IRS Tax Whistleblower Articles

IRS Ignores Comments in Final Definition of Proceeds for Whistleblower Awards

by Jeremiah Coder

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Final regulations issued February 21 dismissed considerable public input on how the government should define collected proceeds for purposes of making award payments under the revised statutory tax whistleblower framework, but their preamble hinted at limited administrative openness to a few suggestions.

The final rules adopt without change proposed regs issued last January, retaining general improvements to the proceeds definition that found favor at the time with practitioners who represent tax informants.

The final regs keep language that includes prevented refund payments in the potential base amount for calculating an award paid to a whistleblower for information leading to a successful recovery of unpaid taxes under section 7623.

"The unchanged final regulations confirm that awards can be paid on information that leads to the denial of a claim for refund that otherwise would have been paid -- which is a huge victory for whistleblowers because the IRS initially sought to make these amounts ineligible for awards," said Scott A. Knott, a tax partner at the Ferraro Law Firm. "The Whistleblower Office has broad authority under section 7623, and also now under the language in the final reg, to cover all the various scenarios that lead to denied refunds." (For T.D. 9580, see Doc 2011-3531.

"It's good to see the IRS and Treasury Department move to finalize rules for tax whistleblowers, especially when regulations in many other areas are lagging. These new regulations provide more clarity about what type of claims will result in awards to whistleblowers," Senate Finance Committee member Chuck Grassley, R-Iowa, told Tax Analysts.

But the final rules rejected recommendations to specifically include net operating losses in the definition of collected proceeds. Bryan C. Skarlatos of Kostelanetz & Fink LLP said Treasury provided some reassurance even while refusing to make a specific reference to NOLs in the definition of collected proceeds. "At least the preamble to the final regulations does confirm that if an NOL claimed by a taxpayer is disallowed in whole or in part as a result of information provided by a whistleblower, the IRS will factor that disallowance into the computation of collected proceeds," he said.

It appears that if any portion of an NOL carryback or carryover that was reduced as a result of information provided by a whistleblower would have been used by the taxpayer to claim a refund or reduce taxes as of the date the IRS computes the amount of collected proceeds, the whistleblower will get credit for the reduced refund claim or the increased tax liability, Skarlatos said. "This leaves open the question of what happens when an NOL carryforward does not have tax consequences until after the date the IRS computes the amount of collected proceeds," he noted, adding that in that case, "the whistleblower should be allowed to claim his or her award at that time."

Other comments on the proposed regs recommended removing the term "overpayment" as a modifier of credit balance and adding criminal fines to the definition of collected proceeds. According to the preamble, however, restitution that a court orders to the IRS is encompassed in the definition of collected proceeds. (For prior coverage of the proposed regs, see Doc 2011-883 or 2011 TNT 11-3. For prior coverage of the hearing, see Doc 2011-10213 or 2011 TNT 92-1.)

"Treasury affirmatively responded to our hearing testimony with respect to the question of whether restitution payments are award-eligible and whether the reduction of a tax attribute in one year can result in an award from proceeds collected in another year," Knott said. It is common in corporate whistleblower cases for the whistleblower's information to reduce an NOL or credit balance for one year that actually results in collected proceeds in an earlier or later year, he said.

Dean Zerbe, national managing director at Alliantgroup LP and a former tax counsel to Senate Finance Committee Republicans, said there is a large number of whistleblowers who want to come forward with claims that affect NOLs. "Those whistleblowers should be encouraged, not given mixed signals from the Treasury. The Treasury and IRS missed a real opportunity," he said.

The IRS should make it clear that in cases when NOLs are reduced in part because of the whistleblower, the whistleblower should be eligible for an award when the company is again paying taxes, Zerbe said. If, for example, a whistleblower's information leads the IRS to reduce a company's NOLs from $100 million to $5 million in 2010, and in 2011 the company uses its remaining NOLs and starts paying tax, that tax (up to$95 million) is collected proceeds, and the law intended for the whistleblower to be awarded, he said.

In response to several commentators who suggested that whistleblowers should be rewarded for the prevention of future tax avoidance based on the whistleblower's information, the preamble to the final reg said the suggestion was beyond the scope of the regs. Other issues concerning the whistleblower statute, including terminology, additional definitions, and implementation of the statute, were also beyond the scope of the regs, with the IRS and Treasury saying that those issues have been deferred and will be considered and possibly addressed in future guidance.

"Unfortunately, the final reg was silent on the question of when whistleblower cases become award-eligible," Knott said, noting that the IRS has not yet responded to inquiries submitted last year by both the Ferraro Law Firm and by Grassley as to why outdated policies in the Internal Revenue Manual are often delaying awards by up to two years. "The IRS could simply revoke these outdated IRM sections which are now in conflict with this final regulation," Knott said. Grassley similarly tempered his praise of the regs, saying, "I remain concerned about what remains unsaid, particularly regarding claims involving net operating losses that are carried forward to future tax years. The IRS and Treasury need to ensure that a whistleblower's rights are preserved in such cases, even if it means benefits may not be realized for many years."

Erika A. Kelton of Phillips & Cohen LLP told Tax Analysts that despite the improvements in the reg language, "the IRS is strangling what could be a promising program to recover billions that the government is owed." She said that "the institutional resistance to whistleblowers at the IRS is so strong that not even the numerous public comments pointing out the problems with the proposed rules persuaded the Service to modify them." Rather, "these rules are shortsighted, contrary to Congress's intent, and ignore judicial precedent governing similar statutes. Any tax cheat who was concerned that an insider might turn them in will be popping open the champagne, knowing that the IRS has created even more uncertainty for whistleblowers," she said.

Knott said the pro forma adoption of the proposed reg language, while disappointing, still had positive elements. "Although the language of the final whistleblower regulation was unchanged from the proposed regulation, the supplementary information to the final reg reveals that Treasury shares our view that section 7623's definition of collected proceeds should be read broadly," he said.