More Cheese for the Rats: Tax Court and Congress Give Big Win to Whistleblowers with Broad Definition of "Proceeds": Whistleblower 21276-13W v. Commissioner of Internal Revenue.

• Author: Carman, Stephen W.
• Position: NOTE

1. INTRODUCTION

   The United States has a voluntary tax compliance system, whereby the burden to report income and take appropriate deductions is on the taxpayer. (1) This self-reporting system encourages some taxpayers to underreport their taxes owed, as a result of fraud or simply a misunderstanding of the Tax Code. (2) This underreporting has created a tax gap, the difference between what the Internal Revenue Service ("IRS" or "the Service") receives and what is actually owed. (3) One avenue for the IRS to combat this tax gap is through a program that rewards those who provide leads to the Service that result in recovering significant revenue for the federal government. (4) The Service has this option through section 7623 of the Internal Revenue Code ("IRC" or "the Code"), which created a whistleblower program to reward informants for information leading to "detecting underpayments of tax" or "detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same." (5)

   To be successful, the whistleblower program should provide an adequate incentive for whistleblowers to risk their reputations and careers and come forward with information, while also maintaining its ability to collect sufficient revenue to close the tax gap. (6) This balancing was at issue in Whistleblower 21276-13W v. Commissioner, where the Tax Court evaluated whether proceeds collected under provisions not located in the IRC, including the criminal fines and civil forfeitures at issue in the case, should be considered in the payment of a whistleblower award. (7) The Tax Court ruled in favor of a broad interpretation of the statute, giving a win to whistleblowers by increasing their potential rewards. (8) After the Tax Court's decision, Congress cemented this whistleblower victory by amending section 7623 to explicitly include criminal fines, civil forfeitures, and other reporting penalties. (9) While the broad holding and statutory amendment certainly increase the incentive for whistleblowers to come forward with information, (10) the new law partially hinders the ability of the whistleblower program to make a dent in the tax gap. This note examines the impact of this decision and the subsequent statutory amendment on the whistleblower program and suggests changes to make the program most capable of rewarding whistleblowers while also closing the tax gap.

2. FACTS AND HOLDING

   Section 7623(b) of the Code mandates the Commissioner of the IRS to provide whistleblowers with awards for information that results in the Service's detection of underpayment of taxes or its ability to bring to justice individuals guilty of violating the internal revenue laws of the United States, provided that the qualifications of section 7623(b)(5) are met, which require the taxpayer have a gross income greater than $200,000 and "the proceeds in dispute exceed $2,000,000." (11) In hopes of an award under these provisions, the petitioners in Whistleblower 21276-13W v. Commissioner of Internal Revenue, a husband and wife, filed an Application for Award for Original Information with the IRS Whistleblower Office. (12)

   The involvement of the petitioners in the tax recovery consisted of them working with the federal government to tackle a large, targeted business for tax evasion. (13) The husband worked with clients engaged in illegal activity, and his involvement in the case began when he entered into a plea agreement with the Department of Justice to testify to the entity structure used by his clients for illegal activity, which consisted of a large foreign business. (14) In his testimony, he informed the government that a foreign business assisted U.S. taxpayers with tax evasion. (15) While he did not have the necessary documentation to incriminate the targeted business, he knew a senior officer who did, and the petitioner husband developed a plan with the government to bring this officer to the United States, where the government could arrest him, question him, and ask him to incriminate the targeted business. (16)

   To carry out this plan, the wife flew to England and met with the senior officer and explained to him that she and her husband had been paid $1.2 million in embezzled money that they had not paid taxes on and to seek his aid with the problem. (17) After no one had heard from the senior officer for weeks, the government sent the petitioner husband to the Cayman Islands to meet with the same senior officer. (18) Following this meeting, the petitioner wife was again sent to England to meet with the senior officer. (19) After further discussing the plan to move the $1.2 million to a safe account, the senior officer came to the United States. (20) A promise of $15,000 incentivized him to violate an instruction by the targeted business to not come to the United States, where he was arrested and later assisted the government in its investigation of the targeted business. (21) The investigation led to the government finding that the targeted business managed $1.2 billion in secret accounts in order to prevent the Service from finding the money and the income that arose from the accounts. (22)

   Following a guilty plea, the targeted business paid $74,131,694 in tax restitution, a criminal fine, and civil forfeitures to the government for "conspiring to defraud the IRS, file false Federal income tax returns, and evade Federal income tax in violation of 18 U.S.C. sec. 371." (23) The IRS initially denied the petitioners an award on the grounds that they had not submitted the award request forms prior to providing their information. (24) But the Service ultimately granted the award as a result of the Tax Court's holding that failure to submit a timely award claim does not preclude whistleblowers from receiving an award. (25) After the appropriateness of the award was decided by the Tax Court, the parties disagreed as to the amount of the award, with the whistleblowers arguing that they were entitled to a portion of the tax restitution, criminal fines, and civil forfeitures, and the Service arguing that they were entitled only to a portion of the tax restitution. (26)

   The parties' dispute centered around differing interpretations of the term "collected proceeds" as was found in section 7623(b)(1) of the Code at the time of the case. (27) Section 7623(b)(1) stated that, assuming the other qualifications are met, the whistleblower will "receive as an award at least 15 percent but not more than 30 percent of the collected proceeds (including penalties, interest, additions to tax, and additional amounts) resulting from the action (including any related actions) or from any settlement in response to such action." (28) The whistleblowers argued that "collected proceeds" included the entire $74 million collected from the taxpayer, entitling them to a portion of the criminal fines and civil forfeitures imposed upon the taxpayers. (29) The Service argued that, under section 7623, only "collected proceeds" recovered under provisions of the Code could be used to pay the award because section 7623 relates only to violations of Federal tax laws, and, therefore, the whistleblowers were entitled only to a portion of the tax restitution. (30)

   After considering the parties' respective arguments, the Tax Court first held the phrase "collected proceeds," as found in section 7623, was "not limited to amounts assessed and collected under [the Code]." (31) Second, the Tax Court held that collected proceeds should be used only when determining the amount awarded to whistleblowers. (32) Finally, the court held that both criminal fines and civil forfeitures were "collected proceeds" when determining a section 7623 award, (33) and therefore, the whistleblowers were awarded twenty-four percent of the total collected proceeds, which included portions of the tax restitution, the criminal fine, and civil forfeitures. (34)

3. LEGAL BACKGROUND

   1. Section 7623

      In 1867, Congress passed what is now IRC section 7623(a), giving the Secretary of the Treasury the discretion to award amounts to promote the "detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same." (35) This law basically remained unchanged during its first 140 years, with courts finding that the Service's decision of whether to award a whistleblower was unreviewable. (36) In 2006, Congress requested review of the whistleblower program, and an audit found the program was underutilized due to administrative problems and inadequate incentives for whistleblowers. (37) The audit concluded that the whistleblower program was generating significant revenue but was capable of more success if issues regarding the Service's discretion to award and the structure of the awards could be remedied. (38)

      Shortly after the audit, Congress passed the Tax Relief and Health Care Act of 2006, which made several significant changes to the Service's whistleblower program. (39) These changes included (1) creating section 7623(b), which made awards to whistleblowers no longer discretionary provided "the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2,000,000"; (2) giving whistleblowers the right to appeal the Service's award; and (3) creating the Whistleblower Office of the Internal Revenue Service to report to the IRS Commissioner. (40) With these changes in place, the whistleblower program has led to the Service recovering large amounts of tax dollars. (41) According to Whistleblower Office Director, Lee D. Martin, "whistleblowers [have] assisted the...