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As the IRS continues to develop rules for handling claims under a new tax whistle-blower program, some attorneys who represent informants are criticizing the procedures the government is laying out.

In the Tax Relief and Health Care Act of 2006, Congress revised the rules under section 7623 regarding the Service’s whistle-blower program, including increasing the award amount some informants may be eligible for if their information leads to successful recovery of unpaid tax liabilities. The newly created IRS Whistle-Blower Office was statutorily charged with developing guidance by December 2007 detailing initial procedures for taking in information and paying out awards. (For Notice 2008-4, 2008-2 IRB 253, see Doc 2007-27740 or 2007 TNT 245-13 2007 TNT 245-13: Internal Revenue Bulletin.) Since then, the Service has continued to release new rules governing both informant submissions and the steps the government will take when investigating claims.

Chief Counsel Notice 2008-011, issued in February, established guidelines the IRS would follow in handling informant submissions and contacting whistle-blowers and their representatives so as to avoid violating the “one-bite” rule. In the notice, the Service said that absent rare circumstances, it would meet only once with informants to receive any information they had on possible tax avoidance by their employers. Also, informants who acted in administrative tax matters as representatives for the taxpayers they were turning in would automatically cease having a representative capacity once a claim was submitted, the Service said. (For CC-2008-011, see Doc 2008-4425 or 2008 TNT 42-16 2008 TNT 42-16: IRS Chief Counsel Notices.)

The February notice was followed up with a July 21 IRS Large and Midsize Business Division memorandum creating a three-step process for analyzing information received from informants and disseminating it to the field. After receipt and initial review of a claim by the Whistle-Blower Office, the information is passed on to a subject matter expert in each of LMSB’s industry divisions for evaluation of the merits, the directive said. The expert’s role is to “insulate the audit team from direct contact with the whistle-blower” and prevent the transmission of tainted information; no expert can participate in the civil examination. (For LMSB-4-0508-033, see Doc 2008-16791 or 2008 TNT 149-40 2008 TNT 149-40: IRS LMSB Directives.)

In the wake of the Service’s guidance, several practitioners representing sizable whistle-blower claims have been critical of some components of the government’s process. In a March letter to Deborah Butler, IRS associate chief counsel (procedure and administration), Gregory S. Lynam and Scott A. Knott, tax partners with the Ferraro Law Firm, said the procedures in the chief counsel notice limiting interaction with tax whistle-blowers are a “mistake and contrary to Congressional intent.” Congress intended informants to work closely with the IRS, the two said. (For the letter, see Doc 2008-17767 2008 TNT 159-9: IRS Tax Correspondence.)

The Ferraro Law Firm in June submitted a $4.4 billion tax whistle-blower claim against a Fortune 500 company, reportedly the largest ever submitted. (For prior coverage, see Doc 2008-13179 or 2008 TNT 116-1 2008 TNT 116-1: News Stories.)

“We are concerned that the IRS is instructing the agents to take this position of refusing to cooperate with an insider without ever having determined if the ‘one-bite’ rule would even apply in the first place,” Lynam and Knott wrote. “We believe this is a mistake and that the IRS is throwing away an opportunity to obtain the highest quality information from the highest value insiders.”

Although informants and their representatives attempt to present the IRS with a detailed and complete submission in the first meeting, Lynam said, there will be instances when more documentation is needed. “It is important in those cases for the IRS to be able to go back and get additional information from the informant,” he told Tax Analysts.

The LMSB procedures are not necessarily new, Lynam said, adding that he hopes “the finalization of these procedures will speed up the processing of high-quality information to the people who can really use it — the exam team.”

Bryan Skarlatos of Kostelanetz & Fink LLP, another firm representing several billion dollars in whistle-blower claims, said the Service’s rules, while well-intentioned, constrain its ability to pursue cheating taxpayers.

Designing a framework that conforms to the one-bite rule and doesn’t encourage people to violate court protective orders or the attorney-client privilege may ensure the government is a “passive recipient” of information, Skarlatos said, but his experience has shown that the IRS is not always active in following up on the information provided as a result of the restrictive rules. “The Service has been reluctant in some cases to follow up on sources our clients have pointed out to provide additional evidence of tax noncompliance,” he said. “The government should not feel hampered [in issuing] summons or [taking] other administrative action to collect further support” on informants’ claims, he said.

Skarlatos also said that for the whistle-blower program to work in the long run, Congress will have to amend section 6103’s privacy rules to allow a greater range of disclosure from the IRS to an informant. “There is too much of a black hole right now,” he said. “Whistle-blowers can wait for years with no word from the Service on the progression or status of a claim.” The lack of communication will “hamper future participation in the program because some whistle-blowers feel they are taking significant risks in coming forward, but the IRS cannot engage in meaningful communication about what is happening,” he said.

One problem Congress and the IRS have not yet addressed, Skarlatos said, is retaliation against whistle-blowers. “The lack of current protection for whistle-blowers can cause many potential sources to shy away from submitting claims,” he said.