No tax fraud for issuing Form 1099, Seventh Circuit holds

An insurance broker who issued a Form 1099 to a payee who never cashed the check for the payment reported on the form did not commit tax fraud, the Seventh Circuit held, reversing a decision by an Illinois federal district court.

Facts: Bernard Turnoy was an insurance broker who entered into an agreement with lawyer and fellow insurance salesman David Shiner to equally split commissions on insurance policies covering Shiner’s mother-in-law. In 2012, Turnoy sent Shiner a check for $149,060, which Turnoy represented was half of the commissions he had received to date. Shiner, however, disputed the amount, saying it should have been much higher. The check had a restrictive endorsement stating that by cashing the check Shiner would accept it as full payment.

Shiner did not cash the check, and he eventually returned it to Turnoy. Before returning the check, Shiner did not ask for a new check without the restrictive endorsement and did not communicate to Turnoy that he was rejecting the check. More than a month after sending the check but before he received the returned, uncashed check, Turnoy filed a Form 1099-MISC, Miscellaneous Income, with the IRS reporting that he had made a $149,060 payment to Shiner.

Shiner then sued Turnoy in Illinois state court for breach of contract and in federal district court, claiming that Turnoy had committed tax fraud under Sec. 7434 by sending him the Form 1099. The state court rejected the breach-of-contract claim, one day before the federal district court held that the Form 1099 was fraudulent and ordered Turnoy to pay Shiner $16,000 in damages (later discharged in bankruptcy). Turnoy appealed the district court’s decision to the Seventh Circuit. Shiner did not file a brief or any motion in response, claiming the case was moot because the damages had been discharged in bankruptcy.

Issues: Sec. 7434 provides that a plaintiff may bring a civil action for damages against a defendant who willfully files a fraudulent information return with respect to payments purportedly made to the plaintiff. Damages may equal the greater of $5,000 or actual damages, plus costs and attorneys’ fees, proximately resulting from the information-return filing, including costs attributable to resolving resulting deficiencies.

Shiner contended before the district court that the restrictive endorsement constituted a substantial limitation or restriction that prevented his constructive receipt of the check under Regs. Sec. 1.451-2(a). He also cited the holding in Bones, 4 T.C. 415 (1944), which found no constructive receipt where acceptance of a check would compromise the payee’s position with respect to a disputed claim. The district court agreed, reasoning that the check was not an actual, bona fide payment and the Form 1099 was therefore false.

Turnoy also had no good-faith basis for believing he had paid Shiner when he issued the Form 1099, the district court found, since Shiner could only either reject the check or compromise his legal position by accepting it. Thus, the false information return was filed willfully, the court concluded.

Turnoy countered that he at least had a good-faith belief he had satisfied his debt to Shiner with the check—an argument the district court dismissed as “preposterous.”

Holding: The Seventh Circuit found that Shiner’s inaction between when he received the check and the Form 1099 was issued gave Turnoy a solid basis for believing Shiner would accept the check. This undercut Shiner’s argument that the filing of the Form 1099 was a willfully fraudulent act under Sec. 7434. The district court’s decision was also erroneous in light of the state court’s rejection of Shiner’s breach-of-contract claim, the Seventh Circuit stated.

In response to Shiner’s claim that the case was moot, the appeals court explained that Shiner’s tax fraud claim had caused Turnoy harm that included being unable to obtain errors-and-omissions insurance he needed to continue in business. Thus, his continued interest in clearing his name of the judgment prevented the case from being moot.

The appeals court reversed the district court’s decision and remanded the case, instructing the lower court to grant Turnoy’s motion for summary judgment.

• Shiner v. Turnoy, No. 14-2999 (7th Cir. 3/16/17)

—By Sally P. Schreiber, J.D., a JofA senior editor.