Determining the Amount in Dispute for Purposes of a Whistleblower Award

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In Smith v. Commissioner, 148 T.C. No. 21 (June 7, 2017), the Tax Court looked for the first time at the issue of the amount in dispute for purposes of determining whether the individual providing information to the IRS should receive an award based on a mandatory or discretionary basis.  The information provided directly led to recovery of an amount that did not reach the minimum amount to trigger a mandatory award percentage; however, the information caused the IRS to audit a taxpayer and recover through that audit an amount significantly in excess of the amount needed to trigger the mandatory award percentage.  The question before the Court was the meaning of amount in dispute as it related to the triggering of the mandatory award percentage.  The Tax Court decided that the amount in dispute was the larger amount which will mean a bigger payday for the informant.  The Court did not determine the final amount of the award but sent it back to the IRS to make an award determination consistent with its decision.

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When I worked for Chief Counsel, I had a number of cases generated by whistleblowers.  Their information provided vital pointers to underreporting, non-reporting, or false reporting which, at the time, the IRS rewarded with total discretion.  My observation was that the IRS tended not to be too generous in its determination of the award amount but, nonetheless, individuals still came forward with valuable, and not so valuable, information based on motives not always driven by the potential of a financial reward.

Congress decided that it wanted to incentivize individuals to come forward with information about underreporting of taxes in larger cases because it felt greater incentives and more clarity in the amount of the potential reward would ultimately benefit the government by encouraging more people to come forward.  I am unsure if we have enough data yet to know how successful the law has been but enough high profile cases exist to convince me, as a casual observer and as someone who saw the results during their much less public stage prior to the enactment of the whistleblower provisions, that the incentives do make a difference.

Perhaps Congress felt that for smaller cases, other incentives provided the necessary basis for coming forward and the IRS could continue to have discretion on how much to pay the informant which Congress preserved in IRC 7623(a); however, for “big” cases, Congress stepped up with the concept of mandatory awards in 7623(b).

The Smith case works through the statute to find meaning regarding the definition of a big case.  Congress defined it using the term “amount in dispute” in IRC 7623(b)(5)(B) ; however, the meaning of that term still needed interpretation prior to the Smith case.  The Tax Court noted that it had made some determinations regarding 7623(b)(5)(B) starting with the determination in Lippolis v. Commissioner, 143 T.C. 393, 396 (2014) in which it considered whether the $2 million threshold of 7623(b)(5)(B) was jurisdictional or should be asserted as an affirmative defense.  The Smith opinion works its way through other opinions concerning the provision.

The information provided by Mr. Smith proved very valuable to the IRS for reasons that went beyond the direct information he provided.  The IRS ended up collecting almost $20 million; however, it calculated that the portion of this amount directly related to the information he provided only amounted to $1.7 million.  Since the amount directly related to his information fell below the $2 million threshold for a mandatory award, the IRS determined the amount of his award using its discretion.  The minimum mandatory award would net Mr. Smith 15% of the amount related to his information while the IRS using its discretion awarded him 10% – almost $90,000 less.

“Respondent argues that certain common words or phrases in section 7236(b)(1) require him to follow the same quantitative measure in determining the $2 million threshold of section 7623(b)(5)(B).  In particular, respondent focuses on the words “any” and “action” in the context of section 7623(b)(1)….  Respondent goes on to contend that section 7623(b)(1) therefore defines the scope of the words “any action” for purposes of section 7623(b), and accordingly governs the use of the phrase “any action” in section 7623(b)(5).”

The Tax Court finds the interpretation of the IRS to be misplaced.  It looks at IRC 7623 as a whole as its history and determines that “’action’ for purposes of subsection (b) is the detecting of underpayments of tax or violations of tax law without any qualifier as to quantity or amount.”  Based on this interpretation of the statute, the Court finds that “action” does not establish another technical definition for 7623(b).

Therefore, the Tax Court declines to accept the interpretation by the IRS that action means that only the directly attributable dollars count in determining “amounts in dispute” for purposes of determining if the information meets the $2 million threshold for making a mandatory award.  Petitioner’s information caused the IRS to begin an examination that resulted in the collection of over $20 million.  The phrase in the statute “’amounts in dispute’ is not specifically limited to only those amounts directly or indirectly attributable to the whistleblower information.  Once the monetary thresholds are met and the government recovers ‘collected proceeds’ resulting from the action, the mandatory provisions of subsection (b)(1) or (2) apply.”

Looking at the applicable regulation as well as the statute, the Tax Court determines that the “regulation does not support respondent’s narrow view that the ‘amount in dispute’ is limited to the portion to which award percentages are applied….  The regulation provides instead that the amounts in dispute are the amounts that resulted from the actions with which IRS proceeded based on the whistleblower information.  Accordingly, it does not follow that the limiting standards of section 7623(b)(1) and (2) providing for a percentage to be applied to the portion of ‘collected proceeds’ to which the whistleblower’s information ‘substantially contributed’ would also apply in determining whether the initial $2 million threshold has been met.”

The Tax Court’s interpretation will allow whistleblowers to benefit from collateral items discovered by the IRS in an audit in the application of the percentage applied to their award.  In many, if not most, cases, the IRS would not audit the party targeted by the whistleblower.  Because the IRS would not audit the taxpayer without the intervention of the whistleblower, it makes sense to allow the whistleblower to enjoy the mandatory percentage with respect to that portion of the award clearly attributable to the information provided.  The issue should only arise in cases in which the IRS has benefited in material and fairly substantial ways from the information provided by the whistleblower.  Even though it must pay a higher percentage than it would have paid if it had total discretion, the amount paid remains much less than the amount recovered.

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