Today’s post is about how the Tax Court reviews decisions of the IRS Whistleblower Office (WBO). If you want to report a tax cheat, you have a variety of choices, detailed in this IRS webpage. Typically, you write a letter or submit a Form 3439-A. But if you want to also claim an award for blowing the whistle, you must submit a Form 211 with the IRS Whistleblower Office (WBO). That is because the WBO is the office in the IRS that decides whether the information you gave resulted in additional collections of tax. If it did, you get a cut. If you don’t like the amount of the award, you can ask the Tax Court to review the WBO’s decision on the amount.
When the WBO decides that you are entitled to no award, however, it could be for a variety of reasons, only some of which are reviewable by the Tax Court. In John Worthington v. Commissioner, T.C. Memo 2020-141 (Oct. 8, 2020) Judge Gustafson teaches the difference between those decisions the Tax Court will review and those it will not; it turns on the difference between the words “rejection” and “denial.” To me, this case represents a wobbly first step onto a slippery slope towards reviewing IRS audit decisions. That is not what WBO review used to cover but times, they may be a-changing! Details below the fold.
Background: The Whistleblower Award Program
Congress created the current whistleblower award program in the Tax Reform and Health Care Act of 2006, 120 Stat. 2922, 2959. That Act charged the WBO with overseeing the award program under the rules in §7623.
As now structured, the award program consists of a purely discretionary authority and a quasi-discretionary authority.
First, §7623(a) gives total discretion to the WBO to award any person any amount it sees fit when they help in either “detecting underpayments of tax” or simply “detecting and bringing to trial and punishment” those found guilty of violating the tax laws.
Second, §7623(b) describes circumstances where some award is mandatory. Additionally, when the bad-acting taxpayer (the "target") is an individual, §7623(b) will only apply if the target's gross income exceeds $200,000 or if the target cheated the government out of more than $2 million. §7623(b)(5).
Specifically, §7623(b)(1) says that if the IRS takes any administrative or judicial action “based on information” submitted by the whistleblower, then the whistleblower must be awarded between 15% and 30% “of the proceeds collected as a result of the action.”
But even the mandatory award is subject to discretion: “The determination of the amount of such award by the Whistleblower Office shall depend upon the extent to which the individual substantially contributed to such action.” Id.
Section 7623(b)(2) then gives the WBO discretion to make a lesser award of up to 10% even if the action taken is not “based on” the whistleblower’s information but the information was still valuable.
Section 7623(b)(3) gives the WBO more discretion, to reduce an award if the whistleblower turns out to be the source of the taxpayer’s noncompliance! It also says the WBO cannot give awards to folks who were criminally convicted for the actions that led to the noncompliance.
Background: Operation of The Whistleblower Award Program
The WBO has 37 employees who receive and review about 4,500 Form 211 submissions each year covering about 12,000 discrete claims about taxpayer cheating. See Table 2(A) in the 2018 WBO Annual Report to Congress and the 2019 Annual Report. Each Form 211 and accompanying information must survive a three step process before the whistleblower becomes eligible for an award under §7623(b). The three-step review process is governed by both the IRM and the Treasury Regulations.
Step 1: Initial Form Processing. IRM 22.214.171.124. The Initial Claim Evaluation (ICE) team reviews each submitted Form 211 to make sure it is properly completed, that the person submitting the Form is eligible for an award per Treas. Reg. 301.7623-1(b), and that the Form contains the information required by Treas. Reg. 301.7623-1(c).
If the submitted Form 211 does not meet the requirements of Treas. Reg. 301.7623-1(b) or 1(c), the WBO employees will work with the taxpayers to fix the problems. If the problems cannot be fixed, then the WBO will reject the claim and “will provide notice of the rejection to the whistleblower stating the basis for the rejection.” IRM 126.96.36.199. See Treas. Reg. 301.7623-3(c)(7).
The term “rejection” is important. Treas. Reg. 301.7623-3(c)(7) defines the term to mean “a determination that relates solely to the whistleblower and the information on the face of the claim that pertains to the whistleblower.” (emphasis supplied). Again, the ICE review involves tests a claim against requirements “pursuant to §301.7623-1(b) or (c).”
If the submitted Form 211 does meet the requirements in §301.7623-1(b) or (c), then it gets a claim number (or multiple numbers if it blows the whistle on multiple taxpayers) and the claims are sent to the relevant operating division for classification in Step 2.
Step 2. Classification. This second review of the Form 211 is done by operating division employees called classifiers. They again evaluate the information in the claim to see whether it warrants action by an exam or collection field function. IRM 188.8.131.52 emphasizes that “classification’s role is only to determine if the information on the Form 211 warrants further review. It is not classification’s responsibility to determine whether a whistleblower is entitled to an award.”
In other words, classification is a second look at the claim and the information to see if it is worth pursuing. That is, the classifier reviews the whistleblower claims using both the criteria the ICE teams used and more. The classifier must:
“use sound judgment, technical expertise, professional knowledge and experience to identify complex, as well as obvious issues. The classifier will determine whether the information should be forwarded for further review. Those claims not forwarded for further review can be rejected or denied based on classification’s rationale for not forwarding the claim. The recommendation from classification reflects an enforcement decision of the operating division.” Id. (emphasis supplied).
Notice the bolded language. A classifier can either reject or deny a claim for award in Step 2.
You may ask what’s the difference? The regulations tell you. Treas. Reg. 301.7623-3(c)(8) says that a “denial is a determination that relates to or implicates taxpayer information.” It happens when “the IRS either did not proceed based on the information provided by the whistleblower, as defined in §301.7623-2(b), or did not collect proceeds, as defined in § 301.7623-2(d).”
Thus, a “rejection” is when a claim for an award fails to meet the requirements in Treas. Reg. 301.7623-1(b) or (c). A “denial” is when the award fails to meet the requirements in Treas. Reg. 301.7623-2(b) or 2(d).
Step 2 appears to be the step where almost all Form 211 fail. According to the WBO Annual Report for FY19, only 7.45% of total receipts were sent to the field to be worked. For example, in FY19 whistleblowers submitted 483 Form 211’s regarding targets potentially subject to the Large Business & International (LB&I) operating division’s jurisdiction. Those 483 submissions resulted in 1,511 discrete claims being created. Of those 1,511 claims, only 134 claims were actually submitted to the field examination function of the LB&I operating division.
If the claims in a Form 211 survive the operating division’s Classification step, then they are sent to field examination for one more layer of review and disposition.
Step 3: Review by Subject Matter Expert (SME) in field examination. The last step involves an SME in the field function of the operating division reviewing the claims and determining whether they warrant fitting into an existing audit, expanding an existing audit or opening an additional audit. See IRM 184.108.40.206. Because this last step is not relevant to today's lesson, I won't say more.
Law: Scope of Tax Court Review of Whistleblower Awards
Whistleblowers may be unhappy with a WBO decision about an award for many reasons. If a whistleblower believes the WBO did not give them a big enough award under §7623(b), they can petition the Tax Court to review the award decision. §7623(b)(4). That is the classic scope of Tax Court review: ensuring that the WBO gave proper credit for the value added by the whistlebloewer's information.
But what if a whistleblower wants the Tax Court to review a decision by the IRS to simply ignore the information provided? To what extent can the Tax Court require the IRS to re-review the whistleblower's information?
For many years, the Tax Court took the position that its authority in §7623(b)(4) was limited to the WBO’s decision about the size of an award after the IRS took some identified “action” that triggered the mandatory award requirements of §7623. If the IRS took no such action, no award was due and there was nothing for the Court to review. I blogged about this in Lesson From The Tax Court: Whistleblowers Do Not Get TO Work The Case, TaxProfBlog (November 18, 2019).
The leading case was Cohen v. Commissioner, 139 T.C. 299, (2012) aff’d without reported opinion, 550 Fed.Appx. 10 (D.C. Cir. 2014). There, the Court held that a “whistleblower award depends upon the Commissioner commencing an administrative or judicial action and collecting proceeds. Our jurisdiction under section 7623(b) does not contemplate that we review the Commissioner's determinations of the alleged tax liability to which the claim pertains. Nor does section 7623 confer authority to direct the Commissioner to commence an administrative or judicial action.” (internal citations omitted). Under Cohen, the Tax Court would not review a decision to simply not use the information submitted by a whistleblower whether that decision happened at Step 1, 2, or 3.
But then came Lacey v. Commissioner, 153 T.C. No. 8 (2019) where a majority of the Court decided that it could indeed review a Step 1 rejection. In that case, the WBO rejected the whistleblower’s claim on the same day the whistleblower submitted an additional 21-page document to support the claim. The Tax Court held the failure to even consider the 21-page memo was an abuse of discretion. The Court reasoned that while it could not review a decision of the exam function to not use the information, it could review the decision of the WBO to not even pass on the information to the exam function. That made a Step 1 rejection reviewable. I blogged about Lacey in Lesson From The Tax Court: How The Court Reviews Whistleblower Office Decisions, TaxProfBlog (December 2, 2019).
Today’s case exposes a difficulty created by the Lacey opinion: the Tax Court is now reviewing Step 2 decisions, decisions made by the operating division and not by the WBO.
In the early 2000’s Mr. Worthington apparently wanted records held by the West Sound Narcotics Enforcement Team (WestNET), a regional task force created to combat drug-related crime in western Washington state. They did not want to give him those records. He sued. Despite the cool acronym, the Washington Supreme Court held that WestNET was not a legal entity that could be sued under state law. Worthington v. WestNET, 320 P.3d 721, (Wash. Ct. App. 2014).
In 2018, Mr. Worthington filed a confusing Form 211. On his first try, he put himself as the target. Nah, he’s the whistleblower! The “target” is the bad-acting taxpayer who is cheating the federal government out of tax revenue.
Eventually, it appears, he put WestNET as the target, but since that was not an entity subject to federal taxation, the IRS reviewers struggled to figure out just who were the cheating taxpayers. From the excerpt in the Tax Court Opinion Mr. Worthington appears have told the IRS that “components” of WestNET were collecting monies from judgments and spending those monies without anyone reporting federal income taxes. It does not appear that Mr. Worthington identified any actual taxpayers in his Form 211 aside from WestNET, and WestNET had no EIN.
Nonetheless, Mr. Worthington’s Form 211 passed Step 1 and was sent to a classifier in the SB/SE operating division for a Step 2 analysis.
The classifier reviewed the claim and thought it contained sufficient information to justify sending it Criminal Investigation (CI) for a Step 3 review by a Subject Matter Expert. Again, I emphasize the decision to send for Step 3 review was not a decision to use or not use the information. That would be up to the CI Subject Matter Expert to decide.
When the classifier told the WBO that Mr. Worthington’s Form 211 would be sent forward to CI “to consider” in a Step 3 review, a senior tax analyst in the WBO did some additional research and sent a long email to another WBO employee explaining why---in light of that additional information---the “allegations in the filed F211 appear to be speculative.” The email concluded: “I recommend you return it to the classifier for consideration of this additional information and for additional research.”
After receiving the email, the classifier performed additional review, apparently including information the classifier then requested and received from CI. The result of the second review was a decision to “Reject The Claim: Allegations are not specific, credible, or are speculative – Allegations are purely speculative in nature.”
Based on that, the WBO sent Mr. Worthington a letter titled “Final Decision Under Section 7623(a)” The letter said the WBO “has made a final decision to reject your claim for an award....because the IRS decided not to pursue the information you provided.” (Emphasis supplied).
Mr. Worthington sought Tax Court review.
Lesson: Tax Court Will Review (Some) IRS Decisions Not to Use Form 211 Info
Judge Gustafson views Lacey and the regulations as creating what he calls a “binary” regime where the IRS either makes a rejection or a denial. It cannot do both. He reads the regulations as defining a “rejection” as a decision that results from a review of the claim on its face, with no additional research. In contrast, he views a “denial” as resulting from a review of a claim using additional information beyond that contained in the four corners of the claim documents. He says the Tax Court can review rejections but not denials.
He then finds that the WBO’s Final Decision letter was invalid as written because it both rejected and denied Mr. Worthington’s claim for an award. That is, the letter said it was “rejecting” the claim, but then gave as the reason one of the reasons that fall within the definition of “denial” in Treas. Reg. 301.7623-3(c)(8). Adding to the confusion was that the senior tax analyst in the WBO went beyond the four corners of the claims documents and did independent research which the analyst then sent to the classifier.
“The problem,” Judge Gustafson explained, “is not simply that of a poorly drafted determination. If the final determination made a “rejection” that it explained poorly but that the administrative record justified, then we might be able to sustain the rejection. Or if the final determination made a “denial” that it explained poorly but that the administrative record justified, then we might be able to sustain the denial. But in this instance we cannot tell what the WBO actually determined, and this unclarity in the final determination letter corresponds to a lack of clarity that arose in the preceding administrative process....” (emphasis in original).
The upshot was that Judge Gustafson ordered the IRS to show cause why he should not remand the matter to the WBO to revise its letter so the Court could tell "what the WBO actually determined" so he could tell whether it was something he could review.
I think the better view is to look at which office is making the decision. A Step 1 decision is reviewable under Lacey. But this was a Step 2 decision. Step 2 decisions might be either rejections or denials within the meaning of the regulations. Either way, however, they are done by the operating division and, as such, are not subject to Tax Court review under the principles in Cohen even as expanded by Lacey.
Part of Judge Gustafson’s opinion appears to be based on his understanding that this was a Step 1 decision. He appears to believe that the classifier here was performing a Step 1 review (“Her function was that of a classifier making the threshold evaluation of the sufficiency of the claim on its face....” Op. at 23). I am not sure that is correct. I read the IRM provisions I set out above as explaining how a classifier comes into the picture only in Step 2. And Step 2 can result in either a rejection or a denial.
Judge Gustafson believes it is less important who is making the decision that whether the decision is being made is a Step 1 “threshold” decision (resulting in a “rejection”) or a “substantive” decision (resulting in a “denial”). He writes: “the issue is not which IRS office made the determination but rather what the nature of that determination was.” Op. at 23. I am not so sure.
The distinction between rejection and denial is a slippery basis on which to base judicial review. And I don’t read Lacey as relying on that distinction. I think where I might depart company from Judge Gustafson’s very closely-reasoned analysis is in reading Treas. Reg. 301.7623-3(c)(7)'s language that a rejection is a decision based on "the information on the face of the claim that pertains to the whistleblower." Judge Gustafson appears to believe that language means any decision based on research conducted to verify the information on the face of the claim cannot be a “rejection” but must be a “denial” regardless of who does that research.
I am not so sure the regulation is so narrow. For example, one of the criteria in Treas. Reg. 301.7623-1(b) is that the information submitted must be “credible.” Judge Gustafson points that out on page 13. So say a Form 211 claims that a bad-acting target taxpayer reported a large fake NOL. That may not be credible information on its face if the WBO employee cannot verify that the target actually filed a return reporting the alleged fraudulent loss. Looking at the target’s actual return would be research, but it would definitely relate to “the information on the face of the claim.” So the resulting decision to not forward the Form 211 to Step 2 would be a Step 1 rejection, reviewable under Lacey because it was a decision of the WBO to not even give an operating division the chance to see the information.
But a Step 2 decision might be either a rejection or a denial.
On the one hand, perhaps information credible on its face turns out to be incredible on closer scrutiny in Step 2. Perhaps that taxpayer did actually claim a large loss but further Step 2 research shows the information incredible. For example, further research might show that the whistleblower has a vendetta against the target or the whistleblower was convicted of crimes involving fraud. So that kind of review would be a rejection because it would be a determination that the Form 211 did not meet the requirements in Treas. Reg. 301.7623-1(b).
On the other hand, credible information may just not enough to warrant spending exam resources opening an audit. That would be a denial because the decision would be based on Treas. Reg. 301.7623-2(b).
That would seem to be why the IRM instructs Classifiers to explain whether they are rejecting or denying a claim. They can do either depending on whether they determine the claim fails Treas. Reg. 301.7623-1(b) or (c), or whether it fails Treas. Reg. 301.7623-2(b) or 2(d). They could also, as here, do both.
Regardless of whether a Classifier is rejecting or denying a claim, however, the action is still being taken by the operating division. It's an operational call to not use the whistleblower information. Thus it represents a substantive decision to not proceed. And that is the type of decision the Tax Court has said it is not empowered to review under 7623(b)(4). Until now.
This case illustrates what actually happens is interaction between employees. Different IRS employees work together to decide how to treat a claim. Here we had a WBO senior tax analyst push back on an SB/SE classifier’s decision to forward a claim for Step 3 review in CI. The WBO analyst did not make the decision but instead provided information that caused the classifier to engage in further review and, ultimately, change her mind.
This interaction should not be cause for concern unless there is some allegation that the SB/SE classifier was the puppet of the WBO senior tax analyst. The decision on how to treat Mr. Worthington’s claim was that of the classifier. Whether couched in terms “rejecting” his claim or “denying” his claim, it seems pretty darned clear that this was an exercise of Step 2 discretion to not send the information he provided forward to an examination team. Even under Lacey, this should be the kind of "no audit" decision that is beyond the scope of Tax Court review.
To see the slipperiness of the slope, consider what the WBO is asked to do here: it is asked to be more careful with its language. If the WBO simply re-writes the letter to change “reject” to “deny,” would that be sufficient? If so, it is not clear what the point of this review has been. If not, then a remand looks a lot like the Tax Court policing whether the IRS had good cause to refuse further review of Mr. Worthington's information. That is not supposed to be the point of Tax Court review. It is not supposed to review a "no audit" decision.
Has the slide down Lacey’s slippery slope begun?
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law here in Lubbock Texas, where we have no slopes at all. He invites readers to return to TaxProfBlog every Monday for a new Lesson From The Tax Court.