Dot-Com Failures Tax Workers’ Consciences

Margee Fagelson lost her first dot-com job last year when Ingredients.com went belly up in February. That was followed by the shutdown of Virtual Communities, which had hired her as a consultant, and VSlash, which went poof before paying her a $3,000 consulting fee.

Now, the Internet meltdown has visited a final indignity upon the 35-year-old New York music media consultant: With less than a month to go until tax day, two of these former employers haven’t sent Fagelson the forms she needs to file her return.

Of the more than 210 dot-coms that choked to death on the “new economy” last year, many simply boxed up their records and walked away from the wreckage.

That has presented Fagelson and possibly thousands of other dot-com casualties with an intriguing dilemma: to pay or not to pay their taxes.

Legally, of course, there is no choice; income taxes must be paid. Even if companies flout the law by failing to make tax information available to employees and contractors, the workers are expected to calculate their tax bills based on pay stubs, invoices, bank records or even memory. Those who don’t pay face hefty fines or even prison--if they get caught.

So Fagelson could spend dozens of potentially fruitless hours trying to track down her former bosses. Or, following the proud tradition of Internet entrepreneurs who profited by casting aside traditional rules of business, she could take advantage of the missing documents and reduce her tax bill.

“I think about this all the time,” said an exasperated Fagelson, who is practically broke and isn’t sure where she’ll find the money to pay any taxes that weren’t withheld. “I don’t want to get thrown in jail. But it’s like it’s only illegal if you get caught, and I think my chances of getting caught are slim to none.”

After a year that transmogrified hundreds of Internet companies from stock-market darlings to profitless pariahs, Fagelson’s predicament is hardly unusual. Between 12,000 and 15,000 workers lost their jobs last year as a result of dot-com closures, according to Webmergers.com, a research firm that tracks Internet mergers and acquisitions.

Those who have a tax refund coming from their undocumented income will clearly want to report all of it to the government. But for workers who think they still owe taxes, the incentive to cheat is powerful.

No one knows exactly how many people failed to receive their tax forms from last year. But experts say that failing companies are always looking for ways to cut corners, and that the accountants and payroll firms that prepare W2s for employees and 1099s for independent contractors often end up on the chopping block.

Although thousands of companies fail each year, what distinguished 2000 was the speed with which the dot-coms disappeared, some giving only a few hours’ notice to employees. That significantly decreased the chances of a company taking care of some of the little details of death, such as filing tax forms. In this respect, “new-economy” disasters turned out to be a lot like “old-economy” disasters.

“When businesses all of a sudden shut down, typically it’s because they’re broke,” said James C. Counts II, a Hemet accountant who specializes in serving small firms. “Doing the accounting work and the payroll returns--it’s the last thing they want to spend money on.”

A W2 states how much money was paid to an employee over the course of a year, along with the amount of money withheld for federal income, Social Security and other taxes. Companies are supposed to issue a 1099 to document payments to independent contractors whenever they pay a self-employed individual $600 or more in a year. Companies must make W2s and 1099s available to their employees and contractors by Jan. 31.

If companies fail to provide the information, there is little the Internal Revenue Service can do. The burden falls on workers to reconstruct their income themselves. It is a relatively easy process for those who have bothered to save their pay stubs, like Paul Ung.

“Whatever I earn I have to report, and I’d rather do it now,” said Ung, who briefly worked as a database administrator for a now-defunct company called Vox.com and has already paid about $1,500 in estimated taxes on the consulting income he earned.

The IRS does not keep track of how many people file their taxes without their W2s or 1099s, or how often companies shut down without sending out the necessary tax forms. However, IRS spokesman Larry Wright said that in his 25 years with the federal tax agency, he has noticed that the number of people filing without their W2s increases when the economy weakens.

For some dot-com refugees who have suffered through multiple layoffs and long periods of unemployment, the economy now looks so weakened that scamming a few dollars from the government is sorely tempting.

The situation is further complicated by the huge gains made by some workers from stock options back when the market was hot. Many now face enormous income or capital gains tax bills and have no cash to pay them.

The tantalizing prospect of keeping some extra cash has led to some of the most tortured logic and twisted mental gymnastics since the heyday of the new economy.

One Southland programmer, who asked not to be identified, said he convinced himself that it would be safer to break the law under the faulty theory that guessing how much tax he owed and being wrong was worse than not paying at all.

His problems began when he first estimated his tax bill for 2000 at $40,000--a sum he was unable to pay. He figured he could knock about $8,000 off that bill by not reporting about $20,000 he made consulting for MyHome.com, a defunct Pasadena online home furnishing retailer that failed to send him a 1099.

He started thinking that way when he couldn’t get any of the proper documents from either MyHome’s former executives or the company’s lawyer, who refused to go through the records because no one would pay him for the work.

“They put me in a very weird position,” the programmer said. “If I guess too much, I know I will never get [the taxes] back. If I guess too low, is it the same as not putting anything? If it is, then I might as well not put anything and wait until I get caught.”

Feelings of guilt, fear and perhaps duty eventually overpowered him, and he made one last attempt to wrest a 1099 from Idealab, MyHome’s parent company. It worked.

It turns out he also has a healthier financial outlook: Once he decided to come clean on his taxes, he went to a tax professional and discovered that what he thought was a $40,000 bill was actually a $19,000 refund because his tax preparation software had mistakenly double-taxed his stock option income.

“I feel so relieved,” he said. “Now I have a clear conscience.”

Counts, the accountant, said that if neither a company nor a worker reports income to the IRS, tax collectors are “not likely to find out about it.”

But others caution that there are myriad ways the government could discover hidden income, such as in a divorce proceeding or an audit of the company’s principals.

People who try to conceal income from the IRS “are flirting with disaster,” said David Flamer, a Woodland Hills accountant and small-business consultant. “Sooner or later, it’s going to be trouble.”

The IRS generally has three years to catch scofflaws, but the statute of limitations rises to six years if someone fails to report 25% or more of their income, said Karen Goodfriend, a certified public accountant and personal financial specialist at GoldsteinEnright Financial Advisors in Menlo Park, Calif. Fines can be as high as 75% of the unpaid taxes, plus interest. Tax cheats are rarely sent to the slammer, but the worst offenders can face a five-year prison term and a fine of up to $100,000 for each offense, according to the IRS.

Even the faintest possibility of an audit has tormented some workers who have almost come to accept that an IRS investigation naturally follows from the streak of bad luck they’ve had in the last few months.

David Schwartzberg spent six months as the information technology manager at Ingredients.com, which sold personal care products on the Web. He had an $80,000 salary at the New York-based e-commerce firm, which shut down in February and never sent him his W2.

He said his tenure at the company was so stressful that he suffered severe chest pains four times a day. He had no intention of adding to that stress by making himself vulnerable to an IRS audit.

“I definitely want to pay my taxes,” said Schwartzberg, who began his career as an accountant before switching to computer consulting. “If I don’t, maybe three to seven years down the pike the IRS would come to me and say, ‘You didn’t pay taxes on this. Here’s the penalty and the interest.’ I don’t need that in my life.”

Schwartzberg, who figures he owes the government about $5,000 for his work last year at Ingredients, was outraged when his former boss told him there wouldn’t be any W2s this year.

“He said there was no one there to give them to us because the company was gone,” said Schwartzberg, who has launched his own crusade to track down the former executives himself.

“I will just continue to hunt after these people,” he said.

Fagelson, the music media consultant, doesn’t worry too much about the prospect of IRS agents knocking at her door and even speaks openly about her predicament. In her case, the missing tax forms are less of an aggravation than an opportunity. After outlasting three dot-com employers last year, she’s practically daring the new economy to throw her one more piece of bad luck.

Fagelson, who earned less than $40,000 last year, figures that she is so broke that there is no point in considering the ethics of the situation.

“I don’t have enough money to pay my rent, and I certainly don’t have enough money to pay my taxes,” she said.

Fagelson reasons that underreporting her dot-com income from the new economy isn’t all that different from underreporting the tips she used to earn as a waitress in the old economy.

If Fagelson does have a change of heart before tax day, she said she could get money to pay her tax bill by collecting unemployment. But, in her view, that would merely reshuffle money from one branch of the government to another.

“Why bother?”