While the Internal Revenue Service has had an informant program for years, only recently have legislation and administrative developments put significant teeth into it. Most notable are the mandatory monetary awards now required for significant information equal to between 10 percent and 30 percent of the tax, interest and penalties collected.“The new rules have the potential to bring billions of dollars into the Treasury,” predicted Sen. Charles Grassley, R-Iowa, on the passage of the enabling provision within the Tax Relief and Health Care Act of 2006. At least several law firms that specialize in Federal Claims Act litigation are now branching out into whistleblower representation, reporting several billion dollars in suits already pending.
While the danger of strategies going awry has always accompanied tax practice, the prospect of being second-guessed unquestionably increases when people have a financial incentive to call those strategies to task. It’s important, therefore, for business tax planners to know the whistleblower rules, where they are headed and, most important, how to develop procedures that keep problems contained within the organization.
BACKGROUND
The Tax Relief and Health Care Act of 2006 significantly strengthened the IRS’s whistleblower informant program. Amended Code Section 7623(a) created a Whistleblower Office within the IRS. It also increased the monetary incentive for informants to report tax law violations and created a mechanism through which whistleblowers could enforce their right to an award.
Under amended Code Sec. 7623(b), the amount of the award available to an informant must fall between 15 and 30 percent of the total amount recovered by the IRS. Within the IRS’s structure, the Whistleblower Office, which was established by the 2006 act, would make the determination of whether the award should be paid under the statutory guidelines and, if so, the amount to be paid within the 15 to 30 percent of the collected proceeds. Under certain circumstances, such as information also being received elsewhere, the service can limit an award to 10 percent.
The Whistleblower Office’s determination of whether the information provided substantially contributed to a recovery is subject to Tax Court review.
ELIGIBILITY
To claim a mandatory award under Code Section 7623(b), the tax, penalties, interest, additions to tax, and other additional amounts in dispute must exceed $2 million. In addition, the taxpayer against whom the charges are made — if an individual — must have gross income that exceeds $200,000 for each taxable year at issue. Claims below these thresholds will be processed under Code Sec. 7623(a).
Either claim must be filed using the new Form 211, Application for Award for Original Information. Only individuals acting in a non-government capacity may file a claim.
RECENT DEVELOPMENTS
Notice 2008-4, released in January, offers interim guidance on filing claims with the Whistleblower Office under Code Sec. 7623. It addresses threshold-filing requirements and outlines how informants are to report information relating to alleged noncompliance.
Next, temporary and proposed regs issued in March detail the procedures under which the IRS may disclose tax return information to a whistleblower to help in the investigation. These regulations, under the authority of Code Section 6103(n), require a written contract with limitations and safeguards; they also require such disclosure agreements to be used “infrequently.”
Notice 2008-43, also issued in March, announced interim guidance under Section 10.27(b) of Circular 230 clarifying the limited circumstances when a practitioner may charge a contingent fee. A contingent fee for whistleblower claims is among the short list of those allowed. Assuming a minimum recovery threshold of $2 million, a 40 percent contingent fee carries a minimum $240,000 amount. Higher amounts become even more of an incentive to provide the whistleblower with expert representation.
Current attention to the subject has not been confined to for-profit entities either. Whistle- blowing also is a tool being used by the IRS in its growing investigation of abuse in the area of tax-exempt organizations. One of the questions under the new Form 990, which tax-exempt organizations would be required to file starting for 2008, asks in its core governance section about whistleblower policies.
Recently unveiled draft instructions are even more pointed, describing a whistleblower policy as one that “encourages staff and volunteers to come forward with credible information on illegal practices or violations of adopted policies of the organization, specifies that the organization will protect the individual from retaliation, and identifies those staff or board members or outside parties to whom such information can be reported.”
FIRST YEAR REPORT OVERDUE
The year-end 2006 tax legislation had instructed the Treasury and the IRS to issue a report within one year on the operation of the program and the Whistleblower Office. The Senate Finance Committee sponsored a roundtable discussion on the operations of whistleblower complaint systems in February. At that meeting, the Whistleblower Office’s director said that there is a proposal to lower the reporting threshold from $2 million to $20,000. The writing on the wall is that there will be more changes to this area as data and experience over the initial start-up period is evaluated. The report, when it is finally released, should also clarify what happens next.
INNOCENT MISTAKES
Given the potential for a lucrative recovery, Whistleblower Office personnel undoubtedly will sift through stacks of claims from disgruntled employees, ex-spouses and others with a grudge motivated by the increased awards. The additional costs to the taxpayer for working with IRS investigators are not reimbursable, even when the whistleblower is proven to be wrong.
Unfortunate, too, is the fact that the whistleblower statute does not only apply to criminal behavior. Under the statutory scheme, unintentional and innocent behavior that results in a tax liability also is covered if it results in a recovery of taxes. This also presents the likelihood that certain tax strategies will be called to the attention of the IRS when they ordinarily might escape audit.
PREVENTION
In many ways, the Form 990 draft instructions get it right: putting into place a responsive whistleblower policy is good practice, whether for a not-for-profit or a for-profit business. The size of the recoveries available to whistleblowers may create an atmosphere that incentivizes employees to report mistakes to the IRS, rather than bringing them to the attention of their employers so that they might be corrected. Employers must create other incentives as a counterbalance.
Since the new whistleblower awards are aimed at fairly large organizations due to the minimum $2 million that needs to be at issue to trigger the new provision, most small and even midsized businesses are spared dealing with these rules, at least until they might be expanded in the future.
Any size business, however, might do well to work with its legal department, human resources administrators and consultants to structure a formal internal whistleblower policy. The system should strive to empower employees and create as one of their job responsibilities an oversight responsibility that requires reporting up the internal chain of command any matters that otherwise might become the subject of new Code Section 7623(b).
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
