Caveat Insurance Leaders: New Financial Incentives May Lead the IRS to Your Door

By Tom Pliske

after a long period of uncertainty, it has now become clear that insurance companies have a major new threat with which to be concerned. Last year, the Internal Revenue Service paid out its first claim subject to the new Whistleblower laws passed in 2006. Since the law went into effect, there have been many questions and concerns about the ability and commitment of the IRS to the new and improved Whistleblower program. With the payment of the first award, the IRS had signaled that the time for such debate is over – and they’re serious about the Whistleblower program.

While it has not yet publicized appropriately considering the potential upheaval and change that it represents, in 2006 Congress determined to formally recognize Tax Whistleblowers, and encourage individuals with knowledge of large and improper tax “arrangements” to bring forward detailed and comprehensive information leading to successful IRS action against the wrongdoers. Previously, there was an informal (and relatively toothless) “understanding” that motivated virtually no one to report tax abuses. This has now changed. Billions upon billions of dollars of claims being filed on a rapidly increasing basis confirm that sufficient incentives will lead those with evidence of wrongdoing to take quick and effective action. Since the reward to a qualifying Whistleblower ranges from 15% to up to 30% of the total amount ultimately collected by the Service, one of the key Whistleblower lures – a major financial reward – now looms too large to ignore. An employer must prepare for the extreme risk of being targeted from virtually any direction, and typically non-activist or even loyal employees will be reexamining their position on Whistleblowing. Many of those working in the insurance industry are in a similar position, whether it is a tax planning tool such as a QTIP that was flawed, insurance proceeds on property damage that were not taken into account properly in determining the casualty loss, the gross estate failure to include life insurance on the decedent, etc. Although it is the major cases that will attract the most attention, insurers and their agents and representatives must now be aware that any scheme in which they were involved may now have spawned a potential profiteer, thoroughly motivated, protected (within limits by law) and with inside information that the Service may or may not be willing to use to recover the taxes that are owed.

The IRS motive behind their support of the Whistleblower program is clear – the Inspector General of the Treasury estimates that the annual loss to the Treasury is approaching $400 billion annual losses from tax fraud, underreporting, underpayment, etc. With these Whistleblowers armed with the full support of the IRS to more than level the playing field, it is prudent for all business executives, including Insurance executives, to become familiar with the IRS Whistleblower program. With the deficit running thoroughly out of control, it is hard to see the Treasury failing to maximize its utilization of an efficient revenue collector. The enabling statute’s author, Sen. Grassley of Iowa, and the Senate Finance Committee are pushing hard for results.

Brief Overview of the Current Law

The Whistleblower Office was formed by the Tax Relief and Health Care Act of 2006 (TRHCA), which amended IRC § 7623 significantly by changing the Informant Claims Program. Prior to this amendment, the maximum award was limited to 15% and capped at $10 million. Awards were given at the sole discretion of the IRS, and there was no judicial remedy if an informant did not agree with the outcome of the IRS determination. The old rules have been re-designated IRC § 7623(a). The 2006 amendment added what is now designated as IRC § 7623(b), under which Whistleblower awards are no longer discretionary. Award determinations “shall” be 15% to 30% of the proceeds collected, with some exceptions, and may be appealed to the Tax Court. Cases in this category must meet a dollar threshold involving tax disputes of $2 million or more and, in the case of individuals, the gross income for at least one year in dispute must be at least $200,000. If either threshold is not met, the informant claim is processed under the original IRC § 7623(a) rules. In all cases, the informant is required to submit Form 211, Application for Award for Original Information. The Whistleblower Office analyzes the information and works with the appropriate IRS offices for further investigation.

History of IRS Whistleblower Program

What is now IRC § 7623(a) has been on the books since March 1867, allowing the Secretary of the Treasury to pay such amounts as he deems necessary “for detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same..” Prior to 2006, the only substantive change since 1867 was in 1996, when a clause was added allowing payments to be made “for detecting underpayments of tax.” The Treasury Department issued regulations to implement the law, and the IRS instituted a series of policies to define the scope and procedures for the program. However, prior to 2006, the law was not promoted by the IRS, and was improperly implemented. The Courts have considered attempts to challenge award decisions under 7623(a), and uniformly found that the discretion to make, or not make, an award is essentially not reviewable. However, Congress, in revising the law and creating 7623(b), provided a new focus as a result of internal reviews by the IRS, a report issued by the Treasury Inspector General for Tax Administration, efforts by False Claims Act lawyers, and Congressional inquiries. In addition to the new appeal rights and expanded potential rewards, the new law required the IRS to create a Whistleblower Office reporting to the Commissioner to implement the law. Stephen Whitlock was appointed the Director of that office in February 2007, and remains in that position. 2012 will likely be the “breakout” year for Whistleblowers, as cases filed at the inception of the program are just now beginning to bear fruit, in the form of hundreds of millions of dollars in recovered taxes.

How Do You File a Claim?

All Whistleblower claims (i.e. Form 211) must be submitted under penalty of perjury to the Internal Revenue Service. All relevant information should be provided with the Claim, and if the Whistleblower withholds available information, the Whistleblower bears the risk that withheld information may not be considered by the Whistleblower Office in making any award determination. If the documents or supporting evidence are known to the Whistleblower but not in his/her possession, the Whistleblower should describe these documents and identify their location to the best of his or her ability. Except in the most unusual cases involving boxes of data, the Whistleblower should include the evidence (i.e. documentation) with the initial submission. The IRS policy and procedures are such that it does not expect, nor will it condone illegal actions taken to secure documents or supporting evidence. The Service will protect the identity of the Whistleblower to the fullest extent permitted by the law, and indeed, pains are taken by the IRS to protect a Whistleblower’s privacy. However, under some circumstance, such as when the Whistleblower is an essential witness in a judicial proceeding, it may not be possible to pursue the investigation or examination without revealing the Whistleblower’s identity.

In even a seemingly simple case, I highly recommend that any potential Whistleblower strongly consider hiring a contingency lawyer who specializes in IRC § 7623(b) cases. An experienced and knowledgeable tax attorney can make the difference between a case that winds up in a filing cabinet collecting dust, or a case that generates revenue for the IRS and the Whistleblower.

Communications Between the IRS and the Whistleblower

The Service will inform the Whistleblower before deciding to proceed. Once a claim is submitted, the informant may be told only the status and disposition of the claim – not any specific actions taken in the case. Sometimes, the status may become public, such as when the taxpayer files suit, or if the IRS must file a notice of federal tax lien. However, for the most part, the IRS is prohibited from communicating with the Whistleblower as to the status of the case as mandated by the restrictions imposed under IRC § 6103, which protects the disclosure of taxpayer information. If an award is payable under IRC § 7623(b), the Whistleblower has the opportunity to review the award package as part of an administrative proceeding. The purpose of the preliminary recommendation package is to solicit input from the Whistleblower regarding the preliminary award recommendation before a final determination is made by the Director.

After the review of the file, Whistleblowers are given 30 days to respond to the preliminary recommendation package in one of four ways.

1. If the Whistleblower takes no action, then the Director will make a final award determination.

2. If the Whistleblower signs, dates, and returns the consent form agreeing to the proposed award recommendation, then the Director will make a final award determination.

3.If the Whistleblower submits comments on the proposed award recommendation but does not sign, date, and return the confidentiality agreement, the comments will be added to the administrative claim file and reviewed for purposes of making a final award determination.

4. If the Whistleblower signs, dates, and returns the confidentiality agreement, then the Director will provide the Whistleblower with the additional administrative review opportunity to be held in the Whistleblower Headquarter Office located in Washington, DC. In some situations, the IRS will reject the Claim. If a claim is denied, the Service cannot disclose specifically why. However some of the usual explanations for an award denial are:

1. The IRS already had the information from another source.

2. An audit or investigation is conducted but leads to no finding of taxpayer liability.

3. A finding or liability is made but the taxpayer is successful in an administrative or judicial appeal.

4. In the alternative, a finding of liability is made and sustained but there is no collection because the taxpayer has no known assets to pay the tax.

Internal Processing of Claim Cases

A threshold requirement for any award under 7623 is that the information must lead to judicial or administrative action, which has been defined by the IRS as an audit or investigation resulting in the collection of proceeds. When a case is submitted, an analyst in the Whistleblower Office will consider the information provided by the Whistleblower and initially determine whether it is specific and credible. In the cases of a large taxpayer whose returns are audited each year, an administrative action, as determined by the IRS, is the creation of a new issue under the Audit Plan or a change in the way information about an issue is collected or analyzed, which would not otherwise have occurred without the information provided by the Whistleblower. In other cases, an administrative action can mean placing a taxpayer under audit who was not already under audit. The process, from submission of complete information to the Service until the proceeds are collected, averages five to seven years. Payments of awards will not be made until after the taxes, penalties, interest, additions to tax, and additional amounts that are finally determined to be owed to the Service have been collected, and any claim for refund by the taxpayer has expired. This relatively long duration has created an interest in the financing or assignment of portions of claims. With time, an entire financing apparatus will be established by entrepreneurs.

Percentage Applied to Awards under Section 7623(b)

The Whistleblower Office will make the final determination whether an award will be paid and the amount of the award. The award will be paid in proportion to the value of the information furnished, with respect to proceeds collected, including penalties, interest, additions to tax, and additional amounts.

The amount of the award will be at least 15% but not more than 30% of collected proceeds in cases in which the Service determines that the information submitted substantially contributed to the Service’s detection and recovery of tax. In actions where the Whistleblower was NOT the initial source of the information, but rather supplemented public information, a lesser award not more then 10% of the final collection may be made.

There are other situations too, where the reward may be reduced. For instance, if the Whistleblower planned and initiated the actions that led to the underpayment of tax, the Director may reduce the award. If the Whistleblower is convicted of a crime based on his/her role in planning and initiating the action, then the Whistleblower Office is required to deny the award.

Conclusion

Given the enormity and proximity of the consequences that may ensue from this new series of incentives, and the phenomenal growth in the initiations and filings of Whistleblower claims, it is surprising that potential large and solvent “target” entities are not taking these risks properly into account. The musical chairs experienced by executives in the “know” over the past number of years has opened up a large class of knowledgeable and motivated insiders (and former insiders) who can guide the IRS quietly, quickly, and secretly right into the heart of a major tax liability. While it may not appear that much has been accomplished since the passage of the statute in the past few years, huge strides have been made in both public and private infrastructure, case development and Congressional oversight.

The ultimate future of the Whistleblower program is not difficult to predict. Eventually, a major financial ecosystem will develop around the core of Whistleblower contingency lawyers and their clients. Sooner or later, the 5 to 7 year wait for a payout will be slashed. Already, a number of major and influential hedge funds have begun to explore the possibility of financing Whistleblower cases for a percentage of the future proceeds. Should the financing concept develop further, a potential Whistleblower will find it far more favorable to come forward with information, due to the promise of some immediate (or at least more immediate then the current process) financial gain for his information. This development will further underscore the potential perils to vulnerable companies, and hopefully cause them to pay more attention to this burgeoning field.