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Tax Court Rejects Taxpayer's Arguments for Higher Whistleblower Award

(Parker Tax Publishing April 2020)

The Tax Court held that the IRS Whistleblower Office did not abuse it discretion when it determined that the proceeds collected as a result of the taxpayer's information, and upon which his whistleblower award was calculated, should not include certain amounts relating to the targets of the investigation undertaken as a result of the taxpayer's information. The court further held that the Whistleblower Office did not abuse its discretion when it determined that the sequestration provisions of the Budget Control Act of 2011 applied in determining the taxpayer's whistleblower award. Lewis v. Comm'r, 154 T.C. No. 8 (2020).


In 2011, Timothy Lewis submitted a Form 211, Application for Award for Original Information, to the IRS Whistleblower's Office (WBO). Lewis alleged that a closely held corporation and its two married shareholders underpaid income tax for 2010 and prior years. Lewis had been employed as a financial manager at the corporation from 1997 to April 2011, when the corporation terminated his employment. Lewis alleged that the corporation and the shareholders misreported transfers to the shareholders' two sons (son No. 1 and son No. 2). Lewis claimed that the corporation had transferred over $15 million to son No. 1 and deducted the payments as wages even though the son no longer worked for the corporation (wage issue). Lewis also claimed that the corporation improperly treated transfers of approximately $15 million to son No. 2 as loans rather than as gifts.

Based on Lewis's information, the IRS audited the corporation's 2010 tax year and the shareholders' 2010 and 2011 tax years. The IRS did not include the corporation's 2011 tax year in the audit because the corporation had not yet filed its 2011 corporate return, and it was not yet due. Through the audit of its 2010 tax year, the corporation learned of the IRS's position on the wage issue and, when it filed its 2011 return, it did not deduct any wages for son No. 1. A closing agreement was executed stating that the corporation's 2010 wage deduction for son No. 1 for 2010 was disallowed. The parties also agreed that the corporation's loans to son No. 2 during 2010 and 2011were taxable dividends to the shareholders and gifts to son No. 2.

The shareholders filed gift tax returns for 2010 and 2011 reporting the loans to son No. 2 as gifts. They used a portion of their unified credits to offset the resulting gift tax. The husband died in 2014. No estate or gift tax was due on the filing of his estate tax return because the estate claimed his remaining unified credit and a marital deduction for a trust that provided a life estate to his wife and the remainder to his two sons. The trust documents provided that upon the wife's death the trustees would pay the estate tax due before distributing the remaining assets to the beneficiaries. In 2015, the wife made gifts of over $11 million, used her remaining credit, and paid over $4.6 million in gift tax.

Under Code Sec. 7623(b)(1), a whistleblower may be awarded between 15 and 30 percent of the proceeds collected as a result of the action, and Reg. Sec. 301.7623-4(b) provides factors for the IRS Whistleblower Office (WBO) to consider in determining the award percentage. A senior analyst in the WBO determined that Lewis's information resulted in the collection of $1,009,146 of collected proceeds and recommended that he be awarded 22 percent of that amount. The WBO sent Lewis a preliminary letter recommending an award of $206,693 - 22 percent of the collected proceeds less a 6.9 percent sequestration reduction under the Budget Control Act of 2011, which required automatic reductions to certain government payments. Lewis responded that the collected proceeds should include the tax collected from the 2011 wage issue (i.e., the tax resulting from the corporation not claiming a wage deduction for Son No. 1) and the unified credits used to offset the shareholders' gift tax. He also claimed that the sequestration reduction was improperly applied. The WBO eventually issued a final decision letter awarding Lewis $206,693, with no possibility of any future proceeds from the husband's estate, because it determined that any events that could have triggered tax had already occurred and resulted in no tax.

Lewis appealed to the Tax Court. He contended that the collected proceeds should have included the tax resulting from the corporation's decision not to deduct son No. 1's wages for 2011. He also asserted that the deceased husband's used unified credit should have been included in collected proceeds, as well as the tax on the transfer of the trust assets to the husband's named beneficiaries on the termination of his wife's life estate. According to Lewis, the husband merely deferred the payment of estate tax on his assets and any tax from the transfer of his assets to the beneficiaries would be collected proceeds. Regarding the sequestration reduction, Lewis argued that the only permitted reductions to whistleblower awards are provided in Code Sec. 7623 and the regulations. He further argued that whistleblower awards are exempt from sequestration because they are self-funded through the target's payment of its taxes.

Tax Court's Analysis

The first issue addressed by the Tax Court was the applicability date of the amendments to Code Sec. 7623 enacted by the Bipartisan Budget Act of 2018 (BBA), which added a definition of "proceeds" in Code Sec. 7623(c) and made other changes. The BBA provides that the amendments apply to information provided before, on, or after the date of enactment with respect to which "a final determination for an award" has not yet been made, but does not define "a final determination for an award." Based on Reg. Sec. 301.7623-3(c) and Reg. Sec. 301.7623-4(d), which establish when a whistleblower may be paid, the court found that "a final determination for an award" does not occur until the whistleblower award can no longer be further challenged in the Tax Court or elsewhere. The court therefore concluded that the BBA amendments apply to whistleblower claims for which the WBO's determinations properly remain subject to further proceedings if begun.

Next, the Tax Court held that collected proceeds did not include the tax proceeds from the corporation's decision not to deduct wages for son No. 1 in 2011. The Tax Court noted that in Whistleblower 16158-14W v. Comm'r, 148 T.C. No. 12 (2017), a case involving proceeds from a target's change in reporting for a future tax year that was not under audit at the time of the whistleblower award determination, it held that reported, paid tax was not collected proceeds. The Tax Court saw no reason to narrow the holding of that decision on the basis that, in this case, an ongoing audit was expanded to include the year of the reported, paid tax. The court also found that under Reg. Sec. 301.7623-4(b)(1)(viii), a whistleblower may cause a target to change its tax reporting for future years, and such a change may be a positive factor in determining the award percentage, but the change in reporting affects the award percentage only, not the amount of collected proceeds.

Regarding the husband's use of the unified credit, the Tax Court found that the IRS did not collect any gift tax from the husband or estate tax from his estate. The court also found that there was no possibility of future proceeds from the target's estate because an estate tax return had been filed showing no tax due, which the IRS accepted as correct. The court noted that a tax allocation clause in the trust documents provided that any estate tax due on the transfer to the remainder beneficiaries would be paid out of the trust assets before the asset distribution to the beneficiaries. In addition, under Code Sec. 2207A, the surviving spouse's estate can recoup estate tax from the beneficiaries. Nevertheless, the court said that the trust assets remaining after the wife's life estate are included in her estate upon her death, and the resulting estate tax is the liability of her estate under Code Sec. 2044(a). The court therefore concluded that the husband's estate would not owe any tax on the termination of the life estate and there was no possibility of collected proceeds from the husband's use of his unified credit. In the court's view, the WBO properly determined that neither the deceased nor his estate owed additional gift or estate tax, because the events that could have triggered any tax had already occurred and resulted in no tax.

Finally, the court held that it had jurisdiction to review whether the sequestration reduction applied and held that the WBO properly determined that it did apply to Lewis's award. The court found that the factors for determining an award in Reg. Sec. 301.7623-4(b) are specifically described in the regulation as nonexclusive. Further, the court found that IRS whistleblower awards are not specifically listed as exempt direct spending in the Budget Control Act. The court also found that Code Sec. 7623(b) uses collected proceeds only to calculate the amount of a mandatory award, not as the source of funding, and the source of payment of a mandatory award is not limited collected proceeds. According to the court, mandatory awards are not self-funded, as Lewis argued, and the WBO's budgetary authority to pay mandatory whistleblower awards is the authority granted by Code Sec. 7623(b).

For a discussion of the rules for determining the amount of whistleblower awards, see Parker Tax ¶262,320.

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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