While the IRS has recently pledged to expand the reach of its whistleblower program, it also signaled that it will not be as thorough as Congress authorized it to be.
In August IRS Commissioner John Koskinen released a landmark statement proclaiming himself a ‘‘strong believer’’ in the whistleblower program, ‘‘committed to expanding the program’s reach’’ and doing ‘‘everything possible to strengthen’’ it. On September 15, the commissioner reiterated these sentiments, adding that the information provided by whistleblowers is ‘‘a godsend’’ in assisting the IRS in detecting and targeting noncompliance, particularly when the enforcement budget is tight, as ‘‘whistleblowers allow the IRS to do more with very limited compliance resources.’’
The commissioner’s statements were welcomed at a time when leadership was sorely needed and it was unclear whether the whistleblower program had the necessary support within the IRS to accomplish the congressional goals behind section 7623. On their face, the statements should have been heartening to people who understand the critical role of whistleblowers in exposing tax fraud. However, less than a week after the commissioner displayed unqualified commitment to maximizing the program’s effectiveness, IRS officials suggested they were steering it the opposite way.
At an American Bar Association Section of Taxation conference in Denver in September, IRS officials suggested they were formulating guidance to drastically truncate the whistleblower program, specifically calling into question the program’s reach on many ‘‘timing’’ issues. They announced that the IRS may keep claims open and withhold whistleblower awards to see if taxes were reduced in the future, even though they had resulted in collected proceeds in currently audited tax years.3 Had the commissioner’s statements been just platitudes and empty political rhetoric?
By way of background, when corporate taxpayers devise tax avoidance schemes, they may either defer taxes to later tax periods (raising issues of timing) or forever avoid paying taxes (raising issues of permanence). Timing issues may involve shortterm or long-term deferrals (for example, immediately expensing costs rather than capitalizing and recovering them over a depreciable period, which generally may range from three years to 50 years, depending on the type of property). Permanence issues include claiming that income is tax-exempt. There are also indefinite deferrals, such as parking earnings offshore,4 like-kind exchanges, and expensing rather than capitalizing stock acquisition costs. Most corporate tax planning schemes involve timing and indefinite deferral, as corporations have long understood the time value of money.
These timing issues are what make the recent IRS statements troubling. The Service has said that even if a whistleblower provides information that results in collected proceeds in year 1, it may keep the claim open to see if less tax is owed in a future tax period. For example, if collecting proceeds results from denying an immediate deduction for stock acquisition costs, will the IRS hold the claim open indefinitely to see if the taxpayer someday recovers the costs through a taxable disposition of the stock into which the costs are capitalized? Would it be held open for five years, 15 years, or forever? Wouldthe IRS hold the claim open even if there were no facts at the time of audit to reasonably estimate when, if ever, the taxpayer may recover the costs? The IRS did suggest that it would not hold the claim open indefinitely but did not clarify what the limit might be.
Administering the whistleblower program in this manner would flatly contradict the commissioner’s pledge to ‘‘expand’’ and ‘‘do everything possible to strengthen’’ the program. It would also substantially curtail the program’s reach and effectiveness by discouraging whistleblowers from coming forward.
Nothing in the whistleblower statute requires hamstringing the program like this. In fact, it would contradict statutory language requiring the IRS to pay awards out of any ‘‘collected proceeds resulting from the action,’’ with the word ‘‘action’’ basically meaning the audit activity that the whistleblower assisted. Take the stock acquisition cost example. Suppose a taxpayer frivolously claimed that stock acquisition costs were deductible in a situation that clearly required capitalization under reg. section 1.263(a)-5 and INDOPCO principles. Uncovering the frivolous position results in an actual tax liability for year 1 and collected proceeds for the audit period that includes year 1. The fact that maybe in a future year the increased basis that the capitalized costs create in the stock may result in reduced capital gains does not change the taxpayer’s year 1 tax liability or that the IRS collected proceeds resulting from the disallowed deduction in year 1.
Another way to look at it is that each tax period stands on its own and has its own tax liability. The Supreme Court firmly established this decades ago in Sunnen v. Commissioner. 5 In the stock acquisition example, the question whether to capitalize costs in year 1 is separate and distinct from any determination for later years. Once the tax liability for tax year 1 is fixed, there is a final determination for that tax period. Events occurring in an arguably related but later tax period do not change the liability for the earlier period or the fact that proceeds have been collected for the earlier period. This concept squares with the Service’s refusal to grant awards for information that leads merely to decreased net operating losses in year 1. Even though the NOLs may affect a tax attribute in year 1, they do not result in a tax liability or collected proceeds in year 1; the reduced NOLs become award-eligible only if they create a tax liability and result in collected proceeds in a separate, future tax period.
Oddly, the IRS notion of tracking tax attributes to delay awards appears to be a misguided extension of its current position on NOLs. However, tracking NOLs is fundamentally different from tracking events for timing purposes. Unlike an NOL reduction, an event like the disallowance of an immediate expense results in a year 1 tax liability and actual collected proceeds for year 1, which is precisely when Congress intended that an award be granted. If the tax period is closed, those collected proceeds can never be ‘‘clawed back.’’ Any subsequent event may later affect a different tax liability for a different tax period. In the case of NOLs, that new tax liability is award-eligible because at last, the reduced NOLs resulted in collected proceeds. This is why tracking NOLs is necessary to determine whether they result in collected proceeds. Tracking events for timing purposes, however, does not assist in determining ‘‘collected proceeds resulting from the action’’ because the proceeds were collected in year 1, and future events should not alter the amount of the year 1 liability collected by the IRS.
Presumably, even under the Service’s current thinking, tracking would not be required for all timing issues. Information that uncovers tax schemes to defer income should be unaffected. For example, if whistleblower information results in the disallowance of like-kind exchange treatment, income is recognized in year 1, leaving nothing to track. Only the timing of expenses, it seems, is in the crosshairs. This may be good news for proponents of the whistleblower program because it reduces the Service’s self-imposed limitation on the program’s reach, but it also highlights the arbitrariness of excluding one type of timing issue from the program’s scope. There is no statutory or policy justification for distinguishing between income and expense timing issues or for unnecessarily handicapping the efficacy of the formidable enforcement tool of section 7623.
Another point the IRS commissioner made on September 15 that bears highlighting is that ‘‘the deterrence value of the whistleblower program is key.’’ The commissioner explained that ‘‘with a strong, active whistleblower program,’’ corporations will know there are insiders with a strong financial incentive to report tax schemes to the IRS, which ‘‘will certainly make those corporate bigwigs think twice, if they’re smart, and weigh heavily against trying an end run around the tax law.’’6 The point is well taken only if all tax schemes are under the tent. Otherwise, those corporate bigwigs will have an incentive to simply reallocate their resources toward devising tax schemes outside the program’s reach.
The programmatic changes suggested by the IRS commissioner (through his representatives at the ABA tax section conference) would shrink the program. To be fair, the IRS did indicate that further guidance is in the works, and the comments at the ABA conference may reflect that the agency is still studying the whistleblower program; it may not necessarily mean it is restricting the program’s reach. Perhaps the pending guidance will advance rather than contradict the commissioner’s pledge to do ‘‘everything possible to strengthen the whistleblower program’’ and expand its reach. Time will tell whether the commissioner’s actions match the resolve of his words.