Whistleblower Convinces Tax Court to Order IRS to Produce Information Document Requests over IRS Objection

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There have been a number of disputes spinning out of whistleblowers trying to get information from the IRS about both proceeds collected and the link between the information and the proceeds. This week in Whistleblower 11099-13W v Comm’r the Tax Court resolved a discovery dispute involving the IRS’s refusal to serve up Information Document Requests and some related documents it claimed were not relevant in the whistleblower proceeding. The opinion discussed the broad reach of what is relevant and also raises some issues that the Tax Court will likely have to directly address in the future, including how to determine whether subsequent increases in a target’s tax liability which are indirectly related to the whistleblower’s information constitute proceeds for the purposes of Section 7623.

I will briefly describe the legal context, the scheme underlying the 11099-13W proceeding, the dispute and the Tax Court’s resolution.

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For whistleblowers, the entitlement to an award requires that the whistleblower understand what IRS did with the information that the whistleblower provided to the IRS. That in turn requires information that is outside the whistleblower’s control. Getting from the IRS the information about the outcome of an investigation requires the whistleblower to 1) discover what if anything was collected from the target and 2) establish a link between the information provided about the target and the proceeds collected.

As the opinion describes, the case involves a tax evasion scheme (TES) that a target and its affiliates used to manipulate income reporting:

[The scheme] involved target’s engaging in an inventory purchasing scheme that, on account of target’s use of a last-in, first-out (LIFO) method of accounting for inventory, allowed it to artificially inflate its cost of goods sold for tax purposes. Petitioner claims that target used the TES to defer income taxes indefinitely. He claims that he was employed by a corporation (corporation X) affiliated with target that traded commodities that were integral to the purchasing scheme that he had described.

IRS agreed that the issue was one it was unaware of and it did investigate based on the information, though it claimed that the information did not lead anywhere:

Respondent’s position, however, is that he did not use petitioner’s information to make any adjustments to target’s tax returns. He states that his agents added the TES to their examination of target’s tax returns for two of its taxable years (years 1 and 2, respectively) but that because they were unable to discover anything to substantiate petitioner’s claim that the TES violated Federal tax law, he made no adjustments and collected no proceeds on account of petitioner’s information. He does admit to making other adjustments to target’s returns for years 1 and 2, which apparently resulted in the collection of additional taxes from target.

Not surprisingly, the petitioner disagreed with the IRS’s view of the utility of the information:

Petitioner believes that, before the end of year 2, because of the information he provided to the IRS, target stopped using the TES, which increased its year 2 tax bill and would increase its tax bills for subsequent years. Petitioner identifies inventory-related adjustments of $273.7 million and $13.3 million that respondent made to petitioner’s year 1 and year 2 reported income tax, respectively, and that petitioner claims are “in the very area–LIFO valuation–that had been the subject of * * * [petitioner’s] Whistleblower Claim.” Finally, petitioner claims that, in year 5, target announced its abandonment of the use of LIFO altogether. That, according to petitioner, increased its tax bill by at least $3 billion for subsequent years. Petitioner believes that he is entitled to an award because it was his information that caused target to pay, and the IRS to collect, additional tax.

The petitioner sought the documents to show that it was his information that led to the immediate increase in tax and to the future years increase as well. IRS objected to turning over the documents on the grounds of relevancy. The opinion discusses the meaning of relevance under the Federal Rules of Evidence, which ties the term to two related concepts: materiality and probative value. The opinion notes that IRS does not “make clear which of the requested IDRs are irrelevant because they are not material and which are irrelevant because they lack probative value (or which are irrelevant for both reasons…”

Instead, the opinion identifies the implicit interpretative position that the IRS objection raised:

Respondent does not deny that, on the basis of petitioner’s information, he added the TES to his examination of target for years 1 and 2, nor does he deny that he made adjustments to target’s income for those two years. What he does deny is that he proceeded on the basis of petitioner’s information about the TES to make those adjustments (or to make any other adjustments). Implicitly, he is making an argument about the meaning of the term “proceeds * * * based on” in section 7623(b)(1). By emphasizing that he made no adjustments “on petitioner’s issue,” he implies that the Secretary proceeds with an administrative adjustment based on a whistleblower’s information only when the adjustment redresses the specific errors in tax reporting alleged by the whistleblower.

The opinion notes that the IRS position “may have some purchase in the wording of section 7623(b)(1) and of an implementing regulation” but that the discovery dispute is not the forum for resolving that legal issue:

The proper interpretation of section 7623(b)(1) is something that the Court may decide in due course during these proceedings upon argument or briefing by the parties. If respondent is interested in a pretrial ruling from the Court on matters of law, then his proper course of action under our Rules would be to file a motion for summary judgment under Rule 121.

In addition to rejecting a relevance objection based on its implicit legal argument, the opinion also rejects the position that the documents are not probative or would lead to other admissible evidence. The opinion notes the relatively low bar in establishing relevance:

[I]n a discovery dispute, once the discovering party makes some minimal showing of the relevance of the information or response sought to the subject matter involved in the pending case, the party opposing the production of information has the burden of establishing that the documents sought by the other party are not relevant or otherwise not discoverable

Parting Thoughts

This case is worth watching, as the opinion flags some important substantive concepts that the Tax Court has not yet fully addressed but likely will in the near future. From a discovery standpoint, this opinion also should prove helpful for litigants who are trying to get information from the IRS. An earlier order in the case clarified that while the Tax Court is bound to the administrative record in whistleblower disputes, it is not in the IRS’s sole discretion to determine what in fact constitutes the administrative record. Determining what in fact is in the administrative record is one that agencies, litigants and courts confront routinely in non-tax matters, but it is not often an issue in tax cases which generally are reviewed de novo, with the record below not tying the hands of the court.

As courts in the next few years address some of the key concepts in the whistleblower statute, it is likely that some though not all of these disputes concerning what the IRS should provide will go away. Even with the pressure of the Tax Court coming down on the IRS for failing to provide information, I suspect the IRS will likely keep its cards very close to its vest.

 

 

 

 

 

 

 

 

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. Carl Smith says

    It is pretty amazing to me that it is now 10 years since the Tax Court has had whistleblower award review jurisdiction, but we haven’t even yet had an opinion out of the court after the record is complete, so the court hasn’t even yet addressed whether its standard of review is de novo or abuse of discretion or what criteria the Tax Court will use to decide if an award was too small (or should have been given when none was). I know some cases have settled, but it appears that whistleblower award cases are slow as molasses.

  2. And perhaps in my parting thoughts I overstated the point about the court is bound to the record (see https://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=1124 assuming but not deciding that point in holding that IRS generalized objections based on what it thinks is in record is insufficient) There still is as you point out lots for the courts to resolve in these cases

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