Practical approaches to dealing with whistleblowing.

• Author: Rizzi, Robert

Introduction

Whistleblowers have long been an important part of the enforcement of federal law, and are increasingly part of tax compliance as well. (2) The advent of increased awards for tax whistleblowers, coupled with the growth of high stakes corporate tax disputes, heighten the risk that both disgruntled employees and employees troubled by what they perceive to be unjustified corporate tax positions will resort to reporting their concerns directly to the IRS. These risks are exacerbated by recent developments, including enhanced focus on aggressive tax planning, new information technology and easier access to financial information, and highly publicized cases of large bounties paid to "successful" whistleblowers, both in the United States and abroad. (3) In the face of this state of affairs, corporate taxpayers must understand the operation of the whistleblower rules under the Code and adopt practical responses to mitigate the risks they face. They would also be wise to benefit from the experience of companies with whistleblowing in non-tax but parallel fields.

From a policy perspective, whistleblowing can be viewed as an effort to "privatize" aspects of tax enforcement. With that comes the potential for abuse as the promise of "easy money" may motivate whistleblowers to come forward with a laundry, list of issues in the hope something will stick. They may also try to pervert ordinary tax planning, with its acknowledged risks and uncertainties, into disclosures that yield lucrative awards. Corporate taxpayers are increasingly aware of the dangers posed by this privatization trend, and this potential for abuse. Thus, the expansion of tax whistleblowing requires careful and pragmatic responses to minimize both the potential for whistleblowing and the damage it may cause.

Background

Whistleblowing and related privatized enforcement measures have a long history in the U.S. Perhaps the most famous whistleblower in the modern era was Ernie Fitzgerald, whose efforts led to significant savings for the Defense Department and whose saga led to statutory protections for whistleblowers, including the Whistleblower Protection Act of 1989. (4) The IRS has rewarded whistleblowers on a discretionary basis for many years. (5) The current tax whistleblowing rules, which provide a more structured system for non-discretionary (within limits) payments to informants who provide specific and credible information to the IRS, if the information results in the collection of taxes and related amounts from noncompliant taxpayers, were not enacted until 2006. (6)

Basic Whistleblower Rules

The Whistleblowing rules actually provide for two types of awards. If the total amount of the tax, interest, penalties, additions to tax and additional amounts "in dispute" exceeds $2 million, (7) and if certain other qualifications are met) the statute provides that the IRS will pay 15 percent to 30 percent (the exact percentage is discretionary through its special "whistleblower office") of the "collected proceeds," (9) and for qualifying claims, there is no limit on the dollar amount of the award. (10)

In making the award, the Code requires the IRS to take into account the significance of the individual's information and the role of the individual and his or her legal representatives in the IRS "action" that results in the collection. (11) Within the 15-30% award "band," however, there is still considerable scope for exercise of discretion. Thus, the IRS can consider "[a]ll relevant factors, including the value of the information furnished in relation to the facts developed by the investigation of the violation...." (12) The necessary causal link between the whistleblower information and the reward is based upon a broad "but for" analysis. (13) Furthermore, a key factor in the analysis is that the whistleblower submits information that identifies an issue of a type previously unknown to the IRS, or alerts the IRS to "taxpayer behavior" that the IRS was "unlikely to identify or was especially difficult to detect through the exercise of reasonable diligence." (14) Action by the IRS triggering an award can include a broad range of activity, including the initiation of an examination or investigation that would not otherwise have been undertaken, or the modification of a pending or planned examination or investigation as a result of information provided by the whistleblower. (15) Moreover, even "related actions" are eligible. For example, "if a whistleblower identifies a single instance in which a taxpayer engaged in a particular improper activity and the IRS later identifies other instances in which the taxpayer engaged in the improper activity (or a substantially similar improper activity)," then the collected proceeds may include the aggregated improper activity. (16) Similarly, if a whistleblower identifies specific facts relating to an issue with respect to a taxpayer as well as a specific Code section or specific legal theory associated with those facts but the IRS ultimately collects proceeds based upon a different Code section or different legal theory, the whistleblower will nevertheless be entitled to an award based on the entirety of those collected proceeds. (17)

If a collection results principally from allegations from a whistleblower that themselves were based on judicial or administrative proceedings, government reports, hearing, audit, investigation, or the media, an award of a lesser amount, subject to the discretion of the whistleblower office, may be provided; such an award, however, may not exceed 10% of the collected proceeds, including penalties, interest, additions to tax, and additional amounts resulting from the action. This reduction in award percentage does not apply if the IRS determines that the whistleblower claimant was the initial source of the information that resulted in the proceedings or reports regarding the allegations. (18) If the whistleblower claimant planned and initiated the actions that led to the underpayment of tax, or to the violation of the internal revenue laws, the whistleblower office has the discretion to reduce the award. If the whistleblower is convicted of criminal conduct arising from his or her role in planning and initiating the action, then the IRS must deny the claim for an award to the whistleblower. (19)

The IRS also has a more discretionary award program, where amounts in dispute in connection with the whistleblower claims do not meet the dollar threshold discussed above. (20) However, as a practical matter, this program, which is based upon the discretionary whistleblower rules in effect before 2006, and is now framed by Section 7623(a)...