Why is the IRS Withholding on Whistleblower Award Payments?
We informed the Whistleblower Office three years ago that we did not believe that the IRS was either required to or had the legal authority to withhold on award payments to whistleblowers under section 7623. With the payment earlier this month of the first whistleblower award under the enhanced provisions of section 7623(b), we knew a decision on this issue must have been reached by the IRS, so we were preparing a FOIA request to obtain these decision documents. The IRS just released a September 2010 document, PMTA 2010-63 [PDF], in which Chief Counsel admits "There is no specific statutory authority to withhold on Whistleblower awards" and as a footnote to that statement, despite their conclusion to the contrary, that "Historically, all identified existing withholding regimes have a statutory basis." Technically, their conclusion relies solely on a line from a Notice 92-6 [PDF] - which appears to have been written by the IRS Public Affairs Division - that was taken completely out of context. However, the IRS tips their hand as to the real reason that they have decided to withhold, which is: "because they can" ... and they believe it will be at least a year before anyone can challenge them on it. (See "Future Challenges" on page 5) That's like saying: why try to efficiently solve a legal issue now with rational guidance and a cooperative process when you can resolve it next year in protracted litigation.
The only conceivable legal authority for withholding on an award to a U.S. whistleblower under section 7623 is the backup withholding provisions of section 3406. However, section 3406 would only permit the IRS to backup withhold if the informant did not provide the IRS with a social security number. A tax whistleblower not having or disclosing a social security number is the exception rather than the rule.
Why does any of this matter? It is common for tax whistleblowers to be represented by counsel, and those individuals typically do not have the resources to pay legal fees on a time and materials basis during the several years that a case may take before an award is paid, if any. Therefore, many whistleblowers utilize contingent fee contracts with their counsel. Congress anticipated this structure and allowed for an above the line deduction for legal fees in section 7623 cases. The withholding that the IRS has begun imposing on whistleblower awards ignores any deductions a whistleblower has for those contingent fees, leading to significant overwithholding. The whistleblower, who in many cases has waited several years for the IRS to utilize his information and collect the underpayment from the taxpayer, waited as much as an additional two years after the payment is made by the taxpayer for the IRS to decide if the award is eligible to be paid, now gets about half of the award he is expecting because of overwithholding. He then must file a claim for refund when his next tax return is due and wait to receive a big refund, all the while receiving no interest from the government for the use of his money for the last 1-3+ years.
Imagine if IRS did the same thing in another context: what if IRS decided to withhold at the 35% corporate rate on all payments made this year to one of their contractors, such as IBM. The halls of the IRS would immediately fill with IBM lobbyists. They would not only be arguing that the IRS had no legal authority to withhold, but that by withholding on a gross payment for services, the IRS has ignored their deductible costs, resulting in overwithholding of tax which would only be applied to their net taxable income.