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.

PMTA 2010-60, Criminal Fines and Whistleblower Awards [PDF], is a line in the sand signaling that the IRS is willing to litigate whether criminal fines are properly included in “collected proceeds.”  The Proposed Treasury Regulations [PDF] are silent on the issue of both criminal fines and restitution payments.  However, the Internal Revenue Manual states, “Criminal fines, which must be deposited into the Victims of Crime Fund [sic], cannot be used for payment of whistleblower awards.”  The IRS has been silent on whether restitution payments are included in collected proceeds.  Restitution payments should be included in “collected proceeds” because restitution payments are assessed and collected as a tax according to section 6201(a)(4).  After researching this issue in preparation of an article on the topic, I believe that criminal fines and restitution payments should be included in the definition of collected proceeds (and from some phrasing in the memorandum, it seems there is a receptive audience in the Whistleblower Office to this position).

In PMTA 2010-60, the IRS reasons that criminal fines are excluded from collected proceeds because all criminal fines collected for offenses against the United States, unless statutorily exempted, are required to be deposited into the Crime Victims Fund under the Victims of Crime Act of 1984 (42 U.S.C. § 10601).  The memorandum acknowledges that criminal prosecutions as one of the actions that can result in a payment of an award; yet still concludes that the Victims of Crime Act and section 7623 can be read harmoniously, giving full effect to Congressional intent for both statutes.  It is disingenuous to say that the Victims of Crime Act and section 7623(b) can be read harmoniously because each statute mandates that monies collected go to different places. 

The IRS simply dismisses criminal fines from being part of collected proceeds “because the IRS does not collect fines imposed by a court in connection with a criminal prosecution, [the IRS does] not think that these fines can be considered ‘collected proceeds’. [sic]”  Section 7623 does not require that the IRS collect the proceeds for there to be an award.  The award is based on collections resulting from the detection of underpayments of tax, or detection and bringing to trial and punishment persons guilty of violating the internal revenue laws.

Additionally, from a policy prospective, the conclusion that criminal fines are outside of collected proceeds undermines the entire whistleblower program.  The whistleblower program was established to incentivize the public to come forward with information about tax underpayments.  Excluding criminal fines from collected proceeds will have the contrary effect on those coming forward with information regarding the most egregious violations of internal revenue laws.  Claims that involve an allegation of fraud are referred to the Criminal Investigation Division of the IRS after the initial review of the whistleblower claim.  Excluding criminal fines from collected proceeds would result in fewer claims involving fraud because there less of an incentive to come forward with the information. 

I am currently working on an article that explores this topic and will continue to write on the subject.  In the mean time, I encourage the IRS to reexamine its position on criminal fines as part of collected proceeds.  If the IRS does not reexamine its position on collected proceeds, it will likely result in litigation and a loss in faith in the whistleblower program.