Since Congress amended IRC § 7623 in 2006, the IRS’ new Whistleblower Office has seen significant interest from potential informants with tips about multimillion-dollar cases of tax noncompliance.
In the first 12 months after it was established in February 2007, the Whistleblower Office received 116 reports of underpayments of more than $2 million each. Moreover, 24 of those tips involved more than $10 million each in unpaid taxes. The quality of the information appeared promising, the Whistleblower Office’s director, Stephen A. Whitlock, told Congress in his 2008 annual report. “The individuals submitting this information claim to have inside knowledge of the transactions they are reporting, often with extensive documentation to support their claims,” Whitlock wrote.
With so much potentially at stake, some lawyers have specialized in representing whistleblowers. Often, a CPA approached by someone with information might automatically refer that person to an attorney, but the CPA may be better suited than most lawyers to perform much of the groundwork that such a claim entails, starting with helping potential whistleblowers determine whether they have a valid claim and then helping them document and submit it. Furthermore, while the new law has focused attention on high-dollar claims, those under the old law, which still governs tips on underpayments of less than $2 million, may also be on the rise as a result of the renewed attention. To that end, this article outlines provisions of the program and recent guidance, along with observations about roles CPAs might play.
Section 7623(a) authorizes payments to private citizens for assistance in detecting underpayments of tax and tax evasion. Rewards are paid as a percentage of the taxes, interest and penalties collected, based on the value of the informant’s information. Rewards can also be paid if the information leads to the denial of a claim for refund that otherwise would have been paid but should not be. Historically, rewards were limited to 15% of the amount of the underpayment, with a maximum reward of $2 million.
The program was generally considered an effective method of identifying and collecting unpaid taxes. In a June 2006 audit, the Treasury Inspector General for Tax Administration (TIGTA) found that from fiscal years 2001 through 2005, the program was responsible for recovering more than $340 million in taxes, fines, penalties and interest, with rewards of more than $27 million paid to informants. The public participation was all the more impressive, TIGTA said, given that the IRS, apparently stung by public and congressional criticism in the 1990s of its enforcement and collections policies, seemed to have gone out of its way not to publicize the program; the IRS Web site in 2006 contained no references to the whistleblower provisions beyond listing the reporting form (Form 211, Application for Award for Original Information) among those available for download. (Now the Whistleblower Office pages are at irs.gov.) TIGTA supported expanding the program, since examinations arising from informant information were often more effective and efficient than the IRS’ primary enforcement method of selecting returns for examination, it said.
But at the same time, TIGTA criticized the program’s management for long delays in processing claims and a lack of accountability in deciding them. It found an average delay of 7½ years between the initial filing of a claim and payment of an award. It also found sloppy recordkeeping and that many apparently valid claims were rejected for no recorded reason.
The Tax Relief and Health Care Act of 2006 sought to correct these deficiencies. It added section 7623(b), taking away the Service’s discretion in giving high-dollar rewards. Other important changes to the law in 2006 included:
Boosting the maximum award to 30% of collected proceeds for eligible cases;
Setting a minimum award of 15% of collected proceeds in those cases;
Providing appeal rights to claimants up to and including an appeal to the Tax Court; and
Creating the Whistleblower Office, which reports directly to the IRS commissioner. (Previous efforts were regional and did not provide for any national recordkeeping.)
To deter abuse, Congress reduced the maximum reward to 10% for claims based on publicly available information. The Service is also authorized to reduce rewards to informants who planned or initiated the conduct that led to the underreporting or underpayment and deny them to informants convicted of a crime in connection with that conduct. The Service was also required to warn informants that giving false information could subject them to the penalties of perjury.
The 2006 amendment, however, is applicable only to cases where the total taxes, interest and penalties exceed $2 million and, in cases involving individual taxpayers, where the taxpayer has gross income exceeding $200,000 in any taxable year subject to the claim (section 7623(b); see also “Tax Practice Corner: Whistleblowers Wanted,” JofA, May 07, page 86).
These thresholds may have discouraged some people from filing claims. There is a perception among many practitioners that no award may be paid unless the loss meets the section 7623(b) thresholds. This is incorrect. Section 7623(a) and Treas. Reg. § 301.7623-1 still apply to smaller dollar-value cases. The IRS has recently amended its Web site to clarify that such smaller cases are still eligible to share in awards under the older regime of up to 15% of taxes and penalties. Keep in mind, however, that Congress extended the award amount to include a proportion of interest on the underpayment only with respect to 7623(b) cases. In addition, section 7623(a) rewards still lack a right of appeal.
FILING THE CLAIM
In January 2008, the IRS issued additional guidance in Notice 2008-4, 2008-2 IRB 253, setting forth basic information required of informants when submitting a claim. Also detailed on Form 211 and its instructions, this required information includes documentation supporting the underpayment and its amount or an indication where documentation can be found. The informant is also required to explain his or her relationship to the taxpayer. Providing as much documentation and information as possible helps assure that the information will be acted upon. This is an area where CPA practitioners, with their knowledge of substantiation requirements and practices, can provide valuable assistance.
CPA tax advisers may also be asked about whistleblowers’ own tax liability for rewards as gross income. Notice 2008-4 specifically states that awards are subject to all current reporting and withholding requirements. It clarifies that Treasury Department and other government workers acting within the scope of their employment are ineligible for awards. The notice also proclaims the Service’s policy of protecting the informant’s identity “to the fullest extent permitted by law.” Practitioners are reminded to advise clients interested in the program, however, that in a judicial proceeding the whistleblower may nonetheless be identified and called as a witness.
The Service’s chief counsel also issued internal guidance to IRS personnel on the program last year (Chief Counsel Notice CC-2008-011) advising special caution when the whistleblower is an employee of the targeted taxpayer and prohibiting contact with any would-be whistleblower who represents the taxpayer before the IRS. If the whistleblower is an employee of the taxpayer, Service personnel will generally meet with the whistleblower only once. The government may use information obtained illegally only if it received it passively and did not encourage the whistleblower’s activities. Meeting multiple times with the person could create an appearance of encouraging him or her to improperly gather information on the employer. Again, if you are assisting a client with a whistleblower claim and the client is an employee of the taxpayer, make sure the client provides as much documentation as possible. Your client may only have one chance.
If the whistleblower is also the taxpayer’s representative, such as a CPA representing the taxpayer before the IRS, it is inappropriate for IRS personnel to receive the information or to have any contact with the representative, the chief counsel notice advises. Instead, the Service will inform the taxpayer that it no longer considers the CPA or other representative to be representing the taxpayer before the IRS. In other words, the Service will expose practitioners unwisely thinking they can collect an award by informing on a client. The same stricture applies to a party who becomes a representative of the taxpayer after giving information. Circular 230 and, for CPAs, Professional Conduct Rule 301, may also prohibit such conduct. A federal court earlier this year refused to dismiss a civil suit or prevent discovery against a practitioner accused of providing confidential information about a former client to the IRS for compensation (Alpert v. Riley, U.S. District Court for the Southern District of Texas, no. H-04-CV-3774). Thus, while it’s obvious that CPAs should never blow the whistle on their own tax clients, they also should avoid any appearance of colluding with another person to circumvent these rules. If their own client is the target of a whistleblower claim, the client should be advised to seek legal counsel.
Practitioners have the ability to help their clients by informing them of the program and assisting in the filing of claims. If frequently cited tax gap projections of hundreds of billions of dollars in unreported income and uncollected taxes annually are accurate, plenty of potential claimants are out there.
TAX WHISTLEBLOWING NOT NEW
The government’s ability to pay rewards for information about tax law violations is even older than the current federal income tax. In 1867, the secretary of the Treasury was authorized to pay awards “for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws.” Between 1867 and 1996, few changes were made to the program.
In 1996, amendments clarified that payments could be made to persons who assisted the Service in detecting underpayments of tax. That year, the law also indicated that payments to informants should be made from proceeds collected rather than appropriated funds. Although the IRS also adopted comprehensive regulations for the whistleblower program, the program remained fraught with problems and inconsistencies.
The IRS Whistleblower Office received more than 100 tips of multimillion-dollar tax cheating in one year following measures that reformed the program in 2006.
CPAs may be approached by individuals with some knowledge of the program and information that could lead to a reward.
CPAs are in a good position to advise potential informants on the program’s requirements and whether their information is likely to demonstrate an underpayment of taxes that could qualify for a reward under the program.
Under the program, the maximum reward is 30% of the collected proceeds and the minimum 15% for an eligible case—generally, an unreported tax liability of more than $2 million, including interest and penalties, or for individual taxpayers, where gross income exceeds $200,000 for the tax year.
However, even claims involving amounts less than the threshold qualifications can be filed under earlier provisions, which still allow rewards of up to 15% of taxes and penalties (but not interest).
The IRS has provided guidance on the method and information required for filing claims and has advised on situations where the informant is an employee of the taxpayer.