The Tax Relief and Health Care Act of 2006, signed into law on December 20, 2006, amended the Internal Revenue Code to provide increased rewards for turning in tax cheats. In February 2007, the IRS named the first director of its new Whistleblower Office. Expect this existing but now expanded IRS program to get increased attention.
The new program (found at 26 U.S.C. §7623) focuses on large claims. To qualify for the expanded rewards, $2 million of taxes, penalties and interest must be involved. In a redundant provision, individual tax cheats must have $200,000 of taxable income in any year (obviously, to have $2 million owing, one would need to also have at least $200,000 of taxable income). Because of these large amounts, the primary targets under the new program are businesses whose employees and former employees are willing to report malfeasance.
If one reaches these larger amounts, the reward is from 15% to 30% of the tax collected, depending upon the extent to which the whistleblower contributed to the additional collection. If the IRS determines that the whistleblower’s information was not the original source of information, but still contributes to the additional collection, the IRS can award up to 10% of the amount collected.
Under the new law, informants have the right to petition the Tax Court within 30 days of receiving the IRS’s reward determination. Previously, whistleblowers had no recourse if the IRS provided little or no reward.
This program is substantially different from the qui tam provisions of the False Claims Act. Unlike the qui tam program, the IRS may pay a reward even when the informant is not an original source of information. In addition, the IRS whistleblower program has no ability for a private citizen to prosecute a claim if the federal government fails to do so.
Whistleblower changes were going to occur regardless
The IRS whistleblower program was going to get increased attention even without the new law. In June 2006, a Treasury Department audit examined the workings of the Internal Revenue Service’s “Informant’s Reward Program.” The IRS said that it would implement the report’s recommendations. The result is more centralized control and consistent administration of the program. In addition, the IRS will make information about the reward program more accessible in order to encourage additional claims.
The Treasury found that examinations initiated based on informants’ data is more effective and efficient in identifying taxes than returns selected using the IRS’ primary method for selecting returns for examination. (This primary means of return selection is a mathematical technique that classifies income tax returns by assigning weights to return characteristics.) This Treasury audit conclusion is consistent with a 1999 IRS report that showed the total cost (including personnel and all administration) of collection under the reward program was 4 cents for each additional dollar collected, while the cost of other enforcement programs was 10 cents on the dollar.
Nobody knows how large unreported taxes are, but the IRS estimates that the “tax gap” is around $300 billion annually. Most of this is for self-employed individuals who deal in cash, and whose income is not reported on Form 1099. Because of concerns over increased budget deficits, pressure is mounting to close this tax gap. Better use of informants is one way of doing this.
The pre-existing program controls smaller unreported amounts
The new law adds to, but does not replace, the existing whistleblower program, which presumably still applies for smaller amounts. Rewards for smaller amounts are paid as a percentage of the taxes, fines and penalties (but not interest) collected based on the relationship of the informant’s information to the recovery, as follows:
• 15% for information that directly leads to a monetary recovery
• 10% for information that indirectly leads to a monetary recovery
• 1% for information which led to an examination, but which had no direct relationship to the amount collected
Potential rewards of less than $100 are not paid regardless of the quality of the information provided. The maximum reward is $2 million.
Litigation settings are ripe targets
Attorneys are often faced with business disputes and family law matters in which a party wishes to use “real” information, instead of the falsified information used for tax reporting. Attorneys are also commonly involved with investigations of fraudulent activity in closely held business in which skimmed revenues or inappropriate expenses have not been properly reported for tax purposes. In these cases, questions arise as to:
1.The risks of providing such information in a courtroom setting, and
2.How a settling, but still-upset, litigant can get revenge by reporting the misreporting to the authorities.
Since the court system is open, nothing prevents someone who witnesses testimony from reporting information to the IRS. This includes a judge, juror, court reporter, other court employee, and your opponent. Sworn testimony and related evidence in a proceeding can be freely given to the IRS under this whistleblower program. For this reason, matters involving disclosure of tax cheating are better settled before additional information regarding the malfeasance is made public.
The IRS keeps the whistleblower’s identity confidential. Amendments are now before Congress to ensure this confidentiality, even if the Tax Court becomes involved in determining the proper award amount.
Be careful if you participated in the malfeasance, since there is nothing to prevent the IRS from looking into your tax situation once you report someone else. Also, do not expect to submit your information without the IRS identifying you, since the program requires the informant to submit the information under penalty of perjury.
How to report a claim under the IRS’s Whistleblower Program
Expect the IRS’s new Whistleblower Office to expand reporting mechanisms. At present, the IRS receives information about potential tax violations in the mail, over the telephone (800-829-0433), or from visits to IRS walk-in offices. The program guidance is contained in Internal Revenue Manual Section 25.2. Generally, an IRS employee will take the information by completing Form 3949. In order for the IRS to take your complaint seriously, you will need specific information such as the wrongdoer’s social security number, bank accounts used, assets involved, and copies of the accounting books and records.
In order for a reward to be considered, the informant will need to complete Form 211 (Application for Reward for Original Information). Information regarding the reward program is contained in Publication 733.
The typical tipsters are ex-boyfriends/girlfriends, ex-spouses, and ex-business associates/employees. In spite of this inside information, the IRS says that over 90 percent of the information it receives provides little usable information. The best information typically comes from bookkeepers and others with access to a business’s accounting records.
Current Statistics on the IRS Informant Reward Program
Considering the size of the $300 billion annual tax gap, the whistleblower program is currently amazingly small. As noted above, expect this to change. The IRS paid the following amounts in these years:
- Fiscal 2001 $ 3.3 million
- Fiscal 2002 $ 7.7 million
- Fiscal 2003 $ 4.1 million
- Fiscal 2004 $ 4.6 million
- Fiscal 2005 $ 7.6 million
- 5-Year Total $27.3 million
Based on the taxes and penalties collected, the overall average reward was 10.9 percent, and the average individual reward was around $24,000.
For the Treasury’s audit sample, it took over 7½ years on average for the informant’s to be paid. This lengthy time occurred because the IRS makes no reward payments until the IRS collects all amounts owing and the matter is closed. However, an informant can speed this amount by accepting an initial early payment on amounts collected by agreeing to waive further award on subsequent collections.
Fulcrum Inquiry is a forensic accounting firm that provides whistleblower complaint solutions to companies and non-profit organizations. Fulcrum also performs financial investigations, and assists with litigation claims.