Tax whistleblowers: prevention and mitigation of costs associated with meritless claims.

• Author: Blair, David B.

A New Challenge

In December 2006, Congress amended section 7623 of the Internal Revenue Code to establish the IRS Whistleblower Office and set forth new procedures for the granting of rewards to individuals whose whistleblowing activities lead to the collection of additional tax. Based on current press reports, since the legislation was enacted, the IRS Whistleblower Office has received claims seeking rewards based on more than $10 billion in taxes, with many of the claims reportedly involving Fortune 500 companies.

Plaintiff firms, and now even traditional tax firms, are representing whistleblowers who want to bring such claims. The lawyers bringing the claims are motivated and serious in pushing the IRS to promptly and thoroughly investigate the claims. The reasons for this explosion in claims are apparent from the face of new section 7623: The statute establishes awards for whistleblowers of between 15 and 30 percent of the tax interest and penalties recovered based on their tips. There is no requirement that the whistleblower's tip uncover fraud or other mal-intent; any underpayment will suffice. Thus, the new statute offers huge financial incentives for employees and others to allege that corporations misreported their tax. For example, if a company had a "should" level opinion on the tax issues related to a large transaction, a whistleblower could still profit under the statute if, upon audit, the company decided to settle by giving up the 20 or even 10 percent of the issue that it considered to be its litigation hazard.

When section 7623 was enacted, it provided financial incentives to individuals bringing forward claims of taxes due to the United States, and called these individuals "whistleblowers." The textbook definition of "whistleblower" is one who reveals corporate illegality or wrongdoing, rather than merely alleging it. The False Claims Act uses the term "relator," which is more neutral and accurately reflects the status of individual plaintiffs who bring cases that may or may not have merit. The language of section 7623, unrestrained by any requirement to demonstrate fraud or other mal-intent, allows rewards to individuals for innocent, non-malicious, corporate mistakes. Indeed, some lawyers are now actively marketing their services to potential plaintiffs based on tax discrepancies arising from items as innocent as return errors. Furthermore, the potential monetary windfalls from becoming a whistleblower are so great that they likely induce people to bring meritless claims. Thus, the term "whistleblower," in the tax context, must now be understood to include a wide range of individuals, from those who bravely report and bring forward fraudulent corporate conduct to those who attempt to line their own pockets based on innocent errors, to those who attempt to capitalize on false claims of wrongdoing in the hopes that they will receive a personal windfall if the company settles a meritless action.

Any responsible company wants individuals who have evidence of corporate fraud to bring it forward so the problems can be corrected--and companies...