There were two important whistleblower reforms in the Tax Cuts and Jobs Act when the Senate passed its version of the bill a few weeks ago: Both provisions were designed to stop tax evasion, closing loopholes that threatened to undermine whistleblower protections.
But neither provision made it into the House-Senate conference version of the legislation, scheduled to be voted on today. The bill now nearing final passage in Congress might as well be called the “Tax Fraud Protection Act” because it takes away incentives for whistleblowers to come forward in the first place.
In 2006, Congress passed the Internal Revenue Service whistleblower law, designed to encourage the detection of tax fraud. Under this provision, whistleblowers are entitled to a financial reward of 15 to 30 percent of tax proceeds collected if information originally provided by them to the IRS results in successful action against tax cheats. For instance, if a whistleblower’s information results in a $1 million penalty, the whistleblower is entitled to a reward of no less than $150,000.
On its face, the 2006 law covers all tax frauds, a position affirmed in a major U.S. Tax Court ruling, Whistleblower 21276-13W v. Commissioner of Internal Revenue (in which I was one of the attorneys for the whistleblowers). But in that case, the IRS argued that money obtained for violation of criminal tax laws — fines, as opposed to unpaid revenue — should be excluded from the whistleblower law. The Tax Court rejected this argument as a “fundamental misinterpretation of the plain language of the statute.”
The court’s decision makes sense — there shouldn’t be an artificial limit on the monetary incentive that encourages whistleblowing against those looking to cheat the federal government out of revenue. But the IRS disagrees. The commissioner appealed the decision in Whistleblower 21276-13W, arguing in a brief to the court that “the Tax Court erred” in holding that a whistleblower award can be based on a criminal fine. In other words, he asserted that the law doesn’t cover criminal tax frauds — in his reading, if a whistleblower’s information results in criminal fines and penalties, but no recoupment of other revenue owed the government, the whistleblower gets nothing.
If a whistleblower cannot obtain a reward for turning in information proving criminal tax frauds, like my confidential client known only as Whistleblower 21276-13W, there’s little incentive for him or her to come forward as a whistleblower to help the government, let alone work hand in hand with criminal investigators or testify in grand jury proceedings. This position undermines the 2006 law by tilting the scales in favor of tax cheats and against the U.S. government, giving whistleblowers little, if any, incentive to help the government build a criminal tax case against major corporations or wealthy individuals who may have hidden their money illegally overseas.
The commissioner’s arguments are dangerous because the 2006 law doesn’t separately shield employees who blow the whistle on an employer from being fired. The whistleblower can be fired for providing valuable information about the employer while the government uses the whistleblower’s information to win its case. The government could potentially collect millions in criminal fines and penalties while a whistleblower could wind up out of a job, get no remuneration and only try to collect unemployment. This scenario will have a massive chilling effect on potential whistleblowers, especially those who work for the large financial institutions accused of money laundering or illegally sheltering moneys in offshore accounts.
To the Senate’s credit, it used the Tax Cuts and Jobs Act to try to close this loophole and clarify the law — an amendment to the Senate bill would have ensured that criminal tax frauds were covered under the whistleblower law.
In conference, though, without explanation, justification — or logic — this provision was cut. It means top officials at major financial institutions can rest better knowing that their employees may be without any protection if they expose money laundering and criminal tax schemes.
The conference committee also cut a provision from the Senate bill that would have protected corporate whistleblowers from double taxation on their awards. Under a Supreme Court ruling, Commissioner of IRS v. Banks, that upheld an internal IRS policy, if a whistleblower wins an award, he or she must pay income tax on the attorney fee portion of any judgment obtained, even if the attorney also pays income tax on the same amount.
Congress thought it had fixed this issue when it passed the Civil Rights Tax Relief Act as part of the American Jobs Creation Act of 2004, exempting existing whistleblower and employment discrimination laws from double taxation. But the law, with respect to whistleblowers in securities fraud cases, enacted as part of Dodd-Frank in 2010, is not explicitly covered in the Relief Act. So whistleblowers in those cases are justly concerned as to whether their rewards will be subjected to double taxation.
The Senate’s amendment clarified that whistleblowers under the securities and commodities anti-fraud laws are covered under the Civil Rights Tax Relief Act. But the removal of this amendment from the final tax cut legislation leaves these whistleblowers vulnerable to potential double taxation, discouraging reports.
The tax bill has been critiqued because the wealthy are the big winners, not the average American. The other big winners? Tax evaders and corporate criminals, who will have one less reason now to fear that they will be outed by whistleblowers.