was not entitled to consider their contributions to the "bitter circumstances" of the litigation when exercising its discretion over attorneys' fees. They offer no authority for this limitation on district court discretion, and we know of no reason the district court may not weigh all of the facts in making a determination on the fairness of an attorneys' fee award. The statute that establishes the cause of action grants the courts discretion over the award of attorneys' fees. The district court in this case exercised that discretion in light of "the unusual circumstances of this case."

Acrimony in litigation is not at all unusual, and advisers may find clients who want to “turn in” the opposition in a case to the IRS. This case serves as a cautionary tale about the risks of doing so, especially in cases where the client is “pushing the envelope” in terms of what must be reported (or even going beyond it) because he/she is sure the client is “lying” to the IRS and not reporting something that should be reported.