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February 07, 2008
By Mark Labaton
This article appears on Page 6.
Of all debts, men are least willing to pay taxes." So said Ralph Waldo Emerson more than 150 years ago. Little has changed, except perhaps the federal government's ongoing and increased efforts to collect tax debts.
For example, faced with billions of dollars of undetected tax fraud and encouraged by the success of the federal False Claims Act, Congress, a little more than a year ago, overhauled the Internal Revenue Code to enhance the collection of Internal Revenue Service debts. This overhaul followed a series of changes made in the last 12 years to accomplish this purpose.
Congress' recent amendments to the tax code substantially enhanced rewards to whistle-blowers who report tax underpayment and fraud and set up a whistle-blower office in Washington, D.C. to start and coordinate governmental investigations of tax cases. That office has started dozens of cases and will issue regulations and procedures later this month.
The new Internal Revenue Code provisions are modeled after the False Claims Act, Civil War legislation designed to uncover, punish and recoup the costs of fraud committed by government contractors.
Although once of limited effectiveness, in 1986 Congress amended the act, which does not cover tax fraud. These amendments increased monetary incentives for whistle-blowers reporting fraud, enhanced protections for whistle-blowers against employer retaliation and increased funding and government resources to prosecute fraud cases.
The result has been dramatic. Since 1986, the federal government has recovered approximately $25 billion from contractors who defrauded federal agencies, with the largest recoveries coming from military procurement, health care and pharmaceutical contractors. The act has led to safer medical practices and has deterred hundreds of billions of dollars of potential fraud by contractors who sell goods or services to the government, according to the Department of Justice and taxpayer interest groups.
Under the overhauled IRS legislation, whistle-blowers who bring tax fraud and underpayment cases to the attention of the federal government are entitled to an award of between 15 percent and 30 percent of the amount recovered, the same award scale used in False Claims Act cases.
Previously, the IRS had unlimited discretion in determining the awards to whistle-blowers reporting tax fraud and, on average, gave awards of approximately 10.9 percent of the collected proceeds. The new legislation eliminates the $10 million ceiling on any award.
Larger whistle-blower rewards and vigorous prosecution of tax fraud are intended to reduce the multibillion-dollar "tax gap," the difference between what the IRS collects and what it believes is withheld because of tax fraud, evasion and underreporting.
The IRS expects it will take more than five years for these changes to bear fruit because the cases typically take at least that long to resolve. To date, the IRS has not announced any recoveries from this new program. Information about cases is kept confidential while investigations are active.
Persons or entities referring cases must, at the outset, submit a detailed accounting of the alleged tax fraud together with an affidavit signed under penalty of perjury.
As a lawyer who recently put together a case for a client, I was impressed with the IRS's professionalism. My client had evidence of a substantial tax fraud committed by a large public company, and our submission included a lengthy letter to the IRS describing our evidence, along with many exhibits.
Approximately two months after we submitted this material, the client and I met with IRS and other federal agents investigating our case for several hours and answered their probative questions.
Although modeled after the False Claims Act, the new IRS legislation also differs from the act in two important respects.
First, the IRS program is limited to cases where the losses to the government exceed $2 million if the wrongdoer is a business and $200,000 if the wrongdoer is an individual. The False Claims Act does not impose any such limitations.
Second, the act allows private parties to litigate cases on behalf of the United States when the federal government declines to pursue a case reported by a whistle-blower.
The IRS legislation does not give whistle-blowers that opportunity. The reason: Congress believed permitting whistle-blowers to independently pursue their actions would foster too many marginal lawsuits and possibly expose taxpayers to unfair intrusions into private matters. Once the whistle-blower gives the IRS all relevant material, the case is in the government's hands with the whistle-blower being more of an informed tipster rather than a full partner working with the government.
Not giving whistle-blowers the opportunity to pursue certain cases is shortsighted. As a result of this policy, some strong cases might never see the light of day. The risk that the government will lack sufficient resources to investigate some meritorious cases is likely to increase as whistle-blowers refer more cases.
As referrals increase, Congress should consider modifying the IRS program to permit whistle-blowers to pursue certain cases largely on their own.
Privacy considerations should not inhibit whistle-blowers from pursuing actions. Protective orders could be crafted, in such cases, to protect confidential tax information, and the IRS could maintain authority to oversee and monitor private actions and intervene in them if necessary.
As with the False Claims Act, the IRS's new program already has both critics and advocates.
Critics complain that the program rewards "tattletales," a criticism also leveled against the previous, more limited, IRS program once derisively dubbed the "Rewards for Rats" program. But this view is hardly universal: One person's "rat" is someone else's "patriot."
Characterizations aside, some whistle-blowers are heroes and some are not. But regardless of how they are viewed and regardless of their individual motives, whistle-blowers - be they False Claims Act or IRS whistle-blowers - perform a valuable service by exposing (and deterring) fraud that, if unchecked, bleeds our treasury, causing grave harm.
Mark Labaton, a partner at Kreindler & Kreindler, litigates securities and consumer class actions, corporate governance cases and whistle-blower actions.
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