Proposed IRS Whistleblower Rules Could Undermine FATCA, Critics Argue

By Ben DiPietro

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The U.S. Treasury has weathered complaints over the reach of the Foreign Account Tax Compliance Act, which aims to prevent international tax evasion, but some critics say the law could be weakened by changes to whistleblower rules proposed by another bureau of the department: the Internal Revenue Service.

If such warnings are accurate, the rules could impede the enforcement of FATCA, which requires U.S. taxpayers who hold certain foreign assets to report those assets to the IRS, and mandates foreign financial institutions to report to the IRS information about accounts held by U.S. taxpayers.

Those critics of the proposed IRS rules say they would make it harder for whistleblowers to collect awards and less likely people will disclose wrongdoing. They say the changes will limit the number of categories eligible for a whistleblower award, severely limit the size of awards and allow the IRS to let whistleblower claims to languish without having to act on them.

“If some of these regulations go through it will make it very hard to be a whistleblower,” said David Kovel, a partner at Kirby McInerney.

Taxpayers with a financial interest or signature authority over a foreign financial account are required under the Bank Secrecy Act to report the account each year to the IRS by filing a Report of Foreign Bank and Financial Accounts. Under Section 7623 of the IRS Code, whistleblowers can currently collect awards if the information they provide helps the IRS collect taxes.

The proposed rules would eliminate payments under Title 31 for FBAR violations, and this will discourage potential whistleblowers from coming forward, said Scott Knott, an attorney at The Ferraro Law Firm who represents whistleblowers in IRS cases.

If the proposed rules are enacted, it would “take the teeth out of one of their enforcement mechanisms, which is whistleblowers,” Knott said, adding such a provision would likely face a court challenge.

The IRS didn’t respond to a request for comment, but is accepting public comments on the proposed rules until Feb. 19, with public hearings likely after that.

U.S. Sen. Charles Grassley, R-Iowa is among the critics. Grassley, who co-authored the Whistleblower Protection Act in 1989 and was part of efforts to revise the law in 2006, said in a Jan. 28 letter to the IRS and Department of Treasury the proposed regulations will “hamstring the program by limiting whistleblower awards and discouraging knowledgeable insiders from coming forward.”

Reducing proposed award amounts, and what types of information will qualify for awards could reduce the incentive for people to step forward, said Stanley Foodman, chief executive of Florida-based Foodman CPAs & Advisors.“It’s possible that it could [affect FATCA] if people aren’t incentivized,” Foodman said. “The way people are incentivized is by money.”

Even though he served time in prison, a $104 million award from the Internal Revenue Service was enough of an incentive to get Bradley Birkenfeld to turn into a whistleblower against his former employer UBS .

As part of its settlement with the IRS, UBS agreed to pay $780 million and provide the names of 4,500 U.S. taxpayers who held illegal accounts with the bank, but only doing so after Switzerland amended its treaty with the U.S.

Although the size of the settlement made headlines, it’s the disclosure of the 4,500 names that could have the bigger impact on U.S. taxpayers, as other financial institutions could be forced to follow suit, or choose to do so to stay in the good graces of the U.S. government. The Treasury sees its pursuit of tax evasion as part of the effort to stop money laundering.

Critics, including Grassley, also contend the proposed rules regarding “collected proceeds” will make it harder for a whistleblower to get an award. Under those rules, companies will be able to offset tax underpayments with net operating losses, which critics say could leave whistleblowers without rewards. Currently, IRS whistleblowers are paid an amount based on payments made during an audit cycle, which Knott said typically lasts about two years, but can be as short as one year or as long as three or four years.

“Instead of making an award determination now if you didn’t collect any proceeds, wait until the next audit cycle is resolved and see if that elimination or reduction of the NOL did result in the collection of more tax,” Knott said.

Another concern is the proposed rules don’t address the issue of timeliness of payments made to whistleblowers by the IRS. Whistleblowers are unhappy with how long it can take the agency to make an award payment. “There is no time period for them to reach out and communicate,” said Paul Dougherty, a tax partner with EisnerAmper. “It would help if they had more time frames for when things will happen.”

A similar criticism was raised in a 2011 report on the program by the Government Accountability Office.

A lawsuit is pending in federal court filed by former Rabobank executive Joseph Insigna, who says he has supplied information to the IRS through the whistleblower program but has yet to receive an award he says he is entitled to because the information he supplied helped the IRS to collect a significant amount of money.

Write to Ben DiPietro at ben.dipietro@dowjones.com, and follow him on Twitter @BenDiPietro1.

Correction: In an earlier version of the story, the fifth paragraph referenced Section 31 of the IRS code; the correct section of the Code is 7623.