Employer Asking Me to Pay Taxes Retroactively?

[Bali Hai Again]

Dear Bali Hai:

I would like to direct focus and hopefully engender professional discussion on whether resolving the OP's issues with his former employer may call for the application of the "Clean Hands Doctrine".

I am not a legal professional but am happy to discuss.

So, may I please have your kind indulgence and professional attention to the following hypothetical - which I see as somewhat analogous to the issue at hand?

You have my attention.

Employer "A" is engaged in importing and selling consumer goods. Employee "B" knows of a source to export counterfeit merchandise - say smart phones. "A" and "B" conspire to import the bogus phones with "A" to front the money to the exporter, market the merchandise as genuine and split the net with "B".

Things run smoothly for a time until CBP seizes and confiscates a shipment of bogus phones. Criminal investigation is pending. However, in the meantime "A" is out-of- pocket _x_ dollars being the amount he paid for the commandeered shipment.

Question #1. Does "A" (theoretically speaking) have civil recourse against "B" with respect to reimbursement or restitution of any part of his said out-of-pocket costs?

In my unprofessional opinion no. I have watched Judge Judy enough to know this.

Clearly, "A" would be asking the court to adjudicate subject matter systemically tainted with fraud, i.e., enforce an inherently illegal agreement.

My second question is how does my hypothetical which is imbedded in the conspiracy to illegal import counterfeit consumer goods and sell them as genuine differ in principle from conspiring to engage in a violation of Internal Revenue Cade requiring the withholding of an employee's income tax. Each of which have criminal consequences.

No.

Dear Litigator22:

Aside from the criminal conspiracy inferred of which there has been no evidence offered, I have the following questions:

1. Does the OP owe payroll taxes regardless of whether they are an employee or independent contractor?
2. Did OP pay those taxes in addition to the employer paying the same payroll taxes for OP.
3. If the answer to question #2 is no, does the OP owe the employer a reimbursement for paying the taxes owed by the OP?
4. If the answer to question #2 is yes, proceed with the recommendations offered by the tax experts in this thread?

 

[Litigator22]

In principle there isn't a difference between them if both parties are aware that what they are doing is illegal. That agreement is the essence of a conspiracy. In most cases I encountered while working for IRS there was no evidence of any such agreement and indeed the employees tended to be rather convincing in their anger when told their boss screwed them over.

Moreover, few employees kmowingly make that bargain without something extra from the employer to cover the extra tax the employee pays as an independent contractor vs being an employee. The main benefit for most employers out of this is saving the employer's share of FICA (Social Security and Medicare), unemployment and worker's comp taxes. The arrangement shifts those obligations to the worker. If the worker is properly classified as an employee, the independent contractor arrangement screws the employee because worker now is paying both the employer and employee share of FICA, and has has to pay the worker's comp and unemployment tax or not be covered by those programs.

The worker, if he/she knows that the employer is pulling a fast one on the IRS and state and shafting the employee to do it would demand compensation for the extra money the worker must now pay for all these taxes. If the employer covers all that so the worker is made whole then there is no point to the tax scheme because the employer is still paying the taxes, just to the worker rather than to the IRS. In short, in these arrangements the IRS is not losing out on any money. Thus the reason the IRS enforces the withholding requirements for employees is not directly about the money. It's about making sure that employers don't cheat their employees by shifting some of employer's tax burden to the employee. There is an indirect money benefit for the IRS, too, but that is more in the abstract.

The employer would certainly benefit from illegal classification of the worker, but the employee doesn't typically get anything out of it. The worker pays more with this scheme. For that reason the employer doesn't tell the worker that it is misclassifying the worker to save the employer money. Instead they tell the workers that they are indeed independent contractors and thus worker is responsible for all those taxes. Telling the employee what's really going risks sinking the whole plan. The upshot of all of this is that in my experience most workers do not know they are misclassified and are angry at the employer for screwing them over when they find out.

Thank you - very informative and as always, well stated.

Also, I must admit to overstating the "under the table" conspiracy aspects of the case at hand. Although I don't believe that the application of the clean hands doctrine would require a finding that both parties share guilt. The employer holding all the cards and being under the table all by his born self ought to suffice.

But I do hold to a fairly firm belief that in order for the employer to prevail he will need to drag the judge under the same table. Which isn't about to or shouldn't happen. But who knows in this turbulent and most frightening day and age! What is needed is a reset button, or a Jules Verne time machine

Anyhow, Messire MoralessK8 seems to have left the scene. So, so be it. Win some, lose some and some are rained out.

 

[Taxing Matters]

Dear Litigator22:

As far as I know Litigator22, while well versed in litigation matters, does not do much, if any, tax law work as part of his/her practice. If I'm wrong on that I'm quite sure Litigator22 will correct me on that. My primary area of practice is tax law, and so far as I know there is only one other tax professional who posts answers on these boards, LdiJ.

1. Does the OP owe payroll taxes regardless of whether they are an employee or independent contractor?

Yes, but how the tax is paid differs and the amount coming out of the OP's pocket for it is more if the OP is an an independent contractor than he/she would pay as an employee. If the OP is an employee, the employer pays half the FICA (Social Security and Medicare taxes) and withholds the other half from the employee's pay. If the OP is an independent contractor then the OP pays all of the FICA (though the OP does get a deduction on his/her income tax for the employer half as that is a deductible business expense for him/her). Even with that deduction the OP is paying more in tax as an independent contractor than as an employee because the income tax deduction only has the effect of reducing the amount of the employer share the OP pays. It does not eliminate it.

2. Did OP pay those taxes in addition to the employer paying the same payroll taxes for OP.

If the OP did that, then the OP or the employer really screwed this up. The whole point of the employer wanting the OP to be an independent contractor is so that the employer does NOT have to pay them.

If the employer paid the taxes (thus treating the OP as an employee) then the OP would receive a Form W-2 from the employer. With the W-2 the employee pays nothing more in payroll tax than the half the employer already deducted. If the OP instead got a Form 1009-NEC for the work (and was properly classified as an independent contractor) then the OP ends up paying more because now the OP is paying both the employer and employee share of FICA. The employer should not send both a 1099-NEC and a W-2 for the same work. And if the employer only sends one of the two forms then the worker only ends up paying the taxes once. The problem is that as an independent contractor (thus receiving a Form 1099) the OP's FICA taxes are higher because he pays both the employer and employee share of FICA. As an employee (thus receiving a W-2) the OP would only pay the employee's share of FICA via withholding deductions from the OP's pay.

[/QUOTE]3. If the answer to question #2 is no, does the OP owe the employer a reimbursement for paying the taxes owed by the OP?[/QUOTE]

If the employer did it correctly the answer to that is no. The same is true if the OP was misclassified as an independent contractor by the employer.

Under the scheme described by the by OP, either the IRS or the employer would owe the OP for the employer share of FICA if the OP is properly classified as an employee rather than an independent contractor, which how the employer treated the arrangement. There isn't a scenerio here in which the employee would be required to pay the employer for this. If the OP was incorrectly classified as an independent contractor then the OP over paid the FICA and should get the employer's share of FICA returned to him/her.

4. If the answer to question #2 is yes, proceed with the recommendations offered by the tax experts in this thread?

If the OP was improperly classified then the OP needs to get the employer share of FICA back. Whether that's through the IRS or from the employer depends on the details of the employment tax audit that the OP's employer is evidently going through. But one way or the other either the IRS or the employer owes the OP some money and the OP will need to actively pursue it. If the OP just sits around and hopes that the result of the IRS exam will automatically get him/her that refund it may be that the OP never sees the money.

 

[Taxing Matters]

Thank you - very informative and as always, well stated.

Although I don't believe that the application of the clean hands doctrine would require a finding that both parties share guilt. The employer holding all the cards and being under the table all by his born self ought to suffice.

I agree. If it wasn't clear before, I was referring to whether the OP would be tainted by the clean hands doctrine. In most of these situations it is the employer who initiates the scheme and misleads the employee into believing that he/she is an independent contractor. In that circumstance I agree the employer would be tainted, but not the employee who bought the line the employer gave him/her. And when the IRS does employment tax audits regarding classication of workers, if the employer misclassified the worker as an independent contractor, you are quite correct that it the employer who takes the hit for it.

But I do hold to a fairly firm belief that in order for the employer to prevail he will need to drag the judge under the same table.

The employer would need to first complete the audit process and if the employer disagrees with the examiner's position he/she has a right to go to IRS appeals. If he loses there, too, then his options are to pay the entire tax the IRS determined is owed and then sue the IRS in either U.S. District Court or the Court of Claims for a refund of what the employer paid. The employer does not have the option to go to Tax Court as the Tax Court's jurisdiction is limited to income, estate, and gift taxes, and collection due process appeals. The government in a tax case in District Court or the Court of Claims is an attorney from the Department of Justice, Tax Division. All those folks do is litigate tax cases; they have nothing to do with any of the IRS administrative procedures that preceded the refund lawsuit. They tend to be quite good litigators but sometimes need the help of the IRS to fully understand what the tax issue is.

Getting the District Court judge or Claims Court judge to go down the same hole as the employer in knowingly misclassifying the employee is something I've never seen and I think, as it seems you do too, that it would take some extraordinary effort for the employer to get the judge to go down that hole with the employer. Not that it hasn't happened. When I lived in PA many years ago there was quite a scandal involving some Philadelphia judges taking bribes from the Roofer's Union to throw cases in favor of the union member. But I'd like to think that most judges are above that sort of thing.

Which isn't about to or shouldn't happen. But who knows in this turbulent and most frightening day and age! What is needed is a reset button, or a Jules Verne time machine

I agree there too. While the DOJ attorney may need to educate the judge (or the jury if the employer elects to go to District Court and asks for a jury) about how the payroll tax system works, the employer's attorney really has only one option to win: convince the judge or jury that the OP was properly classified as an independent contractor. Most of the time it's not a close call. That said, I have seen the occasional case where the judge or jury comes out with a truly bizarre decision.

 

[Bali Hai Again]

With no criminal intent, the innocent click of the wrong radio button can create these messes. I have seen this more and more where I worked (ten thousand employees in an intellectual institution) in the last 10-15 years.

 

[Litigator22]

* * * * * * *

I agree there too. While the DOJ attorney may need to educate the judge (or the jury if the employer elects to go to District Court and asks for a jury) about how the payroll tax system works, the employer's attorney really has only one option to win: convince the judge or jury that the OP was properly classified as an independent contractor. Most of the time it's not a close call. That said, I have seen the occasional case where the judge or jury comes out with a truly bizarre decision.

Unfortunately, your exhaustive effort completely ignores the rationale and historic concept and its possible application here of the Clean Hands Doctrine! Which, if you will recall I posed for discussion. Not the "payroll tax system".

Whether the potential claimant (the OP's former employer) could prevail in court would not be of immediate concern. If the doctrine were to be injected as an affirmative defense, the question to be first resolved is whether or not the proposed claimant even has access to the courts.

For yours and others edification an explanation of the preclusive and impeding features of the doctrine appears in the early United States Supreme Court case of Keystone Driller, Co. vs General Excavator Co., 290 U. S. 240:

"Whenever a party who as actor seeks to set the judicial machinery in motion and obtain some remedy has violated conscience or good faith, or other equitable principle in his or her prior conduct, then the doors of the court will be shut against him in limine; (as) the court will refuse to interfere on his or her behalf, to acknowledge his or her right or award him or her any remedy." (Emphasis added)

And again in Bein vs. Heath 47 U. S. (6. How.) 228:

"The doctrine is rooted in the historical concept of courts of equity as a vehicle (demanding) conscience and good faith."

Nor does the concept require prior patently illegal or criminal conduct of the part of the acting party. As in the Maryland case of Manown vs. Adams 98 A2 821.

There the plaintiff Adams sought to recover from Manown the repayment of a series of loans. The defendant asserted the clean hands doctrine as an affirmative defense. The evidence revealed that Adams had failed to list the loans as assets in either his prior bankruptcy filing or in a recent divorce action.

The Maryland Appellate Court upheld the lower court's denial of the claim emphasizing that the doctrine "served to protect the court and suppress illegal and fraudulent transactions."

I find it worthy of noting for purposes of bolstering the OP's possible argument that in the Maryland case the improper conduct of the claimant that denied him judicial relief was not particularly directed towards nor affected the defendant Manown (the maker of the notes). But towards Adam's creditors, ex-wife, and especially the DOJ which oversees the administration of the federal bankruptcy laws. The parallel affected agency here being the IRS.
_______

Now, whether or not the prior conduct of the OP's employer in falsely treating him as independent contractor rather than an employee (and now admitting to having improperly done so and to his then financial advantage) rises to the level of fraudulent conduct needed to "close the court doors and refuse to set the judicial machinery in motion" is a matter of proof.
____________

For an excellent treatment of the subject see Anenson, T. Leigh (2010) "Limiting Legal Remedies: An Analysis of Unclean Hands," Kentucky Law Journal: Vol. 99: Iss. 1, Article 4. Available at: https://uknowledge.uky.edu/klj/vol99/iss1/4

 

[Taxing Matters]

Unfortunately, your exhaustive effort completely ignores the rationale and historic concept and its possible application here of the Clean Hands Doctrine! Which, if you will recall I posed for discussion. Not the "payroll tax system".

I agree, my reference to the payroll tax system was not right and was not intended. I appreciate you spotting the error.