Tax Whistleblower Report

A congratulations and a thank you to Erica Brady, who yesterday spoke on behalf of The Ferraro Law Firm’s clients at the public hearing on the Proposed Treasury Regulations that outline how the IRS will interpret section 7623.  Erica joined other practitioners in pointing out that the Proposed Treasury Regulations should not be finalized in their current form. 

Erica reiterated my message from the hearing on the previous Proposed Regulations of, “Do no harm.”  The regulations should not narrow a broad statute or thwart Congressional intent by limiting existing whistleblower’s rights or discouraging whistleblowers from coming forward.  Erica highlighted four topics at the hearing:

1. The narrowing of “Proceeds Based On,”
2. The arbitrary cut off for reduced tax attributes to be included in collected proceeds,
3. The method in which the award percentage is calculated, and
4. When the administrative proceeding starts.

Erica showed a little chutzpah by asking all those assembled in the large IRS auditorium to raise their hand if they thought that the Proposed Treasury Regulations as written would actually attract whistleblowers into the program… but only the hands of those who were responsible for writing the Proposed Regulations went up.  When she asked if anyone who did not have a hand in writing the Proposed Regulations felt that the Proposed Treasury Regulations would help attract whistleblowers, no hands remained up.

Proposed Treasury Regulations for the IRS whistleblower program were released on December 14, 2012.  These regulations cover many issues and deserve a complete reading; however, below is a short outline of what each section of the proposed regulations covers.

§301.6103(h)(4)-1, Disclosure of returns and return information in whistleblower administrative proceedings.

This section of the proposed regulations establishes that that a whistleblower administrative proceeding (as described in §301.7623-3) is an administrative proceeding pertaining to tax administration within the meaning of section 6103(h)(4).  Therefore, the Director, officers, and employees of the Whistleblower Office may disclose returns and return information (as defined in section 6103(b)) to the whistleblower (or the whistleblower’s legal representative) to the extent necessary to conduct a whistleblower administrative proceeding.

§301.7623-1, General rules, submitting information on underpayments of tax or violations of the internal revenue laws, and filing claims for award.

This section of the proposed regulations provides the general rules for submitting information and filing claims for an award.  This is the “who, what, when, where, and how” of submitting a claim for an award.  A whistleblower must follow these rules to ensure that their claim for an award is appropriately filed to ensure that the IRS Whistleblower Office will consider their claim for an award.  The proposed regulations in section 301.7623-1(e) states that the IRS will use its best efforts to protect the identity of whistleblowers.

§301.7623-2, Definitions

This section of the proposed regulation defines key terms used in the statute and the regulations.  The proposed regulations build on definitions in the current regulations and define additional key terms for section 7623.  These definitions will affect how the IRS Whistleblower Office interprets section 7623 and ultimately will makes award determinations based on these definitions.  How “proceed based on,” “related action,” and “collected proceeds” are defined will greatly influence the number of awards issued and the amount of those awards. 

Particular attention should be paid to the definition of “proceed based on” and “collected proceeds.”  The definition of “proceed based on” in the proposed regulations seems to be reading the word “only” into the statute and requiring that the IRS take action that it would not have taken but for the information provided to be award eligible.  This reading goes beyond the language of section 7623, which simply requires that the IRS use the whistleblower’s information in an administrative or judicial action in order for the whistleblower to be able to collect an award.  The proposed regulations appear to assume that the IRS would discover an issue simply because the issue was listed generally in an audit plan.  Hopefully, this narrowing of the statute will be addressed in the final regulations after hearing comments from the public.  Either way, we are confident that this regulatory expansion would not survive judicial review.

The definition of “collected proceeds” continues to be an area that should be focused on.  The proposed regulations continue to claim that criminal fines are not part of collected proceeds; however, as discussed at length on this blog and elsewhere, this position goes against the language of the statute and the intent of Congress.  The definition of collected proceeds also touches on the inclusion of tax attributes in collected proceeds.  The preamble to the regulations goes into more detail illustrating that tax attributes that are used as of the date that the award computation is made will be counted as collected proceeds.  There does not appear to be a clear legal theory behind this cut off, but our discussions with various IRS personnel suggests this is an administrative compromise.

§301.7623-3, Whistleblower administrative proceedings and appeal of award determinations.

This section provides outlines of the administrative proceedings and appeal rights for award determinations.  The largest changes here are the creation of administrative proceedings for cases that do not meet the requirements of section 7623(b) (under §301.7623-3(b)) and claims that are denied (under §301.7623-3(c)(7)).  The creation of the administrative procedures for denied cases is likely to reduce the number of whistleblower cases filed in the United States Tax Court that are ultimately dismissed because the IRS did not use the information, did not detect an underpayment of tax based on the information, or collect proceeds based on the information.  The proposed regulations states that, “The Whistleblower Office will send to the claimant a preliminary denial letter that states the basis for the denial of the claim.”  §301.7623-3(c)(7).  This letter and administrative proceeding should provide claimants with a sense of closure as to what happened with the information that was provided. 

§301.7623-4, Amount and payment of award.

This section outlines the procedures that the Whistleblower Office uses to determine the award amount, including what factors are considered in determining the award percentage, what happens when there are multiple independent claimants, and when payment of an award is made.  In particular whistleblowers will want to look at §301.7623-4(c)(3), which discusses the Whistleblower Office’s application of “planned and initiated” for purposes of reduction or denial of an award.  If the Whistleblower Office determines that a claim for award is brought by an individual who planned and initiated the actions, transaction, or events that led to the underpayment of tax, the Whistleblower Office may appropriately reduce the amount of the award percentage that would otherwise result under section 7623.  Section 301.7623-4(c)(3)(ii) of the proposed regulations states when the IRS Whistleblower office is determining whether a whistleblower planned or initiated the scheme that the IRS Whistleblower Office will look at whether the individual “(A) Designed, structured, drafted, arranges, formed the plan leading to, or otherwise planned, an underlying act, (B) Took steps to start, introduce, originate, set into motion, promote or otherwise initiate an underlying act, and (C) Knew or had reason to know that there were tax implications to planning and initiating the underlying act.” 

The Tax Court dismissed a whistleblower’s complaint that challenged the IRS’s decision not to act on the whistleblower’s information.  In Raymond Cohen v. Commissioner of Internal Revenue, 139 T.C. No. 12 (October 9, 2012), the Tax Court holds that section 7623(b) does not authorize the Tax Court to order the IRS to reopen Petitioner’s award claim.

The Petitioner, Raymond Cohen, is a CPA who provided information to the IRS Whistleblower Office regarding a corporation that he believes had unreported income from uncashed dividend checks that had not been turned over to the state.  The Whistleblower Office informed Mr. Cohen that he was not entitled to an award because no proceeds were collected based on the information he provided.  Mr. Cohen requested the Whistleblower Office to reconsider the claim.  The Whistleblower Office reiterated the denial, noting that the claim was based on publicly available information.  Mr. Cohen filed a petition with the Tax Court requesting that the Tax Court order the IRS to reopen his claim, arguing that the IRS abused its discretion by not acting on his information.  The IRS moved to dismiss for failure to state a claim upon which relief can be granted.

The opinion’s reasoning starts with a review of the Tax Court’s ability to review whistleblower award determinations.  Tax Court may exercise jurisdiction only to the extent authorized by Congress.  In a whistleblower action, that jurisdiction is limited to the Commissioner’s award determination.  The opinion states that the “jurisdiction under section 7623(b) does not contemplate that we review the Commissioner’s determinations of alleged tax liability to which the claim pertains.  See Cooper v. Commissioner, 136 T.C. 597, 600 (2011) (Cooper II).  Nor does section 7623 confer authority to direct the Commissioner to commence an administrative or judicial action.  Id.”  Mr. Cohen admits that his information did not lead to the Commissioner commencing an action against, or collecting any proceeds from the corporation.  Nevertheless Mr. Cohen argues that he should be granted relief.  Mr. Cohen first argues that he is entitled to relief because the IRS did not comply with the Administrative Procedure Act (“APA”).  The opinion states that “[t]he APA, however, does not create a right of action or expand our jurisdiction.  See Anonymous v. Commissioner, 134 T.C. 13, 19 (2010).”  As the APA does not expand the Tax Court’s jurisdiction the Tax Court can provide relief under section 7623(b) only after the Commissioner has initiated an administrative or judicial action and collected proceeds.  Mr. Cohen’s second argument is that he is entitled to a legal and factual explanation of respondent’s denial of the claim.  While the opinion in Cooper II noted that the Commissioner had produced through the course of litigation a memorandum explaining why the whistleblower claim had been denied, the court “did not hold that the Commissioner was obligated under section 7623 to detail his legal and factual reasons for not pursuing a claim.”  Mr. Cohen’s third argument is that he is entitled to equitable relief; however, the Tax Court is not a court of equity and section 7623 does not provide for equitable relief. 

For these reasons, submissions made to the IRS Whistleblower Office should be carefully prepared and should act as a roadmap that the IRS can simply follow to detect underpayments, making the decision to act on the information an easy one for the IRS.

As discussed in an earlier blog post, the Tax Court formally adopted amendments to the Tax Court Rules of Practice and Procedure on July 6, 2012.  The amendments rules include Rule 345, which provides that a whistleblower may proceed anonymously by redacting the whistleblower’s identifying information, if appropriate, and provides that the taxpayer’s identifying information be redacted.  On September 13, 2012, the IRS issued CC-2012-016 to alert its attorneys to the amendments to the Tax Court Rules and how the IRS will implement the rules.  The discussion of Rule 345 focuses largely how to prevent the whistleblower from disclosing the taxpayer’s information to third parties outside of the whistleblower’s Tax Court appeal of a whistleblower award determination.

The notice asks IRS attorneys to balance privacy concerns of taxpayers with the need for disclosure of taxpayer information to whistleblowers.  The notice points out that Rule 345 “does not require that confidential taxpayer information be sealed or otherwise protected in whistleblower cases.  Instead, the court stated it will address the need to protect nonparty taxpayer information on a case-by-case basis.”  The notice states that “section 6103(h)(4) may permit the disclosure of nonparty taxpayer information to a petitioner in a whistleblower award case during discovery, but neither a petitioner nor petitioner’s attorney are under any duty not to further disclose that information once it has been produced to them.”  When the Tax Court announced the finalization of the amendments, the court explained that section 7461(b)(1) provides ample authority for the court to protect the confidential taxpayer information on nonparty taxpayers in whistleblower award cases.  The notice instructs attorneys to be mindful of limitations on discovery in Rule 70(b)(1), which limits discovery to matters that are not privileged and relevant to the pending case.  To limit redisclosure of the taxpayer’s information that is produced in discovery or at trial the IRS may seek a protective order under Rule 103, under the appropriate circumstances.  So far there is no elaboration of when the IRS considers it appropriate to seek a protective order to prevent the redisclosure of nonparty taxpayer information.

An interesting letter was released last night from IRS Commissioner Shulman to Senator Grassley.  Commissioner Shulman’s letter says more about what is in the pipeline for large whistleblower case award determinations than any statement the IRS has made to date, much more so than even the annual reports that the Whistleblower Office is required by law to provide to Congress.  Shulman says that: 3 award determinations have already been made (and presumed paid), 3 more award determinations are in progress, 9 cases are closed out and waiting for the statutes of limitation to run, and another 60+ have resulted in audit adjustments already that look like they will result in mandatory awards.  We know of a bunch more cases with proposed adjustments, so the case pipeline is moving slowly but surely.  The IRS is still leaving huge dollars on the table in some cases, and while that’s to be expected as part of the tax controversy process, it still disturbing to see the government lose out on potential revenue in these austere times.

Commissioner Shulman also committed the IRS to a 90 day timeline for making award determinations once the refund statute of limitations has closed on the taxpayer which was set forth in Deputy Commissioner Steven Miller’s June memo.  Shulman added a new twist though – he said that the combined determination and payment timeframe so far has actually been completed within that 90 day period – specifically he said ”With respect to payments made to date, awards have been generally been paid within three months of resolution of legal issues.”  According to my review of the relevant procedures and my discussions with IRS officials, payment processing once the award determination is accepted should be a matter of weeks, so it makes sense that they can get both the determination and payment done within that timeframe.

Some of our clients and readers of this blog have asked that we publish the amicus curiae brief that The Ferraro Law Firm recently filed with the United States Tax Court in the case of Joseph A. Insinga v. Commissioner of Internal Revenue.  Mr. Insinga is the whistleblower who reported his former employer, Rabobank, to the IRS for facilitating tax avoidance transactions for United States taxpayers.  Mr. Insinga saw SEC disclosures by several of the United States taxpayers/Rabobank customers he turned in that lead Mr. Insinga to believe that last year they paid some of the tax he alleged that they owed, and therefore he is due an award.  However, the IRS has refused to make an award determination.  The Ferraro Law Firm’s amicus curiae brief highlighted the fact that the IRS’s refusal to issue a whistleblower award determination, despite having allegedly collected proceeds within the meaning of section 7623(b), is tantamount to a negative award determination, or what we call a de facto denial.  

The denial of an award through the IRS’s refusal to make a determination could potentially be more harmful for the whistleblower than a flat denial because a flat denial is clearly a determination, which a whistleblower can appeal to the Tax Court under Cooper v. Commissioner.  Mr. Insinga never received a rejection letter, even after being told that it was unlikely that he would receive an award and requesting that if the IRS intended to deny his claim that the IRS issue him a rejection letter.  We believe that the failure to either pay an award or deny a whistleblower’s claim in a timely manner could side step whistleblowers’ rights to judicial review unless the IRS’s failure to act is treated as a de facto denial.  Our brief’s argument centered on the fact that other IRS “determinations” (pursuant to other Internal Revenue Code sections) can be “denied” by the passage of time without requiring a written denial, and that the Tax Court would be treating section 7623(b) award determinations consistent with other determinations by assuming jurisdiction when such a de facto denial occurs.

The need for award determination timelines was echoed just days later in Deputy Commissioner Miller’s field directive to the extent that it called for the Whistleblower Office to make an award determination within 90 days of when proceeds are finally determined in a matter.  It appears based on the allegations in Insinga’s petition that this new timeline was not met.  Not even close.  We hope that the establishment of an internal timeline prevents these de facto denials from happening in the future.

The IRS has adopted internal timelines for how long the IRS has to act on whistleblower submissions according to a field directive sent to the agency’s operating divisions on June 20, 2012.  According to the field directive, Deputy Commissioner Steven T. Miller is asking that the following timelines are adhered to:

• Whistleblower Office – claims received should be initially evaluated by the Whistleblower Office within 90 days.
• Operating Divisions and Criminal Investigation – review by subject matter experts should be completed within 90 days of receipt.
• Whistleblower Office – whistleblowers should be notified of an award decision within 90 days of when collected proceeds can be finally determined.

If followed, these timelines will greatly affect whistleblower case resolution as currently the whistleblower office takes on average 131 days to review a submission and field examinations average 299 days according to the IRS Whistleblower Office’s Fiscal Year 2011 Annual Report, which is discussed in further detail here.

Joseph A. Insinga, retired Rabobank Finance Specialist, filed a petition with the Tax Court arguing that the IRS’s continued refusal to issue a formal determination constitutes a de facto rejection of his claim and appeals this de facto rejection.  This filing details five years of interaction between Mr. Insinga and the IRS and has brought the operations of the IRS’s Whistleblower Office to the public’s attention.  Mr. Insinga’s petition also raises several questions that should be looked at closer…

What information is award eligible?

Mr. Insinga goes to great lengths to state that he was the only way the IRS could get the information.  However, this goes above and beyond the requirements of section 7623(b).  The statute does not say that the IRS needs to proceed with an administrative or judicial action based "solely" on information provided by the tax whistleblower.  The statute simply requires the IRS utilize the information.  This is shown clearly in the last sentence of section 7623(b)(1), "The determination of the amount of such award by the Whistleblower Office shall depend upon the extent to which the individual substantially contributed to such action."  

There are many ways for a whistleblower to make a substantial contribution even if they are not the sole or initial source of information about an underpayment.  The IRM section on Award Computations, 25.2.2.9.2 (06-18-2010), itself does not require that a whistleblower’s information be the sole or initial source of information in order to be eligible for an award, so long as the case is not based on public information under section 7623(b)(2).  Even if the whistleblower’s information was not the IRS’s original source of information and was public information about the underpayment, section 7623(b)(2)(A) still provides for an award of up to 10% of the collected proceeds “taking into account the significance of the individual’s information and the role of such individual and any legal representative of such individual in contributing to such action.”  

It follows that one does not need to be the sole basis for the action, if you can get an award for "contributing" to an action.  It appears from the Petition that Mr. Insinga's information went to the Field Revenue Agents directly working on the examination of the taxpayers.  If this is the case, to actually use his help and not pay is both contrary to the statute and so patently unjust that we are concerned for the survival of the program if this position of the IRS is sustained.

When is there a de facto denial of a claim?

The Tax Court faces a new issue in Mr. Insinga’s Petition.  Does the court have jurisdiction when the IRS fails to make an award determination?  The answer must be yes otherwise a tax whistleblower could effectively be denied judicial oversight if the IRS just chooses not to act by simply never issuing an award determination.  In Cooper v. Commissioner, the IRS was taking the position that a denial letter was not an award determination, and therefore the Tax Court did not have the jurisdiction to review their award denial. The Tax Court saw through that charade in Cooper and held that they have jurisdiction over negative award determinations, but Mr. Insinga has the harder argument that when the IRS sits on their proverbial hands, that is a de facto negative award determination.  How long does a tax whistleblower need to wait before there is a de facto determination?  Here, Mr. Insinga alleges there has been an administrative action and collection of tax.  This may be a case where the court can determine that the IRS's failure to make an award determination is arbitrary, capricious, and unreasonable.

When should partial payments be made?

One of the issues raised in the Petition is that of "partial payments."  There are two parts to this issue and both appear to be at play in Mr. Insinga's case.  The first is what years must close for the IRS to make a determination.  Most of the hundreds of submissions made by The Ferraro Law Firm to the IRS Whistleblower Office involve more than one tax year of a taxpayer, and many involve multiple taxpayers.  If a tax whistleblower outlines five years of tax cheating by a taxpayer and the IRS is auditing on two-year audit cycles, when does the award determination get made?  In all other areas of tax law the rule is clear that each tax year stands on its own.  Following that line of thinking, whenever a year is closed and tax collected, the IRS should make an award determination for that year.  To take a different position could cause decades of delays.  Consider an amortization case, will the IRS wait 20 years until all of the years with improper amortization play out?  The even more egregious position would be that in a case involving multiple taxpayers, all taxpayers identified must have all tax years at issue closed before an award determination can be made.  It simply cannot be that case that this is the proper way to make award determinations.  If 999 out of 1000 identified taxpayers close and pay and one tax cheat has one tax year open for unrelated issues the IRS cannot delay payment on the 999 taxpayers it collected from - to do so would be arbitrary, capricious, and unreasonable.

Is the naming the target taxpayers appropriate?

The Tax Court's proposed rule for redacting taxpayer names would have pulled the target taxpayers names out of this Petition but the rule itself misses the point.  Mr. Insinga is not seeking to file anonymously.  He has a first amendment right to tell the world of the evils he believes Rabobank et al. committed.  Were he to file this Petition after the rule took effect he could provide his redaction index to any and all who would listen.  The Proposed Rule will only be effective in anonymous cases where the Tax Court could already require that redaction as a condition of anonymity.

Is this an example of a larger pattern of Whistleblower Office dysfunction?

We have always said that with tax whistleblower cases you can lead a horse to water but you cannot make him drink.  What would really be dysfunctional would be if the IRS had been offered quality information from Mr. Insinga that it did not otherwise have and failed to use it.  Or if the IRS did in fact use his information and the IRS is failing to make an award determination in order to avoid judicial review of a denial or paying an award even though section 7623(b) requires paying an award.  

They say things come in threes, and last week three program manager technical assistance (“PMTA”) memoranda relating to whistleblower cases were released.  Two of the three PMTAs relate to power of attorney forms and the third discusses disclosure of taxpayer information to the whistleblower in certain circumstances. 

In PMTA 2011-31, Whistleblower Office Disclosures of Tax Return Information, the IRS concluded that employees of the Whistleblower Office are authorized to disclose taxpayer return information when (1) making determinations pursuant to section 7623, and/or (2) by providing status updates to whistleblowers regarding pending, unprocessed, or dismissed claims under section 7623.  However, the specific taxpayer return information that may be disclosed to a whistleblower in a particular instance will depend on the facts and circumstances of the matter.  The disclosure will be made pursuant to section 6103(h)(4)(A), (h)(4)(B), and/or (h)(4)(C) depending on the particular facts and circumstances. 

It is good news that the IRS is trying to find a balance between the Whistleblower Office’s non-disclosure obligation and its obligations to convey appealable determinations to whistleblowers.  However, practically this has had no effect on information provided to whistleblowers during the pendency of their claim.  PMTA 2011-31 was written a year ago and Whistleblower Analysts still only are able to say whether the claim is open or has been closed.  Clearly an award determination procedure that commences once the target taxpayer’s case is conclusively resolved is an “administrative proceeding” under section 6103(h)(4) so that a disclosure of otherwise section 6103 protected information can be made to the whistleblower, and this PTMA agrees with that concept.  Not surprising.

Additionally, in PMTA 2011-33, Powers of Attorney in the Context of Whistleblower Cases, and PMTA 2011-32, Powers of Attorney in the Context of Whistleblower Cases, the IRS concludes that any power of attorney used in the context of whistleblower representation must adhere to the standards set forth in either Circular 230, or the Conference and Practice Requirements (section 601.501 et seq. of Subpart E of Part 601 of Title 26), essentially an unaltered Form 2848, Power of Attorney and Declaration of Representation.  Again, not surprising.

It is hardly news that the IRS can be a slow moving, and an often-frustrating agency to work with.  These inefficiencies can discourage potential whistleblowers from coming forward.  In an effort to improve the IRS Whistleblower Program, the GAO conducted a study and has issued its findings in a report suggesting how to improve the IRS's Whistleblower Program to ensure that the claims are given timely consideration.  The finds in this report should also serve as a warning to those thinking of going to the IRS without representation because of the innumerable pitfalls and the complex procedures (for example, how would one know when their claim was taking an in ordinate amount of time to reach a certain step in the process).  GAO Report GAO-11-683, “TAX WHISTLEBLOWERS - Incomplete Data Hinders IRS’s Ability to Manage Claim Processing Time and Enhance External Communication” takes a hard look at the IRS’s Whistleblower program, noting that the Whistle blower program suffers a lack of complete data made it hard to evaluate the whistleblower program and a failure to adequately communicate with whistleblowers and the public.  Scott Knott and Greg Lynam, Tax Partners at The Ferraro Law Firm and contributors to this blog, were interviewed for the GAO report late last year and then again earlier this year as part of their review of the IRS Whistleblower Program as the prepared this report. 

The report noted that whistleblower claims often languish in various stages of review.  Of the claims that were submitted in fiscal years 2007 through 2009, 192 claims continue to languish, waiting for review by an operating division Subject Matter Expert to decide if the claim is worth further investigation for more than two years.  The length of time it takes the IRS to determine if it wants to move forward with the information is a point frustration for whistleblowers and their attorneys.  Greg was quoted by Laura Saunders of The Wall Street Journal in “IRS Whistleblower Program Faulted” as saying:

The IRS shouldn’t take three years to determine if a case could be valid.

Greg points out that by allowing cases to linger in these initial stages of review, the Whistleblower Office ensures that these claims will not be valid due to the expiration of the statute of limitations. 

The report cites various reasons that the Whistleblower Office put forward for why claims take significant time to review and examine whistleblower claims.  However, the report does not state how long the average claim spends at each step because, according to the report, “the Whistleblower Office and operating divisions do not have complete data on the length of time claims spend at each step of the review process.”  Another problem is the lack of accountability due to the way claims are tracked.  Scott was quoted in “GAO Faults IRS Whistleblower Program for Award Delays” by Jeremiah Coder of Tax Analysts as saying:

The current IRS system of tracking whistleblower cases does not put any responsibility on either the subject matter expert or chief counsel for delaying a case because their evaluation time gets lumped together, such that they can each blame the other for taking too long and not be held accountable to their supervisors.

Scott went on to point out that subject matter expert and chief counsel supervisors cannot see how long their staffs are taking to process a case.  The lack of information about how long the IRS is taking to get the information provided by whistleblowers into the hands of auditors creates additional uneasiness regarding the years that a whistleblower claim takes to process. 

The lack of communication between the IRS and whistleblowers makes the process unnecessarily frustrating for the whistleblower.  The report suggests increasing communications on the overall results of the whistleblower program could improve program transparency, while complying with the restrictions on disclosing taxpayer information.  The report also pointed out that the IRS is not fully utilizing the tools that Congress had given them when the enhanced whistleblower provisions were enacted.  Specifically, as Scott and Greg discussed in “GAO Faults IRS Whistleblower Program for Award Delays,” the IRS has yet to enter into any section 6103(n) agreements, which would allow the IRS to discuss the case with the whistleblower.  Section 6103(n) contracts would allow the IRS to know when a taxpayer had provided the IRS with false information.  Scott went on to say that “apparently there is an institutional resistance to asking for help.”  One of the primary issues Scott and Greg raised with the GAO was the IRS’s reluctance to enter into 6103(n) agreements despite the obvious benefits. 

The IRS said that it generally agreed with the GAO’s recommendations, such as improving E-TRAK to record the time-in-step for all claims and more accurately track the number of days in each step, track the reasons for claim rejections and suspensions, collect additional information through the Form 211, provide additional statistics in the annual report to Congress, and (most importantly) establish a process for the Whistleblower Office to follow up with subject matter experts that have had a claim for review for more than a set number of days.  If the IRS implements these recommendations, the IRS and the GAO may be able to make more specific recommendations, which in turn may help improve the efficiency of the Whistleblower Office. 

This weekend Laura Sanders of the Wall Street Journal published an article interestingly titled “Taxes: How To Turn Your Neighbor In To The IRS”, in which she described how the IRS Whistleblower Program works and the keys to making a good submission.  It was unfortunate that no one at the IRS could get clearance to comment about some of the issues that we have raised to improve the Program, but as a how-to piece Ms. Sanders was on the right track and it was a pleasure speaking with her about what we do for our clients.  Even one of Greg’s favorite stories about the Arby’s kid got in the article.  We hear some interesting tales, believe me!

The IRS has released on its website the “Fiscal Year 2010 Report to the Congress on the Use of Section 7623,” which details the progress of the IRS Whistleblower Office over the Fiscal 2010 year (thru September 30, 2010).  The first and most important thing we noticed was that there was a huge jump in the “Amounts Collected” as a result of information from whistleblowers from FY 2009 to FY 2010 (See Table 2).  The amount that the IRS collected due to this program doubled to nearly half a billion dollars per year in FY 2010.  In addition, at 7,577 whistleblower submissions made to the IRS in FY 2010, they are receiving more tips than ever before.

The number of large case 7623(b) submissions has remained fairly stable according to Table 1, however, the number of Taxpayers involved greatly increased in 2010 (TP/Submission ratio: 2008 – 3.6, 2009 – 4.6, 2010 – 12.6.)  Overall though most of the submissions the IRS is getting are small cases under section 7623(a).  The IRS said “85 percent of submissions do not appear to meet the income amount or the amount in dispute thresholds but will be considered for awards under section 7623(a) if the IRS acts on them and collects proceeds.”  See part IV.B.2 

A reader of the FY 2010 Report cannot use the ratio of Awards Paid to Amounts Collected to determine average award percentage paid to whistleblowers because of timing of collection and payment for two reasons: (1) the delay in award payments as a result of the 2009 policy change/decision to only make award determinations after the section 6511 period of limitations on refunds has expired; and (2) the time it takes each case to go through the award procedures.  Of the 97 awards paid: 9 related to collections of $2 million or more, and 17 were partial payments totaling $13 million.  No payments were made in FY 2010 under 7623(b).  The IRS said that they “expect” the first payments under section 7623(b) to be paid in 2Q 2011, but it was already public knowledge that a section 7623(b) award was paid to an accountant at the end of 2Q 2011.

The IRS also said they expect to finalize the Proposed Treasury Regulations defining collected proceeds and issue proposed regulations updating section 7623 regulations to reflect 2006 Amendments in 2011.  But we believe that the bigger problem that needs to be addressed is that the IRM needs to reflect the recent guidance in e.g. PTMA 2010-62, etc., as well as the finalized Regulations, but we’ll write more about that another time.

Last week, Ferraro Law Firm partner, Scott Knott, spoke at the IRS’s public hearing on Proposed Treasury Regulations on the definition of “collected proceeds” in the context of paying whistleblower awards under section 7623. 

Scott joined other practitioners in pointing out that the Proposed Regs are too narrow in scope and may prevent the IRS for paying awards that are otherwise authorized under the statute.  As Scott noted, the current language “unduly ties the hands of the IRS Whistleblower Office.”

The tax press picked up on Scott’s message that the current language of the Reg unreasonably limits the scope of the statute and may unjustifiably shackle the IRS when it comes time to pay awards.  Jeremiah Coder of Tax Notes Today, TNT 2011-10213 [PDF], highlighted Scott’s point that problems with the current wording are a “breadth issue.”  Mr. Coder’s article reported that the other practitioners’ testimony echoed Scott’s message: the IRS needs to adopt a broader definition of “collected proceeds.”  Similarly, CCH, CCH Federal Tax Day (May 11, 2011) [PDF], relayed Scott and the other practitioners’ message that the IRS needs to expand the scope of the definition of “collected proceeds.” The CCH article noted that whistleblower-favorable language will encourage more whistleblowers to come forward with information about tax evasion.

Scott's Comments.

Scott’s oral comments echoed the major points The Ferraro Law Firm presented in written comments on the same Regs.  His comments addressed four areas of concern with the proposed language:

(1)  Refunds;                                                                                                       (2)  Credits;                                                                                                                                         (3)  Criminal fines and restitution payments; and                                                               (4)  The question of when awards are eligible to be paid.

In summarizing The Ferraro Law Firm’s concerns with the current, narrow language, Scott testified, “[the IRS should] want to make sure that the Regulation does no harm in limiting the statute which is otherwise broad and limiting the Commissioner’s own interpretation of the statute the recently [released] guidance.”

“Do no harm.” Scott Knott, The Ferraro Law Firm.

What Scott meant by “do no harm” is that the Regs should not limit the broadly drafted statute, which Congress intended to be inclusive and whistleblower-friendly, and should not limit the Commissioner’s own interpretation of the statute.  For example, the Commissioner recently issued guidance, PMTA 2010-62 [PDF], which already authorizes the Whistleblower Office to pay awards based on denied claims for refund, even though the Regs are not yet final.  However, the narrow language of the Regs, as currently written, may unnecessarily hinder the Whistleblower Office’s ability to pay an award in such a situation, even though the Commissioner has stated the IRS’s clear intention to pay awards in such a situation.  Scott testified that the current language may unintentionally limit awards in these situations, contrary to the Commissioner’s stated position, because the Regs use the phrase, “overpayment credit balance” rather than “overpayment of a credit balance,” as stated by the Commissioner in PMTA 2010-62.  As Scott explained, the semantic distinction means, if the Regs are finalized as currently worded, the IRS may only be able to pay awards in the case of an overpayment credit balance, but as the Commissioner’s guidance confirms, there are many more types of credit balances than just “overpayment credit balances.”  Scott proposed eliminating the word “overpayment” in order to eliminate unnecessary confusion (and litigation) in the future.

Scott also addressed the Regs' failure to answer the “when” question—that is when can the Whistleblower Office pay an award?  Scott raised concerns over the contradiction between the Internal Revenue Manual, I.R.M. 25.2.2.12 (06-18-2010), which states that the IRS should wait until the statutory period of filing a refund has expired, and PMTA 2010-62, in which the Commissioner states that a whistleblower can be paid an award based on the denial of a claim for refund.  Scott asked the government panel to consider the tension between the two positions and consider revoking the I.R.M. policy in light of the Commissioner’s clear intention to the contrary.

The Government's Response.

The Government’s panel included IRS Whistleblower Office Director, Stephen Whitlock; Tom Kane, Senior IRS Counsel; Kristen Whitter, IRS Office of Chief Counsel; and Alexandra Minkovick, an Attorney Advisor for the Treasury Department.  The Government’s representatives were very engaged in the process and clearly thinking about how to make award determinations fair based on the statute.  The IRS attorneys from Chief Counsel’s Office seemed keen to consider the comments made by Scott and other practitioners in drafting final regulations.  

The IRS addressed several common practitioner concerns.  Notably, Mr. Kane addressed concerns over the Proposed Regs’ failure to specifically address the treatment of net operating losses.  As BNA reported, 92 DTR G-4 [PDF], Mr. Kane explained that the explicit exclusion of net operating losses from the regulation should not be a concern. Mr. Kane continued, “if a whistleblower's information affects a net operating loss deduction, the whistleblower will be entitled to an award based on that contribution.”

Mr. Kane also addressed the common concern over the failure to include criminal fines in the definition of collected proceeds.  The inclusion of criminal fines is a hot button issue because the Internal Revenue Manual, I.R.M. 25.2.2.12 (06-18-2010), states, “criminal fines, which must be deposited into the Victims of Crime Fund, cannot be used for the payment of whistleblower awards.”  Mr. Kane responded to the practitioners’ concerns over the treatment of criminal fines and explained that the IRS is aware that Congress intended to include criminal fines in “collected proceeds” and assured that the issue of criminal fines would be addressed in future guidance.

It was good to see that Chief Counsel’s office was so engaged in the process, and it was refreshing to see the IRS acknowledge that Congress intended the statute to be whistleblower friendly.  We are encouraged by the IRS’s assurances that they understand that Congress intentionally worded the statute broadly to maximize award payments, thereby encouraging whistleblowers to come forward.  Knowing that the IRS has the best interests of the whistleblower in mind, we look forward to seeing the IRS’s future guidance on award payments.

Treasury Regulations for section 6103(n), Disclosure of Return Information in Connection with Written Contracts Among the IRS, Whistleblowers, and Legal Representatives of Whistleblowers, were finalized today.  The finalized regulations are essentially what were put in place in March of 2008 with a few slight language tweaks.  The regulation had to be finalized now because the temporary regulation authorizing disclosure contracts with whistleblowers expired on March 24th, 2011.  However, as a practical matter, the expiration of the temporary regulations does not make much of a difference, as the IRS is not entering into these contracts because of either extreme caution bordering on neglect, a failure of internal communication, or both. 

As of March 14, 2011, not even a single section 6103(n) disclosure contract has been entered into with a whistleblower.  Let’s break that down by year since such agreements were authorized in the original Temporary Regulations:

The IRS is simply squandering the opportunity to make the best and highest use of the insiders that Congress was seeking when it amended section 7623 in December of 2006.  Some of the schemes we have presented to the IRS are extremely complex, with a labyrinth of layers and steps put in place just to make it harder to figure out. Even though we do our best to break down such schemes factually and legally in our initial submission to the IRS so that they have a roadmap of how to attack the abusive scheme, they have still refused the additional ongoing help we offered.  In several of our cases, the IRS has even gone to the extreme of having the field ask questions to the taint review team, who then asks questions to the tax whistleblower, and then the taint review team relays the answers to the field.  We engage in this grown-up game of operator because no one in the IRS knows who can and should be setting up section 6103(n) agreements.

The complaint that the IRS is squandering the opportunity to work directly with whistleblowers to work through the tax avoidance schemes has been voiced before.  On October 22, 2010, Gregory Lynam and Scott Knott, Tax Partners at The Ferraro Law Firm and contributors to this blog, were interviewed by the Government Accounting Office (“GAO”) as part of an audit they were doing of the IRS Whistleblower Program resulting from Senator Grassley's scathing letter to Secretary Geithner criticizing the whistleblower guidance published in the Internal Revenue Manual on June 18, 2010.  The main criticism of the IRS Whistleblower Program Lynam and Knott reported to the GAO was the failure to enter into a single section 6103(n) agreement with a whistleblower, which is preventing the IRS from getting the benefit of two-way communications with knowledgeable insiders that Congress had hoped for to prevent tax avoidance.  We'll see if the results of the GOA audit (which is expected to be completed this summer) or the finalization of these regulations make any difference. 

On December 13, 2010, the IRS Whistleblower Office published its annual report to Congress for fiscal year 2009 (PDF). The report revealed that the IRS Whistleblower Office has received a steady stream of information about multi-million dollar tax underpayments over fiscal years 2008 and 2009. The IRS reported receiving 460 submissions relating to 1941 taxpayers in their fiscal year 2009 that meet the criteria for section 7623(b), which is the mandatory award program for multi-million dollar cases. The IRS had previously reported receiving 476 of these submissions relating to 1246 in fiscal year 2008. The report failed to discuss several sensitive issues that have not been resolved internally, are awaiting public guidance, or have been criticized by practitioners.

The report did address an internal change in policy in the timing of payment of award determinations. In the past, the IRS processed the award determination after collecting the unreported tax liabilities discussed in the whistleblower claim. However, as of a July 2009 decision by IRS Chief Counsel’s Office, the IRS is now waiting to making an award determination until after the time the taxpayer has to appeal or seek a refund has passed.

In the report, the IRS notes that it has yet to pay an award under the new program. Stephen Whitlock, Director of the IRS Whistleblower Office, recently stated that he expects the first awards to be paid in 2011. Once the awards start being paid, we believe the floodgates will open and new whistleblower submissions will pour into the IRS. Those who come forward with information early are in a better position to collect an award because award determinations are based in part on when the whistleblower came forward.  If someone else beat you to the punch, you may not be entitled to an award at all.