We help claimants submit whistleblower claims. But when we receive calls asking for help with whistleblower claims, we do everything we can to dissuade the callers from submitting claims.
The IRS’s whistleblower program has been plagued by mismanagement. Cases have long been mishandled by the IRS. Legitimate awards denied. Claimants have to be prepared to fight just to get the IRS to respond to their inquiries, let alone to get their awards.
Some fights just aren’t worth it. The recent Lewis v. Commissioner, 154 T.C. 8, court case provides an example. The case upholds a sequestration reduction to a legitimate and substantial whistleblower claim.
While the claimant received an award, the claimant likely spent most of the award on legal fees to obtain the award. After the claimant pays taxes on the award, he may have even lost money and may have been better off having not submitted the claim in the first place.
Facts & Procedural History
The whistleblower was terminated from his job. He was the financial manager for a corporation owned by a husband and wife.
He filed a whistleblower for the corporation. The claim alleged that the corporation continued to pay the owner’s son over $500,000 a year and deducted the payments as wages, even though the son had stopped working for the company more than 10 years prior.
The claim asserted that the deductions should be disallowed for the corporation, that the payments be treated as taxable dividends to the owners, and that the transfers trigger a gift tax for the transfers to the son.
The IRS audited the corporate tax return. The son then filed a return to report the wages for the 2010 tax year. The parties agreed that the corporation was not able to deduct the $500,000 in wages. But the IRS agent did not assert that the amount was a dividend taxable to the owners or that the transfer to the son was a gift.
The IRS did change a loan to the owner’s other son to a dividend, however. The corporation had made several million dollars in loans to the other son.
The IRS also disallowed automobile expenses claimed on the corporate tax return.
The IRS also imposed accuracy-related penalties.
The IRS’s Whistleblower Office determined that a 22% award should be made. This resulted in a $206,693 award. This was 22% of the collected proceeds of $1,009,146 less a 6.9% sequestration reduction.
The dispute focused on the sequestration reduction.
About IRS Whistleblower Claims
The IRS is authorized to make awards to those who report wrongdoing to the IRS. Congress established the Whistleblower Office to handle these claims. The office has been widely criticized over the years. This includes criticism by members of Congress. It has also triggered quite a bit of litigation.
The authority for these claims is found in Section 7623:
[The IRS] is authorized to pay such sums as he deems necessary for—
(1) detecting underpayments of tax, or
(2) detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same, in cases where such expenses are not otherwise provided for by law. Any amount payable under the preceding sentence shall be paid from the proceeds of amounts collected by reason of the information provided, and any amount so collected shall be available for such payments.
The amount of the award is to be “at least 15 percent but not more than 30 percent of the proceeds collected as a result of the action (including any related actions) or from any settlement in response to such action.”
The term “proceeds” includes penalties, interest, additions to tax, and additional amounts provided under the internal revenue laws. It also includes criminal fines and civil forfeitures.
The Code also authorizes the U.S. Tax Court to review whistleblower awards. There is a growing body of case law that helps define what awards are permissible and the limitations on awards. The current court case addresses the IRS’s sequestration reduction to the award.
The Sequestration Reduction
With respect to the sequestration, the IRS Whistleblower Office’s letter stated:
The Budget Control Act of 2011, as amended by the American Tax Relief Act of 2012, requires that automatic reductions be made with respect to certain government payments. The required reduction percentage is determined annually by the Office of Management and Budget for the year in which payments are made. As a result, your preliminary recommended award reflects a reduction in accordance with the Office of Management and Budget guidance for the 2017 Fiscal Year reduction amount of 6.9%. The final award amount will use the reduction required in the year of payment.
The IRS attorney argued that the IRS Whistleblower Office did not determine the percentage used for sequestration; rather, the IRS merely followed guidance from the OMB that whistleblower awards are subject to sequestration.
The court describes sequestration as follows:
Sequestration is a measure by which Congress enforces mandatory spending cuts across most Government programs and agencies during the budgetary process. Sequestration applies to all nonexempt direct spending when Congress fails to enact certain budgetary legislation for the fiscal year.7 Budget Control Act of 2011 (Budget Control Act), Pub. L. No. 112-25, secs. 101-103, 125 Stat. at 241-246, as amended by American Taxpayer Relief Act of 2012 (codified as amended at 2 U.S.C. sec. 901(a) (2012)), Pub. L. No. 112-240, sec. 901, 126 Stat. at 2370. The applicability of the sequestration and the sequestration percentage are determined on the basis of the Government fiscal year that the award is paid. The WBO informed petitioner that the sequestration would have resulted in a $15,319 reduction in his award if it had been paid during the Government’s 2017 fiscal year, ended September 30, 2017. The Office of Management and Budget (OMB) calculates the sequestration percentage for each fiscal year following the procedures set forth in the statute.
The whistleblower argued that whistleblower awards are statutorily exempt from the sequestration of direct spending.
The court did not agree with the whistleblower. It concluded that IRS whistleblower awards are subject to sequestration. It reached this conclusion by noting that the sequestration rules include exceptions, but there is no exception provided for whistleblower awards. Thus, the court construed the statute as saying that whistleblower awards are subject to sequestration.
The result is that the whistleblower’s award was reduced by the 6.9% sequestration reduction.
The Takeaway: Most Claims Shouldn’t be Submitted
The IRS often denies whistleblower awards. It does so by:
- Opting not to audit returns based on information submitted.
- Choosing to not pursue issues as part of the audit.
- Settling tax balances with the taxpayer before an award is made.
- Arguing that the taxpayer’s information was either not that helpful or would have been discovered by the IRS anyway.
- Applying a percentage reduction in the award rate.
If the whistleblower award survives this gauntlet of reductions, it will also be reduced by the sequestration rate. The IRS’s website indicates that the sequestration rate is currently 5.9% for 2020.
Would-be whistleblowers should factor this reduction into their calculations as to whether to submit claims. Given the high probability that the IRS will not make an award or, if it does make an award, that the award will be reduced significantly, most would-be whistleblowers shouldn’t bother submitting claims.
In most cases, the time and hassle involved in dealing with the IRS Whistleblower Office are not worth it.
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