The federal government, through legislation, has stepped up its efforts to reduce the nation's estimated $290 billion tax gap through the help of IRS whistleblowers. The tax gap is the difference between what the Internal Revenue Service estimates it is owed and what it actually collects. A provision in the Tax Relief and Health Care Act of 2006, signed into law in December 2006, increased the motivation and potential rewards for people providing tips on individuals and businesses that substantially underpay income taxes.
Although enacted more than 18 months ago, the legislation is still evolving. Significant developments during the last several months include the issuance of several IRS notices and temporary regulations for filing whistleblower claims, as well as proposed amended rules and procedures from the tax court for filing appeals from IRS whistleblower award decisions.
While whistleblower provisions have existed for more than 100 years, the earlier provisions offered little incentive for whistleblowers to report tax fraud and tax violations, given that rewards to whistleblowers were discretionary, infrequent, slow and small. Despite the success of examinations conducted based upon claims by informants, the program was largely ineffective. Factors contributing to the ineffectiveness of the program were that the IRS had complete discretion over the awarding of whistleblower rewards, the amounts were limited to zero to 15 percent of the tax collected and an individual reward could not exceed $10 million. Additionally, the rewards were not well-publicized, the submission and review process was decentralized and an average of seven and one-half years passed between the filing of the initial claim and the payment of the reward. It's no wonder that few informants came forward.
The ineffectiveness of the earlier whistleblower program was in direct contrast to the huge success of another whistleblower statute, the federal False Claims Act. The FCA utilizes tips from whistleblowers to expose and prosecute fraud in federal government programs. Tax violations, however, fall outside the scope of the FCA. Since the FCA was amended in 1986 to boost whistleblower rewards to 25 percent to 30 percent of recoveries (previously 10 percent to 25 percent), the Department of Justice has reported that the federal government's fraud recoveries have increased exponentially, from less than $100 million in 1987 to more than $3 billion in 2006, with over $20 billion in total. The 1986 amendment of the FCA also omitted a cap on the amount recoverable and provided whistleblowers with the right to enforce their claims in federal district court. All of these incentives were absent from the old whistleblower program.
In an effort to expand the IRS whistleblower program, legislation was modeled after the amended FCA and enacted by Congress in December 2006. This legislation increased (in some cases doubling) the awards to whistleblowers. The key changes to the law were:
- The doubling of the rewards to 15 percent to 30 percent of the recovery amount, depending upon the value of the evidence presented.
- The creation of a "Whistleblower Office" to coordinate whistleblower claims and make determinations about rewards.
- The right of whistleblowers to appeal the IRS's reward determination to the U.S. Tax Court.
- The allowance of persons participating in the tax violations to qualify for the increased rewards, so long as they were not involved in the planning or initiation of the acts in question.
The new whistleblower program is limited to claims against individuals whose gross annual income exceeds $200,000 and whose potential tax indebtedness (including interest and penalties) is greater than $2 million. There is no income floor for businesses.
Despite this limitation, the IRS may still grant discretionary rewards for whistleblower claims under $2 million.
There have been considerable developments in the evolution of the new whistleblower program during the last several months, and the IRS has issued several notices as well as temporary regulation 301.6103(n)-2T, which provide essential interim guidance on various issues related to whistleblower claims.
IRS Notice 2008-4 provides interim guidance for filing whistleblower claims under the new IRS Whistleblower Program, while IRS Notice 2008-43 approves the use of contingent fee arrangements in retaining tax whistleblower attorneys. The temporary regulations address how the IRS can disclose and share information with whistleblowers under contracts between the IRS, the whistleblowers and their attorneys.
Additionally, as a result of the right to appeal IRS reward decisions that was created by the 2006 whistleblower provisions, the U.S. Tax Court proposed amending its rules and procedures to include whistleblower award actions. Among the proposed changes are amendments to the rules which provide procedures for commencing whistleblower award actions as well as references to actions for redetermination of employment status and the determination of relief from joint and several liability and lien or levy. Public comments to the proposed amendments may be submitted by July 31.
The Claim Process
All whistleblower claims must be submitted to the IRS Whistleblower Office, under penalty of perjury, using IRS Form 211, Application for Award of Original Information. A detailed summary of the facts and supporting evidence should be submitted along with Form 211 to support the claim. Generalized claims or descriptions are insufficient and specific information is needed to prove the violation. The Whistleblower Office, upon submission of a claim, is responsible for assessing and analyzing the incoming tips. They are responsible for determining the degree of credibility of a claim and whether the case is worth pursuing. When a case is determined to be worth pursuing it will be assigned to the appropriate IRS office for further investigation.
Once a claim is submitted, the informant may only be advised as to the status and disposition of the claim and not the action taken against the taxpayer. Additionally, the IRS will protect the identity of the whistleblower to the fullest extent permitted by the law. However, under some circumstances, such as when the whistleblower is an essential witness in a judicial proceeding, it may not be possible to pursue the investigation or examination without revealing the whistleblower's identify.
Payments of awards to whistleblowers will not be disbursed until after the taxes, penalties, interest, additions to tax and additional amounts that are finally determined to be owed to the IRS have been collected. Additionally, a claim may be denied if: the IRS already had the information from another source; an audit or investigation is conducted but leads to no finding of taxpayer liability; a finding of liability is made but the taxpayer is successful in an administrative or judicial appeal; a finding of liability is made and sustained but there is no collection because the taxpayer has no known assets that the IRS can collect against.
The entire process, from submission of complete information to the IRS until the tax proceeds are collected, can take up to several years.
The IRS also allows and encourages informants to report violations of the tax law without claiming a reward and there are a number of reporting methods available. The filing of IRS Form 3949-A, Information Referral, is generally the most effective approach, however information from informants can also be submitted via telephone calls, office visits and correspondence from an individual wishing to report an alleged tax law violation.
Information referrals are screened by IRS representatives and when a case is determined to be worth pursuing it will be assigned to the appropriate IRS office for further investigation. Cases with unreported income of less than $50,000 per year are typically routed to the service center examination unit, while cases with unreported income of $50,000 or more per year are likely to be routed to an area office criminal investigation in the area where the alleged tax violator resides. Cases involving a failure to pay tax and/or failure to file a tax return are typically routed to a field territory manager.
Successes and Future Prospects
Although the changes to the whistleblower provisions have only been in effect for a brief time, the provisions are already yielding significant results. In the first year of the enhanced program, informants have come forward with evidence on alleged tax noncompliance amounting to tens of millions of dollars, and in some cases hundreds of million of dollars, according to Stephen Whitlock, the director of the Whistleblower Office. More than 80 claims were filed through the end of 2007 with more than half submitted in the final few months.
It is likely that claims will continue to increase dramatically in 2008 and that further IRS guidance will be issued as the program continues to evolve.
Barbara A. Ruth is a senior manager in the tax accounting group of Duane Morris, where she devotes her practice to federal, state and local taxation. Ruth also devotes her practice to litigation consulting services, including criminal and civil tax controversies, damage measurement and marital dissolution.
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