The Internal Revenue Service has given a $2 million reward to a whistleblower who exposed an alleged tax avoidance scheme by an Illinois tool maker that cost the U.S. Treasury hundreds of millions of dollars.

The allegations reported by the anonymous whistleblower against Illinois Tool Works involved the artificial replication of tax basis. A Swiss bank allegedly duplicated its own tax deductions in order for ITW, as a client and unrelated taxpayer, to claim the same deductions as an offset to ITW’s otherwise taxable income.

It is the third time the whistleblower, represented by Phillips & Cohen LLP, has received a seven-figure reward from the IRS, the law firm noted. Last year, the IRS Whistleblower Office awarded him $1.1 million for information about abusive tax shelters allegedly set up by Wall Street banks to help Enron evade taxes on more than $600 million of taxable income.

“This award shows how valuable one whistleblower can be,” said Erika A. Kelton, a whistleblower lawyer in Washington, D.C., with Phillips & Cohen LLP. “Our client is a Wall Street insider who provided the IRS with detailed information about numerous abusive tax shelters and was persistent in his efforts to convince the IRS to investigate.”

Phillips & Cohen’s client remains anonymous to protect his career. Under the name “Mr. ABC,” he testified about the IRS whistleblower program in 2004 as a confidential witness before the Senate Finance Committee.

Of the tax avoidance at Illinois Tool Works, he said, “When I looked through all the financial engineering and big words, I believed it was just a fake deduction scheme.”

Although the precise amount of the government’s recovery from ITW is unknown, ITW’s filings reflect a $383 million write-down of its deferred tax asset in connection with the resolution of its U.S. basis replication liability as well as German tax audits. The write-down originally was $580 million, but was reduced partially due to a legal restructuring by ITW to accelerate the use of existing foreign tax credits to offset its resultant U.S. tax exposure.

“The chances of getting caught for this complex type of tax scheme were highly unlikely unless a whistleblower alerted the IRS to the sophisticated practice,” Kelton said.

The ITW whistleblower originally notified IRS revenue agents of the scheme in 1999 and then filed a formal claim with the IRS in 2001, five years before Congress revised the IRS whistleblower program and created the IRS Whistleblower Office. Because of the previous program’s rules, his reward was limited by a $2 million cap. Under current rules, whistleblowers whose information results in the recovery of more than $2 million for taxpayers are rewarded with 15 percent to 30 percent of the recovery, without any cap. UBS whistleblower Bradley Birkenfeld recently received a $104 million whistleblower reward from the IRS for his information on the Swiss bank where he had worked on behalf of U.S. clients (see UBS Whistleblower Secures $104 Million Reward).

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