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IndustryTrends by Robert E. McKenzie, Esq.

NATP Member

New IRS Whistleblower Law

IRS prepares for coming wave of informants looking for monetary rewards

little noticed provision of the entitled to awards under the IRS dis-
Tax Relief and Health Care cretionary award program. Under the
Act of 20061, which became traditional program the IRS limited
effective on December 20, 2006, awards to 15 percent and most
has created a rewards program for were for significantly less. It is
individuals informing the IRS of anticipated that the IRS con-
large tax omissions. The IRS is gearing tinue to be parsimonious on
up for an influx of informant claims. lower dollar whistleblower items.
IRS managers have reported that
whistleblowers have already provided Right to Sue for an Award open, nothing prevents someone who
tips involving hundreds of million The whistleblower law allows a witnesses testimony from reporting
dollars in tax underpayments. claimant to sue the IRS in U.S. Tax information to the IRS. This includes
Court if it denies a reward. In the a judge, juror, court reporter, other
Generous Awards past, a whistleblower had no right to court employee, and your opponent.
The new whistleblower law applies to sue the IRS because rewards were dis- Sworn testimony and related evidence
claims for reward in cases in which cretionary. in a proceeding can be freely given to
the potential amount owed to the the IRS under this whistleblower pro-
IRS for taxes, penalties, and interests Public Information gram. Matters that might disclose tax
exceeds $2 million and, in cases of Whistleblowers may also seek a underpayment should be settled before
individuals, the taxpayer’s gross reward for bringing public available additional information regarding the
annual income must exceed information to the attention of the conduct is made public.
$200,000. The new law provides a IRS if it results in the recovery of
minimum reward of 15 percent and a additional taxes. This type of award is Regulatory Investigations
maximum reward of 30 percent. This limited to 10 percent of the IRS Investigations by state and local regu-
is a substantial increase over the pre- recovery. For example, aspiring latory agencies might also generate
vious regulations that provided a informants might review a company’s informant items to the IRS. A state
minimum recovery of 1 percent and SEC filings to find apparent tax environmental investigator might
a maximum recovery of 15 percent omissions and then file for a reward. note improper expensing of pollution
for whistleblowers. The law does Others might spot apparent tax viola- equipment during the course of veri-
place a cap of 10 percent on rewards tions in the public media and seek an fying environmental compliance and
if the IRS determines that the award. One could contemplate a little decide to try for an award. Likewise,
whistleblower’s information was not noticed story in a newspaper that a liquor inspector might note inven-
the original source of information could provide a tax lead. For exam- tory issues while performing his/her
but still contributes to the additional ple, if a company was accused of bid duties. With so many state and local
collection. The fact that an individual rigging or other financial crimes regulators—from building inspectors
participated in the activities that cre- where the company’s net income was to safety inspectors—checking busi-
ated a tax omission does not preclude not likely to have been properly nesses each year, one can contemplate
an reward but the IRS uses involve- reported, someone could inform the that some may come to view the
ment in the tax underpayment as a IRS and seek a reward. Whistleblowers whistleblower program as a way to
basis to reduce the reward. who planned or initiated the tax secure an economic windfall.
The law also provides that the scheme might be barred from recov-
IRS must make a reward payment in ering a reward, but there may be IRS Whistleblower Office
all cases in which it pursues a remedy instances where they receive money On February 2, 2007, the Internal
against a taxpayer based upon infor- from the IRS depending on the level Revenue Service named Stephen A.
mation provided by the whistle- of complicity. Whitlock as director of its new
blower. The previous awards were Whistleblower Office, where he will be
discretionary and in many cases the Litigation Disclosures responsible for administering the pro-
IRS refused to pay any award to the Another source of potential whistle- gram designed to receive information
informant even when the informa- blower material is company litigation. that helps uncover tax cheating and to
tion resulted in a substantial recovery During the course of most commer- provide appropriate rewards to whistle-
of taxes. Smaller informant items that cial litigation, substantial economic blowers. The IRS Whistleblower
do not meet the statutory minimums information becomes part of the Office, will process tips received from
of the whistleblower law will still be record. Since the court system is individuals who spot tax problems in

42 NATP TAXPRO Journal Summer 2007

their workplace, while conducting For example, one percent
day-to-day personal business, or any- of all wage, salary, and tip
where else they may be encountered. income is misreported, con-
Whitlock’s office will be responsible tributing an estimated $10
for assessing and analyzing incoming billion to the tax gap. In
tips. After determining their degree of contrast, nonfarm sole pro-
credibility, his office will assign the prietor income, which is
information to the appropriate IRS reported on a Schedule C
office for further investigation. and is subject to little third-
party reporting or withhold-
Form 211 ing, has a net misreporting
A whistleblower should submit percentage of 57 percent,
his/her information to the IRS with contributing about $68 bil-
Form 211, Application for Award for lion to the tax gap.
Original Information. If the tax The tax gap can be
omission is substantial, it would be divided into three compo-
also be wise to contact the IRS nents: nonfiling, underre-
Whistleblower office in advance and porting, and underpayment.
negotiate the terms of the award. If The Coming Wave
the whistleblower was in any way Nonfiling of Informants
involved in the tax omission, it Nonfiling occurs when taxpayers Given the immensity of the tax gap,
would wise to consult an experi- who are required to file a return do one must anticipate that the IRS will
enced tax attorney prior to any IRS not do so on time. Underreporting come to increasingly rely on the new
contact. A good example of this of tax occurs when taxpayers either Whistleblower Office to find tax
would be an ex-wife who plans to understate their income or overstate underreporting. There are already
report her ex-husband after filing a their deductions, exemptions, and websites established by law firms
joint return. The informant might credits on timely filed returns. seeking to profit from the coming
end up with significant personal tax Underpayment occurs when taxpay- waive of whistleblowers. Many adver-
problems of her own. ers file their return but fail to remit tise their services on a contingent fee
the amount due by the payment basis. Given the high level of tax
Value of Informant Information due date. cheating in this country, there are
for Tax Enforcement opportunities for rewards.
In June 2006, the U.S. Treasury Underreporting Audits of businesses are long,
issued a report that found that exami- Of these three components, under- complex processes and will prove to
nations initiated based on informants’ reporting of income tax, employ- be a drain on company resources.
data is more effective and efficient in ment taxes, and other taxes Even an inaccurate informant item
identifying taxes than returns selected represents about 80 percent of the might cause the IRS to open an audit
using the IRS’ primary method for tax gap. The single largest sub-com- that may ultimately discover another
selecting returns for examination. ponent of underreporting involves mistake on company tax returns. The
Normally the IRS uses mathematical individuals understating their company may never discover the source
screening programs to select many incomes, taking improper deduc- of the original whistleblower informa-
returns for audits. tions, overstating business expenses, tion because whistleblowers’ identities
and erroneously claiming credits. must be kept secret by the IRS. ♦
Tax Gap Individual underreporting represents
There are billions of dollars in unre- about half of the total tax gap. Indi-
26 U.S.C. §7623
ported taxes in the United States. vidual income tax also accounts for Reprinted from Merten’s Law of Federal Income
Last year, the IRS issued a revised about half of all tax liabilities. Tax Highlights with permission. Copyright
report on the Tax Gap estimating ©2007 Thomson/West.
that there was about $345 billion in Underpayment Tax Lawyer Robert Ernest McKenzie has lec-
unreported and underpayed taxes. Underpayment occurs when a tax- tured extensively on the subject of taxation. He
Though the net misreporting per- payer files a return without paying has presented courses before thousands of CPA's,
centage varies by category of income, the balance of tax due. It also can attorneys and Enrolled Agents nationwide. Mr.
the rates reflect that compliance is occur when the taxpayer fails to pay McKenzie is the author of Representation
highest where there is third-party taxes assessed as a result of an IRS Before the Collection Division of the IRS and
coauthor of Representing the Audited Taxpayer
reporting or withholding. Simply audit. Each year over $30 billion of Before the IRS and Representation Before the
stated, compliance is highest where assessed taxes go uncollected as a U.S. Tax Court. For more information, check
there is third-party reporting. result of taxpayer underpayments. out

Summer 2007 NATP TAXPRO Journal 43