Paul L. Caron

Monday, March 27, 2023

Lesson From The Tax Court: The Whistleblower Who Blew Too Hard

Camp (2017)Section 7623(b)(1) says that the IRS must reward whistleblowers when the information they provide causes the IRS to start “any administrative or judicial action” to collect unreported or unpaid taxes.  In such cases, whistleblowers can get an award of up to 30% of the proceeds actually collected from such actions.  Id.  So what happens if the whistleblower's information does not lead to an administrative or judicial action against the particular taxpayer fingered by the whistleblower, but instead prompts the IRS to create a general administrative program to target taxpayers like the one fingered by the whistleblower?

That was the claim in Thomas Shands v. Commissioner, 160 T.C. No. 5 (Mar. 8, 2023) (Judge Greaves).  There, the whistleblower claimed entitlement to 30% of some $1 billion collected from the IRS’s second Offshore Voluntary Disclosure Initiative (OVDI) in 2011.  His theory was that his blowing the whistle on one particularly influential tax evader prompted both the creation of the second OVDI and a rush by taxpayers to voluntarily disclose under the program.

The Tax Court ruled that Mr. Shands’ claim was overblown (pun totally intended).  Both the statute and implementing regulations make it clear that the relevant “administrative or judicial action” is one against particular identified taxpayers.  The creation of a general administrative program such as OVDI was not the kind of action that triggered a mandatory award.  Therefore, under the newly restricted reading of its authority to review whistleblower petitions, the Tax Court held that it lacked jurisdiction to review whether his information really did or did not contribute to OVDI.  The IRS simply had not started a requisite administrative or judicial action.  Details below the fold.

Law: §7623’s Structure
Congress created the current whistleblower award program in the Tax Reform and Health Care Act of 2006, 120 Stat. 2922, 2959.  The provisions are codified in §7623.  The program is administered by the Whistleblower’s Office (WBO).

The award program consists of a purely discretionary authority and a mandatory authority.

The discretionary authority is found in §7623(a), which permits the WBO to award any amount it sees fit to any person who helps in either “detecting underpayments of tax” or “detecting and bringing to trial and punishment” those found guilty of violating the tax laws.  The awards must be paid from “the proceeds of amounts collected by reason of the information provided.” Id.  In keeping with the completely discretionary nature of this authority, there is no ability for judicial review.

Today case, however, concerns mandatory awards.  In contrast to the discretionary authority, §7623(b) describes circumstances where awards are seemingly mandatory.  Specifically, §7623(b)(1) says that if the IRS proceeds with any administrative or judicial action described in subsection (a) based on information brought to the Secretary’s attention by an individual” then the whistleblower must be awarded between 15% and 30% “of the proceeds collected as a result of the action.”  Remember that the “action described in subsection (a)” includes “detecting underpayments of tax.”

But there are two important caveats to these seemingly mandatory awards.

First, even the mandatory award is subject to discretion.  Section 7623(b)(1) gives the WBO discretion to decide what percentage between 15% and 30% to award.  And §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.  And §7623(b)(3) then gives the WBO discretion to reduce an award if the whistleblower turns out to be the source of the taxpayer’s noncompliance!

Second, the mandatory award is only available against certain taxpayers and this is the caveat that is most applicable to today’s lesson.  Section 7623(b)(5) provides that the mandatory provisions in subsection (b) shall apply with respect to any action—(A) against any taxpayer, but in the case of any individual, only if such individual’s gross income exceeds $200,000 for any taxable year subject to such action, and (B) if the proceeds in dispute exceed $2,000,000.”

Treas. Reg. 301.7623-2(e)(1) interprets that language to require an “action against any taxpayer in which the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2,000,000 but, if the taxpayer is an individual, then only if the taxpayer's gross income exceeds $200,000 in at least one taxable year subject to the action.”

A whistleblower’s submission must survive a 3-stage 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.  Judge Greaves gives a nice summary.  I give another one Lesson From The Tax Court: The Slippery Slope Of Tax Court Review, TaxProf Blog (Oct. 12, 2020).  For today’s purposes, here’s what you need to know.

Stage 1: Processing.  The WBO office evaluates both the form and content of the information the whistleblower has submitted to see if it meets applicable threshold requirements.  If the submission is incomplete or otherwise not in conformance with the regulations, the WBO issues what is called a “rejection” of the submission and will invite the whistleblower to resubmit.  See generally Treas. Reg. 301.7623-1(c)(4) (“If a whistleblower files a claim for award that does not include information described under paragraph (c)(2) of this section, does not contain specific and credible information as described in paragraph (c)(1) of this section, or is based on information that was not submitted under penalty of perjury as required by paragraph (c)(3) of this section, the Whistleblower Office may reject the claim....”)

Stage 2: Classification.  If the WBO does not reject the submission it sends it over to an IRS subject matter classifier in the relevant Operating Division (e.g. SB/SE or LBI, etc.).  That classifier gives the information a second review to see if it is worth passing on to an Exam or Collection function within the Operating Division to use in an existing case or to create a new case.  IRM 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.”

It may be that the subject matter classifier decides that the information does not warrant further review because the information on the face of the claim is insufficient to send on to the next stage or the whistleblower is somehow a disqualified whistleblower.  In that case, the Stage 2 decision results in a rejection because, as Treas. Reg. 301.7623-3(c)(7) tells us: “A rejection is a determination that relates solely to the whistleblower and the information on the face of the claim that pertains to the whistleblower.”

However, it also may be that the subject matter classifier might decide that the information just is not sufficient to pass on to the next stage.  For example, while the information might be useful, it is not likely to be useful enough to warrant further review if the year at issue is too old or if the information is too speculative.  See IRM (05-28-2020) (“Classification Steps (in general)”).  In that case, the Stage 2 decision results in a denial because, as Treas. Reg. 301.7623-3(c)(8) tells us: “A denial is a determination that relates to or implicates taxpayer information.”

Stage 3: Final Determination.  If the information submitted on Form 211 and attachments survives the operating division’s Classification step, then a field employee called a Subject Matter Expert (SME) reviews the information one more time “to determine whether it may materially contribute to the identification, development or resolution of taxpayer liability or collection issues.” IRM  If the SME finds a fit, the SME then sends the information on to the appropriate Exam or Collection function and any further decision regarding an award will be subject to judicial review.  As with Stage 2, however, if the SME decides not to send the information to the Exam or Collection function, that might be either a rejection of the whistleblower’s claim or a denial of the claim.  It just depends on the reason.  Either way, however, it represents a decision to ignore the whistleblower’s information.  And boy can that piss off a whistleblower!  They want judicial review!

Law: Judicial Review of Decisions About Whistleblower Awards
The Tax Court’s authority to review award decisions is given in §7623(b)(4).  That statute gives the Tax Court jurisdiction only over awards covered by subsection (b), the so-called mandatory awards.  Section 7623(b)(4) has seeming broad language, permitting whistleblowers to ask the Tax Court to review “any determination regarding an award.” §7623(b)(4).

Well, that language is not as broad as you might think, although the case law has flipped and flopped.

Initially, 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.  If the IRS took no such action, no award was due and there was nothing for the Court to review.  See Cohen v. Commissioner, 139 T.C. 299 (2012) aff’d without reported opinion, 550 Fed.Appx. 10 (D.C. Cir. 2014) (“whistleblower award depends upon the Commissioner commencing an administrative or judicial action and collecting proceeds.”).  I blogged about this in Lesson From The Tax Court: Whistleblowers Do Not Get To Work The Case,  TaxProf Blog (Nov. 18, 2019).

Flip. The Tax Court changed its collective mind.  In Lacey v. Commissioner, 153 T.C. 146 (2019) a majority of the Court decided that it could indeed review a rejection as much as it could a denial.  Recall that a rejection is always a decision to not even start an action.  I blogged about that in Lesson From The Tax Court: How The Court Reviews Whistleblower Office Decisions, TaxProf Blog (Dec. 2, 2019).

Flop.  In 2022 the D.C. Circuit overruled Lacey.  Obsessing on the verb “proceeds,” it held that the Tax Court does not have jurisdiction to review any decision where the IRS has declined to take an administrative or judicial action whether that decision is labeled “rejection” or “denial” and regardless of the Stage in which the decision is made.  See Li v. Commissoner, 22 F.4th 1014, 1017 (D.C. Cir. 2022) (“After review, we conclude that Cooper and Lacey were wrongly decided.”).  I did not blog that.  But Keith Fogg did!  See his great post, D.C. Circuit Narrows Tax Court Whistleblower Award Jurisdiction, Procedurally Taxing (Jan. 24, 2022).

Thus, as Judge Greaves explains in today’s case, we’re pretty much back to Cohen: the current availability of judicial review depends on whether the IRS “proceeds” to take an something called an “administrative or judicial action” based on the whistleblower’s information.  Basically a whistleblower only gets judicial review when the IRS acts on the information, but then gives what the whistleblower asserts is less than the proper award.  There is no judicial review when the IRS just takes no “administrative or judicial action” based on the information.

Mr. Shands wore a wire.  It was November 2010.  He was apparently a client of a Swiss banker (Renzo Gadola) and was cooperating with the IRS to document Mr. Gadola’s attempt to persuade clients to hide assets in offshore accounts.  According to this DOJ press release, Mr. Gadola was caught on tape attempting to persuade Mr. Shands not to disclose his offshore accounts, assuring him there was no paper trail and there was a “practically zero percent” chance the IRS would learn of the offshore accounts.

Mr. Gadola was arrested the next day.  Mr. Shands quickly filed a Whistleblower claim.  That’s pretty standard stuff.  Assuming the requirements were met, Mr. Shands’ information that led to the wire might entitled him to between 15% and 30% of any proceeds collected from Mr. Gadola.  Well...if Mr. Gadola actually owed anything.  But that would be only if the IRS “proceeded” to take action against Mr. Gadola.

In February 2011 the IRS announced it was starting a voluntary disclosure program called, amazingly enough, the Offshore Voluntary Disclosure Initiative (OVDI).  Under it, taxpayers who voluntarily disclosed could avoid criminal prosecution and pay reduced penalties.  This program was actually a revival of a prior disclosure program that had ended in 2009.

Why did the IRS start this program?  According to one of the most careful academics I know, the decision to create OVDI resulted from a large influx of taxpayers who continued making informal voluntary disclosures after the closure of the previous program.  See generally, Leandra Lederman, The Use of Voluntary Disclosure Initiatives in the Battle Against Offshore Tax Evasion, 57 Vill. L. Rev. 499, 514 (2012) (“The continuing volume of taxpayers coming in to disclose non-compliance regarding offshore accounts after the close of the 2009 initiative, the government perceived a need for another voluntary disclosure program.”)

But Mr. Shands thought it was all because he wore a wire.  So in June 2012 he filed another claim, saying he was entitled to a percentage of all amounts collected through OVDI.  But he was not greedy.  Oh no.  He did not claim a share of amounts collected from IRS actions related to OVDI disclosures, like additional audits triggered by OVDI disclosures or seizures of taxpayer assets.  Nah, he would modestly take just the $300 million or so from the $1 billion or so collected from the 2011 program.

It is not clear from the Opinion how far Mr. Shands’ OVDI claim worked its way through the process.  But the eventual decision document was a denial and not a rejection, so it had to have at least gone into Stage 2.  Regardless of the administrative nomenclature, the substantive reason for the denial was based on a determination that “the IRS took no action based on the information [petitioner] provided with respect to [OVDI] or any of the taxpayers who participated in it.”  Op. at 5.

Lesson: Administrative Program is not “Action” for §7623 Purposes
Mr. Shands thought the IRS had indeed taken an administrative action based on his information: the OVDI program!  His argument was based on the statutory language in §7623(b)(1) which requires an award whenever “the Secretary proceeds with any administrative or judicial action described in subsection (a).”  And subsection (a) describes those actions, remember, as being either “(1) detecting underpayments of tax, or (2) detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same...” (emphasis added).

Mr. Shands argued that the OVDI program was an administrative action for “detecting underpayments.”

Judge Greaves rejected the argument, teaching us that the term “administrative or judicial action” means an action against specific taxpayers, not a broad administrative program.

Judge Greaves first notes that the statutory terms are undefined in the statute.  He then looks to the regulations and finds that Treas. Reg. 310.7623-2 explicitly defines an “administrative action” as “all or a portion of an Internal Revenue Service (IRS) civil or criminal proceeding against any person that may result in collected proceeds.”  (emphasis supplied).

Applying that definition, Judge Greaves rejects Mr. Shands’ argument.

“Neither of the purported administrative or judicial actions petitioner identifies fits the definitions in Treasury Regulation § 301.7623-2(a). By creating OVDI, the IRS did not undertake a “civil or criminal proceeding against any person” along the lines of the examples provided in the regulation, let alone a court proceeding. The program required voluntary disclosure of foreign accounts and assets, and excluded participation by taxpayers already under examination or investigation. We likewise reject petitioner’s argument that inherently voluntary participation in OVDI by a taxpayer constitutes an administrative or judicial action by the IRS. This Court has recognized that a taxpayer’s voluntary compliance absent an examination entailed no administrative action, even if IRS scrutiny prompted the taxpayer’s compliance.” Op. at 10 (citations omitted).

Mr. Shands also claimed that even if the OVDI was not an “administrative action” certainly the fact that the IRS later took actions against specific taxpayers based OVDI brought his petition within the Court’s jurisdiction.  After all, the statute permits awards if the IRS takes “related actions” on the basis of the information provided.  §7623(b)(1).  But the regulations still define “related actions” as being an specific action against a specific person “based on the specific facts described and documented in the information provided.”  Treas. Reg. 301.7623-2(c)(1).  The information Mr. Shands provided about one bad-acting taxpayer (Mr. Gadola) did not have the proper nexus to the information that the IRS gleaned from the OVDI program.

Bottom Line: If the IRS decides to not use the whistleblower’s information against a specific taxpayer, then the Tax Court has no power to review that decision, whether or not that decision is labeled a “rejection” or a “denial.”

Coda: The Tax Court recently submitted its annual Congressional Budget Justification.  Among many other interesting bits of information, we learn that of the roughly 29,000 petitions filed in Tax Court in FY22, only 46 petitions were filed by Whistleblowers under §7623 to dispute IRS determinations.  After today’s case, that small number may diminish even further.  Carl Smith reports that in 2022, in response to the D.C. Circuit’s opinion in Li the Tax Court dismissed over 40 whistleblower petitions for lack of jurisdiction, but then vacated those dismissals when the taxpayer in Li filed a cert petition.  See Tax Court Vacates at Least 40 Dismissals of Whistleblower Cases, Procedurally Taxing, Sept.12, 2022).  The cert petition was denied and Carl tells me that he believes the Tax Court has since re-dismissed most if not all of those. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) for another Lesson From The Tax Court.

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Tax Notes will be publishing a week from today an article of mine with the following provisional title: “How the D.C. Circuit Could Begin to Undo the IRS’s Nullifications of the Tax Whistleblower Law.” The article provides a complete analysis of the tax whistleblower program created in 2006 by section 7623(b).

Posted by: Michael A. Humphreys | Mar 27, 2023 8:30:35 AM

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