MCLE ARTICLE AND SELF-ASSESSMENT TEST By reading this article and answering the accompanying test questions, you can earn one MCLE credit. To apply for credit, please follow the instructions on the test answer sheet on page 37. by STEVEN TOSCHER and HEATHER KIM LEE BEWARECheaters The IRS’s revamped whistleblower program offers new incentives to inform on corporate and individual tax cheats “Don’t be a tattletale” Congress has provided its response: “Do the income tax.2 A form of the current statu- is advice given to all youngsters. This cau- be a tattletale,” particularly when sufficiently tory provision has been in existence since at tionary note is especially pertinent when the large tax amounts are at issue. In the Tax least the 1939 version of the Internal Revenue infraction by the errant child is minor and the Relief and Health Care Act of 2006,1 Code, authorizing the IRS to pay rewards to tattletale is seeking an advantage. On the Congress amended Internal Revenue Code informants largely for information leading to other hand, children are also taught to call the Section 7623 to substantially enhance the criminal tax violations.3 The statute was sub- police when they observe a crime. So what IRS informant or whistleblower program. stantially amended in 1996 to clearly autho- should adults do when they learn that their This new statute follows a series of changes rize payment of rewards for information employer, neighbor, former business associate, made over the last 10 years to expand the IRS regarding civil violations and to pay rewards business competitor, soon to be ex-spouse— program. or anybody else for that matter—is a tax Rewarding persons who inform on errant Steven Toscher is a principal and Heather Kim Lee cheat? The possible responses on the moral taxpayers is not a new aspect of U.S. tax is an associate of Hochman, Salkin, Rettig, Toscher spectrum range from ignoring the wrong to enforcement policy. The practice has occurred & Perez, PC, specializing in civil and criminal tax reporting it to the Internal Revenue Service. since the earliest U.S. tax laws and predates litigation. Los Angeles Lawyer September 2007 35 out of proceeds collected as a result of the two important conclusions. First, the report issue of how the WBO is to determine information provided by the informant.4 In declared that the IRS informant program has whether the information actually caused the 1997, the IRS raised the reward ceiling from been an effective method of identifying and IRS action. The Joint Committee on Taxation $100,000 to $2 million, although amounts collecting unpaid taxes and detecting and has suggested that the standard should be can exceed the ceiling under an express con- collecting underpaid taxes. According to whether or not the information “substan- tract with the IRS.5 In 2004, the IRS raised information reported by the IRS to Congress tially or directly” caused the action. However, the reward ceiling to $10 million.6 from 2001 through 2005, $340,329,427 was this provides little guidance.16 If the treasury The 2006 act substantially amended recovered as a result of informant informa- secretary proceeds with any administrative or Section 7623 to create a statutory right for tion provided during this period, and an aver- judicial action based principally on “disclo- informants to receive monetary rewards for age reward of 10.9 percent of the collected sures of specific allegations resulting from a information directly leading to an adminis- proceeds, excluding interest, was paid to the judicial or administrative hearing, from a trative or judicial action by the secretary of informants. TIGTA reported that examina- governmental report, hearing, audit, or inves- the treasury that results in a recovery. Section 7623(a) authorizes the secretary of the trea- sury to pay a reward in “such sum as he deems necessary for (1) detecting underpay- ments of tax, or (2) detecting and bringing to trial and punishment persons guilty of vio- lating the internal revenue laws or conniving at the same….” Section 7623(b) allows an informant to receive a reward of at least 15 percent, but no more than 30 percent, of the collected proceeds—including penalties, inter- est, additions to tax, and additional amounts—resulting from the adjudication or settlement of the action.7 The computation of the amount of the reward would include not only the tax and penalties but also the statutory interest collected. The legislation also provides for an award of up to 10 per- cent of the collected proceeds for “less sub- stantial” information. It also eliminates any cap on the amount of potential recoveries, which previously was $10 million.8 The 2006 act reflects the effort of Congress to make the tions based on informant information tigation, or from the news media,” the IRS program more analogous to the pro- involved taxpayers or issues that would not amount of the award is not to exceed 10 gram created by the False Claims Act, which have been selected by the IRS without the percent of the collected proceeds.17 If the permits remedial actions by private whistle- informant information and were more pro- informant is the original source of the infor- blowers.9 ductive than examinations initiated using the mation that leads the treasury secretary to No contract with the IRS is necessary for usual methods of the IRS.14 proceed with an action, the 10 percent cap an individual to have a legal right to an award Second, the TIGTA report concluded that does not apply.18 under Section 7623.10 The 2006 act allows the effectiveness of the informant program The new legislation’s statutory entitle- informants to appeal award determinations was compromised by a lack of standardized ment of prescribed percentages only applies by granting U.S. Tax Court jurisdiction to procedures and limited managerial oversight. to information relating to an individual review these cases. Under the prior law, judi- No database existed to allow management to (nonentity) taxpayer if the individual’s gross cial review of an IRS award determination track and monitor claims on a nationwide annual income exceeds $200,000 for the was limited to cases in which the informant basis. For informant claims paid in 2005, 45 applicable tax year and the potential indebt- had an express contract with the IRS.11 percent of the case files reviewed had a prob- edness for taxes, penalties, and interest The 2006 act also establishes the IRS lem with basic controls—for example, copies exceeds $2 million.19 If the taxpayer is a cor- Whistleblower Office (WBO) to centrally of key forms or letters to informants were poration or other taxpaying entity, there is no process and manage the tax informant reward missing. In most cases, reviewers noted their threshold requirement. The statutory thresh- program. The WBO will set the strategic decisions and reward percentages in approved old for individual taxpayers reflects a balance direction of the program, define specific goals cases but provided little or no description of reached by Congress that will help the IRS and operating guidelines, and communicate the basis for their decisions. In 32 percent of avoid spending limited resources on an and implement guidelines to ensure success of the paid claims reviewed, TIGTA was unable avalanche of informant claims that have lit- the program.12 to determine the justification for the per- tle revenue potential.20 centage granted. In 76 percent of the rejected If the individual taxpayer does not meet Improving the Reward Program claims reviewed, TIGTA was unable to deter- the statutory threshold, the informant still The deficiencies enumerated in a report by the mine the rationale for the reviewer’s deci- may be able to claim a reward under the law Treasury Inspector General for Tax Admin- sion to reject the claim.15 and administrative practice as it existed prior istration (TIGTA) were the impetus for the While the new statute mandates the WBO to the 2006 act. This means that rewards 2006 act.13 The TIGTA report—titled “The to consider the extent to which the infor- under these circumstances generally will be Informant’s Reward Program Needs More mant substantially contributed to an action subject to the discretion of the IRS. Most Centralized Management Oversight”—had in determining the reward, it is silent on the likely the WBO will follow the guidelines it 36 Los Angeles Lawyer September 2007 MCLE Test No. 162 MCLE Answer Sheet #162 CHEATERS BEWARE The Los Angeles County Bar Association certifies that this activity has been approved for Minimum Continuing Legal Education credit by the State Bar of California in the amount of 1 hour. Name Law Firm/Organization 1. The Tax Relief and Health Care Act of 2006 was the individual taxpayer—but only when the taxpayer’s gross first enactment of an IRS tax reward program. annual income exceeds $200,000 for the applicable tax Address True. year, and the potential indebtedness for taxes, penal- City ties, and interest exceeds $500,000. False. State/Zip True. 2. The current program rewards informants for infor- False. E-mail mation leading solely to criminal tax violations. Phone True. 12. An informant who planned and initiated the actions State Bar # False. that led to an underpayment of tax may be eligible for a reward, unless the informant is convicted of a crime INSTRUCTIONS FOR OBTAINING MCLE CREDITS 3. The rewards are derived from the proceeds—includ- for his or her role in the underpayment scheme. ing taxes and penalties, but not interest—that are col- True. 1. Study the MCLE article in this issue. lected as a result of the information provided by infor- False.