14 - Court Determines Damages for Willfully Filing a Fraudulent Information Return

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1 14 - Court Determines Damages for Willfully Filing a Fraudulent Information Return Angelopoulo v. Keystone Orthopedic Specialists, S.C., et al., (DC IL 7/9/2018) 122 AFTR 2d A district court has determined the appropriate damages to be awarded to a taxpayer under Code Sec. 7434(b) where his former associates willfully filed a fraudulent information return (Form 1099-MISC, Miscellaneous Income) stating that he had more than $159,000 in taxable income, rather than the approximately $38,000 that should have been reported. The court considered the taxpayer's attorney and accounting fees and expert expenses incurred, including those in the underlying Tax Court proceeding and IRS settlement and the present district court litigation. Background. Under Code Sec. 7434(a), if any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, the purported payee may bring a civil action for damages against the person filing the fraudulent return. In an action for the fraudulent filing of an information return, the defendant, if found liable, is liable to the plaintiff in an amount equal to the greater of $5,000 or the sum of: actual damages sustained by the plaintiff as a proximate result of the filing of the fraudulent information return (including any costs from resolving deficiencies asserted as a result of the filing); the costs of the action; and in the court's discretion, reasonable attorney fees. (Code Sec. 7434(b)) Facts. In 2011, IRS issued Dr. Nicholas Angelopoulos, the taxpayer, a Notice of Deficiency informing him that he had failed to pay taxes due and owing on $159,577 that had been reported on a Form 1099-MISC for the 2007 tax year. Dr. Angelopoulos challenged the deficiency notice in Tax Court, and subsequently, he and IRS resolved the case by settlement. As part of the settlement, they agreed that of the total amount reported on the Form 1099, Dr. Angelopoulos did not earn and/or receive non-employee compensation in the amount of $121,

2 In district court, Dr. Angelopoulos (plaintiff), an anesthesiologist, brought suit against his former business partner, Dr. Martin Hall (Hall), Keystone Orthopedic Specialists, S.C. (Keystone), a medical practice owned by Hall, and Wachn LLC (Wachn), a limited liability company formed by Dr. Angelopoulos, Hall, and other physicians called (collectively, the defendants) for fraudulently filing an information return in violation of Code Sec (Count 1). Dr. Angelopoulos' suit also alleged common law fraud (Count 2), breach of fiduciary duty (Count 3), breach of the Wachn operating agreement and the Keystone agreement (Counts 5 and 6), and unjust enrichment. Dr. Angelopoulos sought recovery under Code Sec based on allegations that Keystone and Hall caused a fraudulent IRS Form 1099 to be filed in Dr. Angelopoulos' name reporting more than $159,000 as taxable income for the 2007 tax year. Dr. Angelopoulos acknowledged that approximately $38,000 should have been reported on the Form 1099, but claimed that the excess amount was included by Keystone and Hall out of spite arising out of a larger disputes between the parties. The jury agreed with Dr. Angelopoulos as to liability. By agreement of the parties, the calculation of damages was to be done by the court. The defendants insisted that a minimal $5,000 award was sufficient compensation, while Dr. Angelopoulos sought an award of $ 369,466. Dr. Angelopoulos' sought compensation for all of the expenses that he incurred in the Tax Court proceeding, 25% of the expenses he incurred in this district court litigation through trial, 100% of the expenses he incurred post-trial on Count 1, and 25% of the expenses he incurred post-trial on mixed claims, minus 25% of the amount that he was awarded as a discovery sanction. In an earlier proceeding in this case, the district court concluded that although Dr. Angelopoulos could be entitled to award of actual costs, not just a flat $5,000 recovery under Code Sec. 7434(b), he would need to establish the reasonableness of the amounts that he was seeking. The district court then allowed limited and proportional discovery on Dr. Angelopoulos' Count 1 damages claim, including short depositions of his lawyers and accountants, with a focus on justifying the reasonableness of the substantive work for which the individuals billed their time and the results achieved. (Angelopoulos v. Keystone Orthopedic Specialist, S.C., et al., (DC IL 1/18/2018), 121 AFTR 2d ) Court's conclusion. The district court awarded $178,954 in compensatory damages to Dr. Angelopoulos on Count 1. The Court concluded that Plaintiff was entitled to damages equal to 76% of the total amount he spent on attorneys and his accountant pursuing the Tax Court case, or $68,

3 In reaching its determination, the district court set out four principles that it intended to use in its analysis of Dr. Angelopoulos' damages. First, the Court recognized that since a taxpayer may need to initiate costly proceedings to resolve the receipt of a fraudulently inflated Form 1099, it would be unjust not to compensate the taxpayer for the costs incurred in connection with such proceedings. Second, because distinguishing between a proper Form 1099 filing and a fraudulent one might require a lay taxpayer to employ both legal and accounting assistance, attorneys' fees and expert witness fees properly lay within the scope of expenses potentially reimbursable to a wronged taxpayer. Third, the district court would not second guess a taxpayer's decision to retain professional assistance to sort out any alleged deficiencies associated with his return. Fourth, the district court should use "reasonableness" as its touchstone in considering the taxpayer's request for fees. The district court noted that in cases involving the award of fees in civil rights lawsuits, there was a strong presumption that the product of reasonable hours times a reasonable rate represented a "reasonable' fee." But, this amount was just the starting point and might be excessive where a plaintiff had achieved only partial or limited success. A reasonable hourly rate was based on the local market rate for the attorney's services, and the best evidence of the market rate was the amount the attorney actually bills for similar work. But if that rate couldn't be determined, then the district court might rely on evidence of rates charged by similarly experienced attorneys in the community and evidence of rates set for the attorney in similar cases. In addition, the Laffey Matrix (a guideline the U.S. Attorney's Office in Washington, D.C. created to estimate reasonable attorneys' fees) can assist the district court with the challenging task of determining a reasonable hourly rate; however, the court also noted that Laffey Matrix is only one factor in determining a reasonable rate and has never been formally adopted in the Seventh Circuit. The court noted that the Seventh Circuit has "rejected the notion that the fees must be calculated proportionally to damages." It had also rejected the argument that a prevailing party could never have a fee award that was greater than the damages award. But while there was not a categorical ban on considering proportionality, proportionality was only one of the factors that the court might consider in determining a reasonable fee. Beginning with the attorney fees associated with the Tax Court proceeding, the district court concluded that Dr. Angelopoulos was not entitled to an award of 100% of his attorney fees because. in his settlement with IRS. he agreed to pay taxes on a portion of the amount reported on the Form Instead, the district court awarded Dr. Angelopoulos 76% of the amount he requested, based on the fact that 76% of the amount reported on the Form 1099 should not have been included ($121,567 out of the $159,577 reported). 49

4 Other than that reduction to account for the taxpayer's partial success in the Tax Court, the district court was not persuaded by the defendants' arguments for further reducing the award of fees. The district court rejected the defendants' contention that the rate charged by Dr. Angelopoulos' attorney was excessive, that she included litigation fees related to other matters, and that she inadequately allocated the bills between the Tax Court and district court proceedings. The court found that the attorney charged her standard rates, which was the best evidence of the market rate, and her firm's rates were 87% of the Laffey Matrix rates. The court further stated that despite being offered the opportunity for further depositions by the court, defendants made no efforts to discover testimony/evidence that would back up the challenges they made. The court next turned to the bills of Dr. Angelopoulos' accountant in the Tax Court proceeding. He billed $40,875 at his normal hourly rate of $150 per hour for four types of work: (1) dealing with the Form 1099 in connection with filing the 2007 tax return; (2) handling the IRS audit initiated because of the Form 1099; (3) preparing schedules and forms in conjunction with his attorney's firm for presentation to the Tax Court; and (4) preparing four years of amended returns that had to be fixed after the Tax Court's favorable ruling. While the defendants criticized his bills because they were not itemized and in one instance noted work on an additional issue not included in Count 1 (i.e., a Form 1065 K-1 briefly referenced in his bill), the district court found that regardless of whether his bills were itemized to the defendants' satisfaction, the accountant also submitted his underlying time sheets (which he kept in the ordinary course of business), and he testified that the $40,875 fairly and accurately captured the fees he charged for his work in connection with the Form As to the Form 1065 K-1, the court noted that the defendants did not ask the accountant about this in his deposition and that it appeared from the limited information available that it was another "questionable" form received from Keystone with the Form The district court concluded that to the extent the accountant spent any time on a Form 1065 K-1, there was no indication that it was a significant amount or was separable from the work related to the Form The court next considers the fees that Dr. Angelopoulos incurred pursuing this litigation. While the defendants did not challenge the reasonableness of the rates charged or number of hours worked by Dr. Angelopoulos' litigation attorneys and expert, they disputed the portion of the litigation-related fees that were attributable to Count 1. Dr. Angelopoulos contended that the 25% that he requested was reasonable, even conservative, because it was impossible to divide pre-verdict work on the lawsuit between Count 1 and the other counts of his complaint. He also pointed out that Code Sec only applied to intentionally fraudulent issued forms and argued that much of the overall effort was necessary to show the fraudulent intent required in Count 1. On the other hand, the defendants disagreed that Dr. Angelopoulos' claims were inextricably intertwined, arguing that the taxpayer was 50

5 aware of the particular bases for each and every number included on the Form They also asserted that the fees requested ere unreasonable because Dr. Angelopoulos' counsel intentionally made the case more complicated than necessary. Further, they argued that some allocation had to be made to take account of settlements made with other defendants in the case. Taking into account all of the parties' arguments, the district court concluded that Dr. Angelopoulos was entitled to a substantial award. He prevailed on every count of his complaint and on the defendants' counterclaim, obtaining a jury verdict of $990,000 in compensatory damages, $1 million in punitive damages, and $200,000 in interest. This result supported his position that he was not unreasonable in refusing to settle for the much lower amount that the defendants offered. However, the court found that Dr. Angelopoulos was not entitled to the entire 25% of litigation-related fees that he requested. While both parties might have streamlined the proceeding and reduced their costs by being more cooperative, the district court could not say that the failure to do so was the taxpayer's fault, such that his damages award should be reduced. Nonetheless, Dr. Angelopoulos' award of compensatory damages should be limited to those fees that were reasonably attributable to the litigation work on Count 1. The court acknowledged that there was no easy way to determine this, given that some of the work supported multiple claims and that counsel for both sides failed to note in their billing entries the particular claims on which they were working (which the court did not fault them for). And while Dr. Angelopoulos' discovery and evidence provided additional support for his argument that the defendants acted with fraudulent intent, it was not necessary to prevail on Count 1. The district court was not convinced that the taxpayer's attorneys would have done 25% of the total work if Count 1 were the only issue in the case. Instead, the court concluded that 10% was a reasonable estimate of the time that should be attributed to Count 1. The court also found that Dr. Angelopoulos was not entitled to compensation for the fees that he incurred litigating claims against the group of defendants that had settled early on in the district court proceedings. Noting that both sides could have taken more reasonable positions, with regard to post-trial litigation-related fees, the court awarded the taxpayer damages equivalent to 50% of the $32,768 claimed for work attributed to Count 1 (or $16,383.75). In addition, the court awarded the taxpayer damages equivalent to 10% of the $36,847 claimed for work on "mixed" claims (or $3,684.70). This resulted in a total award of $20,068 for post-trial work. 51