IRS Tax Whistleblower Articles
Whistleblower Is Key to New York Tax Probe on Buyout Firms
By Reed Albergotti and Laura Saunders
New York state Attorney General Eric Schneiderman's probe of tax practices at private-equity firms is based on information from a whistleblower, according to a person familiar with the matter.
The information came from someone who approached Mr. Schneiderman's office between roughly nine months and a year ago, this person said. Under the state's False Claims Act, the attorney general can investigate alleged fraud against the state based on a whistleblower's allegations.
The ongoing probe is examining whether partners at private-equity firms changed management fees into investment income to delay and pay less taxes—or avoid taxes altogether. Some private-equity firms use so-called management-fee conversions, while other firms avoid them.
If Mr. Schneiderman files a lawsuit and wins, defendants could be liable for damages of as much as three times the taxes owed. It isn't clear when he will decide whether or not to proceed with a lawsuit.
At least two other whistleblower claims related to management-fee conversions have been filed with the Internal Revenue Service, which has the authority to pay whistleblowers up to 30% of proceeds collected in large cases. Such whistleblower cases usually take four to seven years to resolve.
An IRS representative declined to comment, citing taxpayer privacy laws.
Gregory Lynam, a lawyer at the Ferraro Law Firm in Washington, said he filed one of the IRS whistleblower claims in 2008 on behalf of a whistleblower. Mr. Lynam declined to identify the person but said the case still is active.
In New York, whistleblowers who pursue cases under state law can collect as much as 25% of the total damages. The False Claims Act was expanded in 2010 to include tax fraud against New York. Legislation that led to the change was written by Mr. Schneiderman when he was a state senator. His office sent subpoenas in July to 13 private-equity firms.
In a management-fee conversion, the managers of a private-equity fund typically waive all or part of a management fee, often 2% of the money being managed. In return, they get an investment in the fund.
The conversion amount plus returns on the fund eventually are taxable as long-term capital gains, with a maximum tax rate of 15%. The highest rate on management fees is 35%, and the taxes are owed when the fees are paid.
"The less the fees are at risk, the more it seems as though they are current income from labor that should be taxed at ordinary rates," said Bryan Skarlatos, a partner at law firm Kostelanetz & Fink LLP in New York.
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