Administration of Whistleblower Claims

The Tax Court held that it has jurisdiction to review the IRS’s whistleblower claims award determinations where the informant has alleged that they provided significant information to the IRS before and after December 20, 2006, the effective date of section 7623(b).  Whistleblower 11332-13W v. Commissioner, 142 T.C. No. 21, is a continuation of one of the cases where the whistleblower that was allowed to proceed anonymously and have the record sealed in one of the three cases released on May 20, 2014. 

In this case, the whistleblower first provided generic information regarding the tax fraud scheme engaged in by the whistleblower’s employer and several related entities and subsidiary companies to IRS and the Department of Justice in June of 2006.  The whistleblower had several more meetings with the IRS and DOJ in 2006.  The whistleblower continued to provide additional information relating to the tax scheme and those involved to the IRS and Department of Justice until the fall of 2009.  The whistleblower alleges that the information provided after 2006 was not simply confirmatory details.  The Government entered into a Non-Prosecution Agreement with one of the targets that led to a recovery of more than $30 million in taxes, penalties, and interest.  The Whistleblower Office granted that whistleblower an award under section 7623(a) and denied the whistleblower’s request for an award under section 7623(b).

The Court held that the whistleblower had satisfied the “pleading burden by alleging facts that respondent proceeded with an action against the targets using information brought to respondent’s attention by the whistleblower both before and after December 20, 2006.”  The Court held that the allegations are sufficient to establish jurisdiction. 

The Tax Court also released a second opinion, Whistleblower 10949-13W v. Commissioner, T.C. Memo 2014-106.  The Tax Court held, on similar facts as Whistleblower 11332-13W, 142 T.C. No. 21, that the Tax Court also had jurisdiction to hear their appeal of the IRS Whistleblower Office’s denial of their award under section 7623(b).

It is good to see that the Tax Court continues to broadly interpret its jurisdiction when it comes to appeals of whistleblower award determinations.  These cases demonstrate the Tax Court’s continued fairness in providing whistleblower with a venue to appeal award determinations under section 7623.

Judge Kroupa of the U.S. Tax Court issued three memorandum opinions on Tuesday concerning whether or not the whistleblowers in those cases could proceed anonymously under Rule 345(a).  All three memorandum opinions, T.C. Memo 2014-92, T.C. Memo 2014-93, and T.C. Memo 2014-94 were in favor of the whistleblower’s motion to proceed anonymously.  

We believe that these decisions are consistent with what our experience has been to date as far as whether or not the Tax Court will allow docketed whistleblower cases to proceed anonymously or under seal.  So far, the Tax Court is generally willing to let whistleblowers be anonymous if the requirements of Whistleblower 14106-10W v. Commissioner are met, so whistleblowers should take comfort in knowing that they can proceed anonymously in Tax Court to challenge their award determination on that basis. 

However, the Tax Court has not been so willing to seal whistleblower cases on anything more than a temporary basis, although T.C. Memo 2014-92 shows that an exception to this general rule exists if unsealing the case could likely cause physical harm to the whistleblower.  

On a final note, it looks like T.C. Memo 2014-92 and 2014-94 are related cases. This probably resulted from two different EINs and claim numbers for the targets, and that it ended with the whistleblower getting an award under section 7623(a).  That would happen either where the original information was provided to the government before 12/20/06 or the case resulted in collected proceeds of less than $2 million. 

There seems to be a trend of interpreting SOX in a way that extends the whistleblower protections to a widening circle of persons. Most recently, a judge in Eastern District of Pennsylvania had allowed a retaliation lawsuit under SOX against non-publicly traded subsidiary of a publicly traded corporation to proceed after examining the agency relationship between the subsidiary and the parent in Wiest v. Lynch. The opinion relied heavily on the U.S. Supreme Court’s 2014 ruling in Lawson v. FMR LLC, which held that Section 806 covers “any officer, employee, contractor, subcontractor or agent of” a publicly held company.

The IRS Whistleblower Office has released its Annual Report to Congress for Fiscal Year 2013.  We had a good year with the IRS Whistleblower Program because they paid one of our clients a $38 million award, but overall the report certainly shows that there is a lot of room for improvement.  While fiscal year 2012 gave many whistleblowers a lot of hope for the program with its first big award payout, fiscal year 2013 was somewhat flat.  Some of the highlights from the Fiscal Year 2013 Whistleblower Office Report are:

  • The number of submissions in fiscal year 2013 (355) remained relatively stable from fiscal year 2012 (332).  

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  • Four awards were paid under section 7623(b) in fiscal year 2013.  However, one award was $38 million, leaving $15 million to be shared among all other award recipients (including those receiving awards under 7623(a)).

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  • The IRS planned to finalize the proposed regulations in the second quarter of fiscal year 2014, which ended on March 31, 2014.  We are expecting these to be finalized shortly.
  • The IRS Whistleblower Office increased the number of senior analysts in fiscal year 2013 by three and is actively recruiting four additional staff members.  This increase in staff for the Whistleblower Office is good news for the IRS Whistleblower Program because it shows that the IRS believes that by increasing the staff of the Whistleblower Office it can increase collection of tax in other operating units which are still suffering from hiring freezes.
  • There has been an overall decrease in “collected proceeds” last year from $592 million in FY2012 to $367 million in FY2013.  However, we are aware of much larger cases working their way through the process and those kinds of large corporate cases often take longer than that to resolve.  This is consistent with what the Whistleblower Office has said many times before: it takes on average five to seven years to analyze, investigate and/or audit, and collect proceeds; and that the larger the amount at issue the greater the incentive is for the taxpayer to exercise all of their rights to challenge the IRS determinations.  However, even $367,042,420 of collected proceeds is a drop in the bucket compared to the $385 billion tax gap, or the $191.7 billion of tax reserves for uncertain tax positions set aside only by the top 500 U.S. companies, which demonstrates that the IRS still needs all the help with enforcement of the law that it can get.
  • The Fiscal Year 2013 Whistleblower Office Report indicates that the IRS has developed a communications plan to address outreach to both the public and IRS personnel on changes to the program.  It states that the communication plan “includes efforts to identify opportunities for improvement and potential barriers to change.”  Hopefully the communication plan will allow the IRS staff in the operating divisions to become more comfortable with whistleblowers in general.  Additionally, this may improve the relationship between the public and the IRS and give the public an opportunity to have their concerns heard and addressed by the Whistleblower Office.  
  • The Fiscal Year 2013 Whistleblower Office Report outlines some areas that are likely ripe for litigation, including the definition of “collected proceeds” and amount in dispute.  The report also outlines some areas that need additional guidance or legislative changes, such as providing statutory protection for whistleblowers that provide information to the IRS.
  • The Fiscal Year 2013 Whistleblower Office Report states that Subject Matter Expert review is still on average 190 days.  This means that more than 6 months is lost on average before the field even sees the information.  Depending on the years at issue, this delay could cause the field not to open an audit due to lack of time. 

One of the numbers in the Fiscal Year 2013 Whistleblower Office Report that may require some explanation is the number of claims listed with a current status of “Whistleblower Office – Case Suspended: Whistleblower Litigation Regarding Award Determination” found in Table 4 of the report.  The report shows that only five 7623(b) claims are in suspended status while the whistleblower challenges their award determination in the U.S. Tax Court, but in reality more than 50 whistleblowers have sued the IRS so far.  Many more than five cases are still active, and even more cases have been filed that are still under seal by the Court and will therefore be invisible until they become unsealed by the Court.  We are representing whistleblowers in both sealed and unsealed cases before the Tax Court, and there are a lot of interesting things going on in discovery, but we’ll save that discussion for another day.  The five cases in Table 4 are apparently those cases where the whistleblower is contesting the amount of the award, rather than contesting the denial of an award.  Hopefully, the administrative review process for denied claims in the proposed regulations will be in the final version.  We believe that this administrative review will save the IRS, the whistleblower, and the U.S. Tax Court time and resources by not having cases filed in the U.S. Tax Court that are dismissed once the parties exchange discovery.

Fiscal Year 2014 looks as though it will be a more productive year for the IRS Whistleblower Program.  The Tax Court is preparing for what is supposed to be the first whistleblower case to determine if the whistleblower’s information should result in an award.  The proposed regulations are expected to be finalized soon.  These are both large milestones that will help shape the program.  The IRS Whistleblower Program is taking shape and, hopefully, fiscal year 2014 will bring better news than fiscal year 2013. 

The United States Supreme Court issued its opinion in Lawson v. FMR LLC on March 4, 2014.  This case looked at whether the whistleblower protection provisions of Sarbanes-Oxley, found at 18 U.S.C. § 1514A, protect the employees of a privately held contractor or subcontractor that provides services to a public corporation.  The opinion expressly holds that:

based on the text of §1514A, the mischief to which Congress was responding, and either legislation Congress drew upon, that the provision shelters employees of private contractors and subcontractors, just as it shelters employees of the public company served by the contractors and subcontractors.

The facts involve two former employees, Jackie Hosang Lawson and Jonathan M. Zang, who separately initiated proceedings under section 1514A against their former employers, privately held companies that provide advisory and management services to the Fidelity family of mutual funds.  The mutual funds, which are public companies, are not parties to either case because the Fidelity funds have no employees themselves but instead contract with investment advisors to handle the day-to-day operations.  Fidelity Brokerage Services, LLC employed Ms. Lawson as a Senior Director of Finance.  She alleges that after she raised concerns about certain cost accounting methodologies, believing that they overstated expenses associated with operating the mutual funds, she suffered a series of adverse actions by her employer, which ultimately amounted to constructive discharge.  FMR Co, Inc. employed Mr. Zang as a portfolio manager for several funds.  He alleges that he was fired in retaliation for raising concerns about inaccuracies in a draft SEC registration statement concerning certain Fidelity funds.  The entities that had employed Ms. Lawson and Mr. Zang moved to dismiss both suits, arguing that they are privately held and that section 1514A only protects employees of public companies.

In delivering the opinion of the Court, Justice Ginsberg clearly explained that the language of the statute is interpreted by giving the words used in the statute their ordinary meaning and the operative language of the statute means what it appears to mean.  In this case, that means that a contractor may not retaliate against its own employee for engaging in protected whistleblowing activity.  The opinion goes on to discuss how this interpretation fits with Congress’ goals at the time of enactment, namely to prevent another fraud on shareholders similar to Enron, and by protecting the employees of those that contract with the public company these goals would be meet because the contractor’s employees are likely to be aware of potential fraud.  On the other hand, the narrower interpretation, that contractors and subcontractors are prohibited from retaliating against the employees of the public company, does not make logical sense because contractors and subcontractors are unlikely to be in a position where they can retaliate against the public company’s employees.

Director Whitlock spoke along with Christopher Ehrman, the Director of the Commodity Futures Trading Commission’s whistleblower program, and Sean McKessy, the Director of the Security and Exchange Commission’s whistleblower program, at a webinar put on by the ABA Criminal Justice Section and Center for Professional Development.  During this webinar, Director Whitlock gave a bit of a preview of what will be in the annual report to Congress when it comes out.  First, Awards.  Director Whitlock said that the IRS Whistleblower Office paid approximately $50 million in whistleblower awards in fiscal year 2013.  While this number is not final, it should be a good estimate.  This make fiscal year 2013 the year with the second highest payouts in the history of the program.  Roughly, three quarters of that amount was paid to our client.  Also, they are working on finalizing the regulations that were proposed in December of 2012. 

Finally, Scott Knott’s question about the IRS Whistleblower program’s ability to act as a deterant prompted Director Whitlock to acknowledge that the actions of whistleblowers have been recognized, particularly in the case of offshore compliance, internally, in press releases, and in sentencing.  It is great to hear that the contributions of whistleblowers are being acknowledged, especially internally at the IRS.

Last week the Canada Revenue Agency (“CRA”) formally announced a whistleblower program for reporting Canadian tax fraud. Our contacts in Canada have told us that this measure has been in the works for a long time.  For now the details remain a little thin, but it appears like the program -called the Offshore Tax Informant Program (“OTIP”) – is modeled after the old IRS whistleblower program, whereby whistleblowers have to get a contract with the CRA in advance of submitting any information in order to get an award.  Those awards are between 5 and 15% of the amount collected by the CRA, although their definition of collected proceeds does not appear to be as expansive as the US definition.  Furthermore the scope of tax issues which are subject to OTIP are limited, so you should consult counsel to determine if any information you have may make you eligible for an award.

On October 15, 2013, the United States Supreme Court issued an order denying certiorari of O’Donnell v. Commissioner, a case where summary judgment was granted by the Tax Court, and affirmed on appeal, because the information provided did not cause the IRS to initiate an administrative or judicial proceeding that resulted in the collection of Federal tax from the taxpayer to whom the information.  By denying certiorari, the United States Supreme Court effectively solidified Cooper v. CIR, 136 T.C. 597, 600 (2011) as the law of the land.  This means a whistleblower is not eligible for an award under section 7623(b) where the information provided did not result in an initiation of an administrative or judicial action or the collection of tax proceeds.  This is a reminder that it is not enough to merely hand the IRS information, but that the whistleblower’s submission must also cause the IRS to act on the information in a way that results in collected proceeds.

George and James O’Donnell filed a claim for an award on March 6, 2009, alleging significant tax underpayments based on court records.  The O’Donnells filed a petition with the Tax Court alleging that the IRS failed to proceed as required and that their filing of the Form 211 created a bilateral contract.  The IRS filed a Motion for Summary Judgment that stated the IRS “has not initiated any administrative or judicial proceeding nor collected any proceeds based on information provided by petitioners.”  The Tax Court stated that various statements in various documents submitted by the O’Donnells suggested that the IRS had failed to properly consider the information they submitted or failed to proceed as required by section 7623; however, the O’Donnells “do not allege, much less show, that an administrative or judicial proceeding was initiated by [the IRS] or that any Federal tax was collected from any taxpayer as [the] result of information that they provided to [the IRS].”  The Tax Court cited Cooper for the premise that a person’s eligibility for an award under section 7623(b) requires both an administrative or judicial proceeding and that the administrative or judicial proceeding results in the collection of Federal tax in the order granting the IRS’s Motion for Summary Judgment.

On appeal to the United States Court of Appeals for the District of Columbia Circuit, the DC Circuit Court affirmed the Tax Court’s Order and Decision in an unpublished per curiam decision.  The DC Circuit Court stated that “The Tax Court correctly concluded that because the information appellant provided did not result in ‘initiation of an administrative or judicial action’ or ‘collection of tax proceeds,’ Cooper v. Comm’r of Internal Revenue, 136 T.C. 597, 600 (2011), appellant was not eligible for a whistleblower award under 26 U.S.C § 7623(b).”  Following the decision of the DC Circuit, George O’Donnell sought certiorari, which was denied.  

The IRS Whistleblower Office renewed its position that awards under section 7623 are subject to the automatic sequester cuts, on its website, stating that:

Pursuant to the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, whistleblower award payments issued under Internal Revenue Code section 7623 are subject to sequestration. This means that every award payment made to a whistleblower under Section 7623 on or after October 1, 2013, and on or before September 30, 2014, will be reduced by the fiscal year 2014 sequestration rate of 7.2 percent. The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise impacts the sequester, at which time the sequestration reduction rate is subject to change.

The sequestration reduction will be applied after the Whistleblower Office determines the amount of collected proceeds and the applicable award percentage to be paid under section 7623. Whistleblowers will be advised of the sequestration reduction in correspondence from the Whistleblower Office concerning a proposed award amount and an award determination.

As discussed previously, we believe that ANY sequestration rate that reduces a 7623(b) award is illegal.  The IRS is confusing its discretion under section 7623(a) with their “shall pay” mandate under section 7623(b) and will almost certainly be successfully challenged by a whistleblower in tax court.  Awards paid under section 7623(a) are discretionary and, therefore, may be reduced by the sequestration reduction rate.  However, awards under section 7623(b) are not discretionary, as their payment is mandated by statute, and are not available for reduction.  Section 7623(b) states that the Commissioner shall pay whistleblowers, who meet the threshold requirements, 15 to 30 percent of collected proceeds.  Under the Fiscal Year 2014 sequestration reduction rate cuts these awards would be limited to between 13.92 and 27.84 percent, effectively precluding the Commissioner from paying an award of 30 percent. 

We hope that the battle over the budget ends soon and the issue of sequestration reduction cuts becomes moot; however, in the mean time we will continue to counsel any client whose award is reduced under these guidelines to challenge the reduction in the United States Tax Court.  

I bet that every person reading this blog – people with an interest in the IRS Whistleblower Program – has seen that the IRS has been under fire this summer due to the exempt organization application processing scandal, and is wondering how this situation impacts their tax whistleblower claim or the IRS Whistleblower Program.

Caveat: I’m not a political person.  Despite having practiced tax law in Washington DC for the first dozen years of my legal career, my interest in politics is largely limited to what changes Congress is going to make to the Internal Revenue Code.  I.e., amending section 7623 in December of 2006 caught my attention!  With that said, my first reaction to the current IRS scandal wasn’t: “how could that noxious but revenue-irrelevant situation have been allowed to develop without someone asking themselves how it would look politically once it came to light.”  No, my reaction was: “uh oh, this is going to cause serious problems the next time the IRS needs something from Congress.”  How right I was.

All tax whistleblower cases, and the success of the IRS Whistleblower Program along with them, are wholly dependent on the IRS enforcing the violations of the Internal Revenue Code that we bring to their attention.  We have said from day one that the biggest risk in any whistleblower case is that the IRS will not act on your information, or they will not act with sufficient tenacity and resources to carry the case through to a successful conclusion.  In short, we’ve said the old analogy applies: “You can lead the horse to water but you can’t make him drink,” and the Cooper and Cohen cases have confirmed that analogy applies here.  If the IRS doesn’t act on your information, you get no award.

Fast forward to this summer… the IRS blunders in the total-waste-of-enforcement-resources exempt organizations area, and now it needs next fiscal year’s budget approved by Congress.  Surprise surprise, now some outraged members of Congress want to cut the IRS budget by 30%.  Never mind the fiscal stupidity of cutting the IRS budget in the first place – because it is the principal collector of the money our civilization runs on –  this cut would decimate the IRS’s ability to enforce the Code.  Whistleblower cases could simply have to be abandoned for lack of enforcement resources, e.g. because there are no agents or lawyers available to prosecute the case. 

Now, most political experts will say that this massive IRS budget cut proposal will not be accepted, and the Senate has proposed a budget that restores the funding the House of Representatives wants to slash, but it still highlights the biggest risk that we all have, that the IRS will do nothing with a whistleblower’s information.  The IRS has unfortunately shown that it is willing to ignore whistleblower cases even while the nation is running huge deficits.  The excuses why don’t really matter, although we continue to believe that some IRS officials will ultimately be held accountable for intentionally ignoring specific instances of large-scale non-compliance, what matters is that to have any chance of success in this landscape a whistleblower has to do everything they can to make their case attractive to the decision makers at the IRS.  Those officials in the IRS who decide how their scarce enforcement resources will be allocated hold your case in their hands, along with many other cases competing for those resources.  Budgets that make those enforcement resources even more scarce are a huge threat to a whistleblower case.  Helping them pick your case in spite of that scarcity is what we continue to strive to do.