The IRS recently withdrew its appeal of a 2016 Tax Court ruling, Whistleblower 21276-13W v. Commissioner, 147 T.C. 4 (2016), which held that a husband-and-wife team of tax whistleblowers were entitled to recover a share of all proceeds recovered by the IRS from a delinquent taxpayer, including fines and civil forfeitures.
The Tax Court’s decision in Whistleblower 21276-13W thus will remain the law for the foreseeable future and powerfully incentivizes would-be whistleblowers to alert the IRS to potential tax fraud. As explained below, however, the IRS’ decision to drop the appeal might be a short-term setback in a long-term chess game over which categories of funds should form the basis of tax whistleblower awards.
Background
Years of complex criminal and civil litigation preceded the Tax Court’s decision. In 2009, one of the eventual whistleblowers, P, was arrested for participating in a conspiracy to launder money from the sale of pirated compact discs. He pled guilty in 2010 and, in exchange for leniency, agreed to assist the IRS and other government agencies by providing information on his clients’ illegal activities. While in detention, P tipped off the IRS to a foreign business that helped American taxpayers evade federal income tax and, along with his wife, assisted the IRS in luring an executive of the foreign business to the United States for questioning. The foreign business eventually was indicted for conspiring with taxpayers to conceal more than $1.2 billion and paid a total of $74,131,694 to settle the claims, including $20 million in tax restitution, a criminal fine of approximately $22 million, and civil forfeitures totaling approximately $32 million.
Following the settlement, P and his wife petitioned the Tax Court for an award pursuant to 26 U.S.C. § 7623(b)(1), which authorizes whistleblowers to recover between 15 and 30 percent of the “collected proceeds” from a tax collection action or settlement. After the whistleblowers defeated a timeliness challenge to their petition, the Tax Court faced a novel statutory interpretation question: what types of proceeds are whistleblowers entitled to recover under § 7623(b)(1)? The IRS contended that the whistleblowers were entitled only to a share of the back taxes paid and were not entitled to a share of the collected fine and civil forfeitures. The whistleblowers, on the other hand, contended that they were entitled to a share of the IRS’ entire $74.1 million take.
The Tax Court ultimately agreed with the whistleblowers, holding that they were entitled to a $17.8 million award – 24 percent of the total settlement – for their role in exposing the tax fraud under a plain reading of the statute. Reasoning that § 7623(b)(1) is “straightforward and written in expansive terms,” the Court determined that if Congress wanted to limit the types of funds whistleblowers could recover, “it could, and would, have done so.”
In January 2017, the Tax Court denied the IRS’ motion for reconsideration. The IRS timely appealed the Tax Court’s ruling to the D.C. Circuit, but on March 26, 2018, the IRS dropped its appeal without comment after the parties submitted their briefs and after oral argument was scheduled, but before it was held.
What Lies Ahead
The Tax Court’s decision in Whistleblower 21276-13W creates a powerful financial incentive for prospective informants to blow the whistle, as penalties and civil forfeitures can be substantial, and frequently are substantially greater than the amount of taxes actually owed by a delinquent taxpayer. For example, the practical effect of the whistleblower team’s victory in Whistleblower 21276-13W was their ability to recover over $13 million more than they would have recovered had the IRS prevailed. With increased whistleblower incentives comes increased risk to companies, which should be mindful of potential whistleblower threats from within and without, and which should structure compliance and oversight programs accordingly.
Setting aside its incentivization of would-be whistleblowers, an interesting question undergirds Whistleblower 21276-13W: having briefed the issues, why did the IRS withdraw its appeal at the eleventh hour? Although the IRS does not comment on litigation decisions, one of two possibilities seems likely. Perhaps the IRS reassessed the case’s facts against the judicial draw for oral argument and determined that a reversal of the Tax Court’s decision was unlikely. Rather than risk creating adverse appellate precedent, the IRS may have decided to challenge the Tax Court’s holding through a different set of facts and, potentially, before a different appellate court (or a different panel in the same court). Alternatively, the IRS may have been spooked by the passage of the Bipartisan Budget Act of 2018 during the pendency of the appeal, which defines the term “proceeds” to include “criminal fines and civil forfeitures.” Notably, the IRS advised the D.C. Circuit that it was “analyzing the new legislation” less than three weeks before it dropped the appeal. Congress’ clarification may have spurred the IRS to return to the drawing board in its quest to retain the maximum amount possible of collected proceeds in whistleblower actions. In either scenario, the IRS may have reasoned that the Tax Court’s expansive reading of the statute is ultimately to the IRS’ benefit, since in almost all whistleblower cases, the IRS will recover more than it otherwise would have recovered if the whistle had never been blown at all.
