Whistleblower Award Properly Denied Where Info Didn't Lead to IRS Examination

(Parker Tax Publishing September 2021)

The Tax Court held that the IRS Whistleblower Office did not abuse its discretion when it denied an award to an individual who submitted information regarding a company's alleged failure to include certain items in income after the IRS proceeded with an action against the company for an erroneous deduction. The court found that the IRS did not collect any proceeds "as a result of the action" as required by Code Sec. 7623(b)(1) because under Reg. Sec. 301.7623-2, which the court found is a reasonable interpretation of an ambiguous statute, the examination of the erroneous deduction issue constituted a separate administrative action that was not initiated on the basis of the individual's claim. Lissack v. Comm'r, 157 T.C. No. 5 (2021).

Background

In 2009, Michael Lissack filed a Form 211, Application for Award for Original Information, to inform the IRS that a group of entities (the target), which developed condominiums and offered golf and beach club memberships to residents, had failed to report millions of dollars of membership fees. According to Lissack, the target treated the fees as nontaxable deposits even though it had "complete control over" the fees and was thus required to include them in its income.

The IRS Whistleblower Office (Office) processed Lissack's claim and referred it to a revenue agent, Nora Beardsley, who forwarded the case to the IRS Large Business & International Division (LB&I). An agent in LB&I determined that the entities had properly treated the membership fees as nontaxable deposits. But the revenue agent separately discovered an unrelated issue - that the entities had claimed an erroneous deduction for intercompany bad debt - and made a $60 million adjustment on that account. The agent noted in a report to Beardsley that the erroneous deduction issue was "unrelated to the subject of the whistleblower claims" and emphasized that Lissack had not provided any information for the adjusted issues. On Beardsley's recommendation, the Office denied Lissack's whistleblower claim because the IRS adjustment was unrelated to the information he had supplied. Lissack took his case to the Tax Court.

Code Sec. 7623(a) authorizes the payment of sums necessary for "detecting underpayments of tax" or "detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same." Under Code Sec. 7623(b)(1), a whistleblower award can be paid only if the IRS proceeds with an administrative or judicial action "based on information brought to the Secretary's attention." The whistleblower is entitled to an award only if the IRS collects money "as a result of the action."

Reg. Sec. 301.7623-2(b)(1) provides that the IRS "proceeds based on" a whistleblower's information when the information "substantially contributes to" an administrative or judicial action against a person identified by the whistleblower. Reg. Sec. 301.7623-2(b)(2), Example 2, illustrates this principle. In Example 2, a whistleblower provides facts detailing how a taxpayer underpaid tax in Year 1. The IRS initiates an examination, investigates those facts, then expands the examination to determine whether the taxpayer, by engaging in the same activities, also underpaid tax in Year 2. During the examination, the IRS obtains additional facts that are unrelated to the activities described in the information provided by the whistleblower. Based on these additional facts, the IRS further expands the scope of the examination for Years 1 and 2. Example 2 concludes that the portion of the examination that is unrelated to the facts and issue identified by the whistleblower is not an action with which the IRS proceeds based on the information provided by the whistleblower, because the information provided did not substantially contribute to the action. Rather, that portion of the examination is a separate administrative action.

Lissack supplied no information to the IRS about the target's intercompany bad debt deduction. However, he argued that Congress did not intend to limit awards directly to the issues that the whistleblower provided information on. Recognizing the impediments that the regulations imposed to this argument, Lissack contended that the regulations were to that extent invalid. According to Lissack, Code Sec. 7623 is unambiguous and Example 2 adds new limiting rules that are manifestly contrary to the plain language of the statute. He emphasized the word "any" in the opening clause of Code Sec. 7623(b)(1), which asks whether the Treasury Secretary has proceeded with "any administrative or judicial action based on information brought to the Secretary's attention by" the whistleblower. Lissack argued that if the IRS initiates "any" action, then that action in its entirety constitutes the "action" for purposes of Code Sec. 7623. He also cited for support a Joint Committee on Taxation (JCT) technical explanation which described preexisting IRS administrative guidelines for discretionary awards under which a whistleblower could receive an award if his or her information caused the investigation but had no direct relationship to the determination of tax liabilities.

Analysis

The Tax Court held that Lissack was not eligible for a whistleblower award because the IRS did not collect any proceeds "as a result of the action" as required by Code Sec. 7623(b)(1). The court also upheld the validity of Reg. Sec. 301.7623-2 under the standard set forth in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984).

The court found that the examination of the membership deposits issue was an "administrative action" that was initiated on the basis of the information Lissack supplied. This "administrative action," however, resulted in no adjustments to income and no collected proceeds. Because the IRS did not collect any proceeds "as a result of th[is] action," the court found that Lissack was not eligible for a whistleblower award. The court noted that, during the course of the examination, the revenue agent discovered an entirely separate issue - the target's deduction for intercompany bad debt - not by any information in Lissack's Form 211 but by the agent's independent review of the target's tax returns. According to the court, that portion of the examination was not an action with which the IRS proceeded based on the information provided by Lissack. After recounting the steps Beardsley took to confirm that the deficiency determination did not arise from the membership deposits issue, the court said it had no difficulty concluding that the Office did not abuse its discretion in denying Lissack's claim for an award.

Next, the court upheld the validity of the regulations after finding that Code Sec. 7623(b)(1) is ambiguous and Reg. Sec. 301.7623-2 is a reasonable interpretation of the statute. The court observed that, while Code Sec. 7623(b)(1) refers to any administrative judicial action "described in subsection (a)," subsection (a) does not describe or define an "administrative or judicial action." Thus, subsection (b) refers to a description in subsection (a) that does not exist. And whereas subsection (b) initially refers to commencement of "any action," it defines the allowable award by reference to proceeds collected as a result of "the" action. For these reasons, the court found that Code Sec. 7623 leaves ample scope to the IRS to define the term "administrative or judicial action." The court rejected Lissack's reliance JCT technical explanation as evidence of Congress's intent, noting that such explanations are not part of the legislative history and do not constitute direct evidence of legislative intent. The court said that even if the technical explanation was part of the legislative history, all it did was explain preexisting IRS administrative guidelines and there was no evidence that Congress intended to incorporate this guideline into the text of the amended statute.

The court found that Reg. Sec. 301.7623-2 is a reasonable interpretation of Code Sec. 7623(b)(1) because it clarifies that a whistleblower will be rewarded only if the information that he or she supplied results in an adjustment. In the court's view, the IRS reasonably concluded that the IRS does not "proceed based on" the whistleblower's information unless that information substantially contributes to the "administrative action" that generates proceeds. Otherwise, whistleblowers would be incentivized to file innumerable claims as mere fishing expeditions, hoping that the IRS will find something wrong with those taxpayers' returns (related to the information they supplied or not). The court said that there was no evidence that Congress wished to encourage this sort of behavior.

For a discussion of whistleblower awards, see Parker Tax ¶262,301.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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