New IRS Whistleblower Program

The Act amended ' 7623 by creating for the first time in the IRS informant program history a statutory right entitling informants to rewards of 15% to 30% of the collected proceeds (taxes, penalties and interest) for information that directly leads to an administrative or judicial action by the Secretary of the Treasury, and up to 10% of the collected proceeds for 'less substantial' information. The legislation also eliminated any cap on the amount of potential recoveries, which previously was $10 million. The Act allows informants to appeal award determinations by granting Tax Court jurisdiction to review such cases. Under the prior law, judicial review of an IRS award determination was limited to the rare case where there was an express contract with the IRS. Finally, the Act established the IRS Whistleblower Office (WBO) to process and manage the tax informant reward program. The 2006 Act reflects Congress's intent to move the IRS program closer to the False Claims Act (FCA), which permits remedial actions by private citizens.

The IRS Informant Program and the Act

Although plagued by management problems, the IRS informant program has been an effective method of identifying and collecting unpaid taxes. From 2001 through 2005, the IRS recovered $340,329,427 through informant information. An average reward of 10.9% of the collected proceeds (excluding interest) was paid to the informants. Congress ' in a time of budget deficits and a 'tax gap' ' has provided a big financial incentive for employees, business competitors, ex-partners, ex-spouses or any other person who has knowledge of your tax affairs, to become an IRS Secret Agent. Disgruntled persons often go to the IRS ' perhaps more for revenge than money. Now, even the non-disgruntled may be prompted by the Act's promise of large rewards to become IRS whistleblowers.

The Act makes a number of significant changes to encourage informants to come forward, especially in the case of taxpayers avoiding or evading large tax liabilities. However, if information relates to an individual taxpayer, the new entitlement to prescribed percentages (15%-30%) applies only to proceeds collected from individuals whose gross annual income exceeds $200,000 and the potential indebtedness for taxes, penalties and interest exceeds $2 million. To collect a reward for reporting other individual tax evaders, the informant would have to claim under the law and administrative practice as it existed prior to the Act, and any such reward would be subject to IRS discretion. However, where the taxpayer is a corporation or other taxpaying entity, there is no threshold as in the case of individuals.

Almost anyone, except certain present and former employees of the Department of Treasury, may submit information relating to a violation of the internal revenue laws and be eligible to file a claim for reward under ' 7623. Even someone involved in the underlying tax cheating might be eligible! The statute expressly provides that the IRS may reduce an award claimed by an individual who 'planned and initiated' the actions that led to the underpayment or violation but may deny the award completely only if the individual is convicted of criminal conduct arising from his role in planning and initiating the actions that led to the underpayment of tax.

This presents some potentially odd results. An employee in a corporate tax department who was a planner and initiator of some tax plan or scheme (whether criminal or not) can benefit from his or her own wrongdoing. If the planner and initiator is the first to get in the door at the IRS or Department of Justice and negotiates an immunity deal (which would imply no criminal conviction), the wrongdoer could not only escape criminal punishment, but receive up to 30% of the tax, penalties and interest collected from the taxpayer. The IRS is empowered to reduce the reward in this circumstance ' perhaps to a de minimis amount ' if the culpability of the informer is substantial but is not apparently empowered to eliminate it all together.

Informants have always been a good source of both criminal and civil investigations for the IRS. Now they'll probably become a better source. A disgruntled employee working for an employer might previously have decided to shut up or move on and not go to the IRS. Rewards were limited and subject to IRS discretion. Now, there is more certainty and a greater inducement to go to the IRS.

Let's say a corporation decides to engage in a transaction to avoid or evade taxes. A low-level accounting or tax employee who worked on the plan ' who then thought it was aggressive and clever ' does not get his or her promotion. He remembers the tax savings to the company would be $100 million in taxes and now thinks the plan was too clever and perhaps even illegal. He has access to all the internal analysis and documents. Now he or she doesn't need a promotion. Congress has given this employee a golden parachute. With penalties and interest, the company's underpayment can easily double to $200 million. The employee, subject to perhaps some reduction if he or she was a 'planner and initiator,' could be looking at a minimum statutory reward of 15%, which would come to $30 million. These numbers are large for demonstration purposes but reflect very strong financial inducement to go to work for the IRS.

The new legislation appears to be having its intended effect. The Director of the Whistle Blower Office recently indicated that, since its enactment, the IRS has received about 20 reward claims, some involving hundreds of millions of dollars. Some rewards have come from knowledgeable insiders. The head of the Whistle Blower Office, Thomas Whitlock, was quoted as saying about recent informants that 'They're coming in with big, fat piles of paper, and they have, at least on the surface ' some credibility about the information they're bringing to us.' See T. Herman, 'Whistleblower Law Scores Early Success,' The Wall Street Journal, May 16, 2007, at D3.

Significant Impact

The new legislation will have an impact on both civil and criminal tax enforcement. Significant informant claims are screened first for criminal potential. If the employee has information suggesting traditional badges of fraud ' backdating or other concealment activity ' the IRS criminal investigation division might be interested. The IRS is always looking for a vehicle to remind Corporate America of its tax obligations. Nothing gets a company's and its officers' attention better than an IRS criminal investigation.

If a criminal case depends on the whistleblower's credibility and comes down to 'he said, she said,' it may be fraught with problems. On the other hand, if the employee is just bringing information to the IRS, which can be corroborated with evidence developed in a criminal investigation, employers have little legal protection in this area.

Fifth Amendment due-process challenges in criminal cases have been made but rejected by the courts. An employer might fare better on Fourth Amendment grounds if the employee became an agent of the IRS and conducted an illegal search.

Depending upon the relationship of the informant to the taxpayer, the informant may be violating his or her fiduciary or other legal duties to the company, and that conduct might be actionable ' at least where the underlying conduct was not criminal but involved only civil tax liabilities. However, the former employee's potential liability may be of little solace to the corporate officers who are put under the microscope of a criminal investigation.

Conclusion

Congress has provided some very powerful financial incentives encouraging employees and others to become tax bounty hunters. While self-preservation and revenge will no doubt remain the strongest inducements to many, money ' big money ' has its fans. Remember why Willie Sutton robbed banks. 'Because that is where the money is.'

Steven Toscher ([email protected]) is a principal and Heather Lee is an associate of Hochman, Salkin, Rettig, Toscher & Perez, P.C. in Beverly Hills. They specialize in civil and criminal tax litigation.

Caution ' an employee of your company may go to work for the IRS. Well, not in the traditional way. In the Tax Relief and Health Care Act of 2006 ('the Act'), effective Oct. 20, 2006, Congress amended ' 7623 of the Internal Revenue Code, substantially enhancing the IRS's informant or whistleblower program.

Section 7623 has been around in some form since at least 1939. Earlier versions authorized the IRS to pay rewards to informants largely for information leading to criminal tax violations. The statute was amended in 1996 to make clear that it authorizes rewards for information relating to civil violations.

'Statutory Right'

The Act amended ' 7623 by creating for the first time in the IRS informant program history a statutory right entitling informants to rewards of 15% to 30% of the collected proceeds (taxes, penalties and interest) for information that directly leads to an administrative or judicial action by the Secretary of the Treasury, and up to 10% of the collected proceeds for 'less substantial' information. The legislation also eliminated any cap on the amount of potential recoveries, which previously was $10 million. The Act allows informants to appeal award determinations by granting Tax Court jurisdiction to review such cases. Under the prior law, judicial review of an IRS award determination was limited to the rare case where there was an express contract with the IRS. Finally, the Act established the IRS Whistleblower Office (WBO) to process and manage the tax informant reward program. The 2006 Act reflects Congress's intent to move the IRS program closer to the False Claims Act (FCA), which permits remedial actions by private citizens.

The IRS Informant Program and the Act

Although plagued by management problems, the IRS informant program has been an effective method of identifying and collecting unpaid taxes. From 2001 through 2005, the IRS recovered $340,329,427 through informant information. An average reward of 10.9% of the collected proceeds (excluding interest) was paid to the informants. Congress ' in a time of budget deficits and a 'tax gap' ' has provided a big financial incentive for employees, business competitors, ex-partners, ex-spouses or any other person who has knowledge of your tax affairs, to become an IRS Secret Agent. Disgruntled persons often go to the IRS ' perhaps more for revenge than money. Now, even the non-disgruntled may be prompted by the Act's promise of large rewards to become IRS whistleblowers.

The Act makes a number of significant changes to encourage informants to come forward, especially in the case of taxpayers avoiding or evading large tax liabilities. However, if information relates to an individual taxpayer, the new entitlement to prescribed percentages (15%-30%) applies only to proceeds collected from individuals whose gross annual income exceeds $200,000 and the potential indebtedness for taxes, penalties and interest exceeds $2 million. To collect a reward for reporting other individual tax evaders, the informant would have to claim under the law and administrative practice as it existed prior to the Act, and any such reward would be subject to IRS discretion. However, where the taxpayer is a corporation or other taxpaying entity, there is no threshold as in the case of individuals.

Almost anyone, except certain present and former employees of the Department of Treasury, may submit information relating to a violation of the internal revenue laws and be eligible to file a claim for reward under ' 7623. Even someone involved in the underlying tax cheating might be eligible! The statute expressly provides that the IRS may reduce an award claimed by an individual who 'planned and initiated' the actions that led to the underpayment or violation but may deny the award completely only if the individual is convicted of criminal conduct arising from his role in planning and initiating the actions that led to the underpayment of tax.

This presents some potentially odd results. An employee in a corporate tax department who was a planner and initiator of some tax plan or scheme (whether criminal or not) can benefit from his or her own wrongdoing. If the planner and initiator is the first to get in the door at the IRS or Department of Justice and negotiates an immunity deal (which would imply no criminal conviction), the wrongdoer could not only escape criminal punishment, but receive up to 30% of the tax, penalties and interest collected from the taxpayer. The IRS is empowered to reduce the reward in this circumstance ' perhaps to a de minimis amount ' if the culpability of the informer is substantial but is not apparently empowered to eliminate it all together.

Informants have always been a good source of both criminal and civil investigations for the IRS. Now they'll probably become a better source. A disgruntled employee working for an employer might previously have decided to shut up or move on and not go to the IRS. Rewards were limited and subject to IRS discretion. Now, there is more certainty and a greater inducement to go to the IRS.

Let's say a corporation decides to engage in a transaction to avoid or evade taxes. A low-level accounting or tax employee who worked on the plan ' who then thought it was aggressive and clever ' does not get his or her promotion. He remembers the tax savings to the company would be $100 million in taxes and now thinks the plan was too clever and perhaps even illegal. He has access to all the internal analysis and documents. Now he or she doesn't need a promotion. Congress has given this employee a golden parachute. With penalties and interest, the company's underpayment can easily double to $200 million. The employee, subject to perhaps some reduction if he or she was a 'planner and initiator,' could be looking at a minimum statutory reward of 15%, which would come to $30 million. These numbers are large for demonstration purposes but reflect very strong financial inducement to go to work for the IRS.

The new legislation appears to be having its intended effect. The Director of the Whistle Blower Office recently indicated that, since its enactment, the IRS has received about 20 reward claims, some involving hundreds of millions of dollars. Some rewards have come from knowledgeable insiders. The head of the Whistle Blower Office, Thomas Whitlock, was quoted as saying about recent informants that 'They're coming in with big, fat piles of paper, and they have, at least on the surface ' some credibility about the information they're bringing to us.' See T. Herman, 'Whistleblower Law Scores Early Success,' The Wall Street Journal, May 16, 2007, at D3.

Significant Impact

The new legislation will have an impact on both civil and criminal tax enforcement. Significant informant claims are screened first for criminal potential. If the employee has information suggesting traditional badges of fraud ' backdating or other concealment activity ' the IRS criminal investigation division might be interested. The IRS is always looking for a vehicle to remind Corporate America of its tax obligations. Nothing gets a company's and its officers' attention better than an IRS criminal investigation.

If a criminal case depends on the whistleblower's credibility and comes down to 'he said, she said,' it may be fraught with problems. On the other hand, if the employee is just bringing information to the IRS, which can be corroborated with evidence developed in a criminal investigation, employers have little legal protection in this area.

Fifth Amendment due-process challenges in criminal cases have been made but rejected by the courts. An employer might fare better on Fourth Amendment grounds if the employee became an agent of the IRS and conducted an illegal search.

Depending upon the relationship of the informant to the taxpayer, the informant may be violating his or her fiduciary or other legal duties to the company, and that conduct might be actionable ' at least where the underlying conduct was not criminal but involved only civil tax liabilities. However, the former employee's potential liability may be of little solace to the corporate officers who are put under the microscope of a criminal investigation.

Conclusion

Congress has provided some very powerful financial incentives encouraging employees and others to become tax bounty hunters. While self-preservation and revenge will no doubt remain the strongest inducements to many, money ' big money ' has its fans. Remember why Willie Sutton robbed banks. 'Because that is where the money is.'

Steven Toscher ([email protected]) is a principal and Heather Lee is an associate of Hochman, Salkin, Rettig, Toscher & Perez, P.C. in Beverly Hills. They specialize in civil and criminal tax litigation.