Tax Day 2017 is fast-approaching, and of course, we are once again reminded that nothing in life is certain, except death and taxes . . . and tax fraud. The tax fraud problem is so pervasive that the Internal Revenue Service (IRS) publishes an annual “dirty dozen” list of the most pervasive tax scams. This year’s list is available at the IRS’ website here. In its 2016 interim filing season report, the Treasury Inspector General for Tax Administration (“TIGTA”) cited an IRS report stating that between 2013 and 2015, the Service identified and stopped about 6 million fraudulent tax returns that sought more than $42 billion in fraudulent refunds. But unfortunately, the problem of tax fraud is far bigger than even these staggering numbers. By the IRS’ own admission, during that same three-year span the Service failed to identify and stop more than 6.5 million fraudulent tax returns, resulting in about $45 billion in fraudulent refunds being paid. The TIGTA report is available at the Department of Treasury’s website here. And those numbers only represent the instances of tax fraud the IRS now knows about; no one can truly calculate the scope of our tax fraud problem.
Overall, according to the most recent IRS study covering 2008 to 2010, the “voluntary compliance rate” for all taxpayers – both individual and corporate – is just over 80%, which creates a corresponding annual “tax gap” – the difference between overall taxpayer liability and the amount of taxes paid on time – of $458 billion. To make matters worse, the IRS study found that the Service has only collected $52 billion of those funds. The IRS discusses these findings here. While the tax gap is by no means attributable entirely to fraud, no one can deny that the $400 billion in taxes the IRS is owed each year results in a huge windfall for tax cheats. Is the IRS doing enough to combat tax fraud, recover America’s stolen funds, and level the playing field for those who follow the rules? Probably not, since the IRS does not use whistleblowers effectively.
Without a doubt, whistleblowing works effectively to combat and deter fraud on the Government. In fact, the federal False Claims Act (FCA) is widely regarded as the Government’s most effective fraud-fighting tool for two primary reasons: (1) it allows the Government to impose significant fines for each attempt to defraud the Government – regardless of whether or not those attempts were successful – plus up to three times the amount the Government actually lost due to the fraud; and (2) it includes a “qui tam” provision that authorizes whistleblowers to sue in the name of the United States and to recover stolen taxpayer funds; whistleblowers are protected from employer retaliation and are incentivized with rewards between 15% and 30% of whatever they return to the federal fisc, but they must be represented by a whistleblower attorney who can properly vet their claims and reduce frivolous filings. According to a December 2016 Department of Justice (DOJ) press release, the FCA works – and works well. DOJ reports that “[f]rom January 2009 to the end of the fiscal year 2016, the government recovered nearly $24 billion in settlements and judgments related to qui tam suits.” The anti-fraud law returned $4.7 billion to the U.S. Treasury just last year alone. Notably, whistleblower cases accounted for nearly $3 billion – almost two-thirds – of those funds. Half of last year’s recoveries came from healthcare fraud cases, while the remainder primarily resulted from cases against the financial industry, and against defense contractors and other suppliers of the Government’s goods and services. DOJ’s press release can be found here.
Notwithstanding its undeniable success, the FCA explicitly prohibits claims alleging tax fraud.
The IRS Whistleblower Office, which was created in 2007, is the only vehicle available to whistleblowers who wish to report tax fraud – often at the risk of losing their jobs and careers – in exchange for a monetary award. The Whistleblower Office actually administers two programs that are modeled in part on the FCA: (1) a program that guarantees rewards between 15% and 30% of collected proceeds (as well as certain rights to appeal award determinations), to whistleblowers who expose the most significant tax frauds – involving unpaid taxes, penalties, and interest of more than $2 million, or involving individual taxpayers whose annual income exceeds $200,000; and (2) a program that covers less significant tax frauds, and provides for purely discretionary whistleblower rewards (with no right to appeal) that are capped at 15% of collected proceeds, up to $10 million. Under both programs, whistleblowers – who do not need to be represented by an attorney – simply fill out an IRS form (not surprisingly), and then wait . . . and wait . . . and wait for a reward, on average for more than seven years in 2016. But despite the consistent annual tax gap, the Whistleblower Office has only recovered a little more than $3 billion during its entire ten-year history.
Unfortunately, the IRS’s whistleblower program has struggled since its inception ten years ago. As discussed above, whistleblowers must simply wait for years and years until IRS investigators decide the validity of their claims and the amount of any reward to be paid. That situation is exacerbated by the fact that the IRS often refuses the assistance of knowledgeable whistleblowers, citing taxpayer privacy concerns. In addition, whistleblowers receive no protection from employer retaliation under the IRS whistleblower program. And whistleblowers are further discouraged by the IRS’s determination in each of the past several years that its whistleblower rewards are subject to 6.9% reductions due to sequestration; the Department of Justice does not similarly reduce rewards to FCA whistleblowers. The IRS Whistleblower Office has never been presented as an attractive option for whistleblowers.
To its credit, the Office is aware of its PR problem and is making efforts to run a more effective program. In its 2016 annual report to Congress (available here), the IRS Whistleblower Office reported that it had finally “fully addressed or eliminated” tens of thousands of backlogged whistleblower claims, thereby “enabling claims to move further along in the process to be worked appropriately. To avoid future backlogs, we reengineered and improved the process flow from claim receipt and onward, so that it is streamlined, efficient, and effective, enabling whistleblower claims to be timely and appropriately evaluated.” Still, the Office is only dealing with about 30,000 open whistleblower claims at present. Encouragingly, the Office also reported increases in the number of whistleblower claims filed as well as in the number of whistleblower rewards paid last year.
But the news was not all good, as the Office also reported that the total amount of whistleblower rewards was down significantly – from just over $100 million in 2015 to only $61 million in 2016 (before sequestration). And most significantly, the Office announced a 40% reduction in personnel last year – from a staff of 61 down to only 37. The Office needs to rely on whistleblowers now more than ever. But the IRS whistleblower program does not properly incentivize whistleblowers, and thus, will continue to suffer.
Senators Chuck Grassley (R-IA) and Ron Wyden (D-OR) – both champions for whistleblower rights and protections – have recognized deficiencies in the IRS Whistleblower Program; last month, they introduced bipartisan legislation designed to fix some of those problems. The IRS Whistleblower Improvements Act of 2017 streamlines the process for whistleblowers and the IRS to exchange information (including periodic updates on the status of the whistleblower claim), while still protecting taxpayer privacy, and provides measures to protect tax whistleblowers from employer retaliation. Certainly, these are important fixes. But without a private right of action, whistleblowers will continue to be shut out of the enforcement and settlement processes, and forced to rely on an understaffed whistleblower office instead. Needless to say, many whistleblowers will still be discouraged from coming forward.
Clearly, the IRS whistleblower program has not come close to replicating the success of the FCA. The solution seems simple – remove the tax bar from the FCA and give whistleblowers a private right of action to bring tax fraud cases. Why should blowing the whistle on tax fraud be treated any differently?
Thirty states and the District of Columbia have FCA laws that protect their respective treasuries from fraud – and most of those laws are directly modeled on the federal law. But only New York’s FCA (available here) specifically permits suits alleging tax fraud – a change the state made in 2010. Similar to the IRS program, New York’s tax whistleblower provision is primarily concerned with the most significant tax frauds and thus, only applies to tax fraud claims that involve net income or sales of at least $1 million for any taxable year and damages in excess of $350,000. Now, New York can recover treble damages and civil penalties, while allowing whistleblowers and qui tam attorneys to share in the work.
Since New York adopted these changes and its attorney general’s office created the state’s Taxpayer Protection Bureau specifically to combat tax fraud and other issues, the results have only been positive. The Bureau has recovered tens of millions in settlements of tax fraud cases brought under the state’s FCA, against a wide variety of fraudsters. The recoveries include: a $7 million settlement with an art collector; a $6.2 million settlement with a medical imaging company; a $5.5 million settlement with a tailor; a $4.3 million settlement with the owners of a for-profit school; a $4.28 million settlement with an art dealer; and a $1.56 million settlement with an appliance retailer. Nearly all of those cases were brought by whistleblowers.
New York’s biggest tax fraud case has yet to be resolved. The state joined a qui tam suit seeking at least $300 million from Sprint Nextel Corp. for failing to collect and pay sales taxes on certain bundled wireless telephone services. Despite a challenge to the State’s highest court and a petition to the United States Supreme Court, the plaintiffs have defeated all attempts to dismiss the suit; the parties are now in discovery. Should the case against Sprint result in a significant return to New York, it will signal a sea change and further underscore the need to revamp tax fraud whistleblowing at the federal level. But the winds of change have already begun blowing, as evidenced by New York’s track record of success.
As the Trump administration turns its attention to tax reform, while the Senate considers legislation to fix the IRS whistleblower program, and the IRS cuts back on staffing in its whistleblower office, the time is right to work most effectively with whistleblowers to combat tax fraud. The only way to do so is to follow New York’s lead and strengthen the federal FCA by removing its bar on significant tax fraud claims. In order to maximize the resources whistleblowers bring to the table, and mimic the success of the FCA, we must not only implement the changes presented in the IRS Whistleblower Improvements Act of 2017, but we must incorporate tax fraud whistleblowing into the FCA and allow whistleblowers, represented by whistleblower lawyers, of course, to file suit on behalf of the Government and to prosecute tax fraud claims on their own when the Government is unable to do so because of staffing or other concerns.