Whistleblowers’ Proceeds Taxable as Income | Settlements

Two recent court decisions and a 2004 statute affirm that False Claims Act whistleblowers have to pay income taxes on their relator’s share of any recovery―at ordinary income rates. Because the taxation questions that arise from whistleblower’s rewards can be significant, as shown below, it remains wise for any successful relator to seek proper and current tax advice.

In the first case, in January 2010, the United States Tax Court ruled in Campbell v. Commissioner that the qui tam payment awarded as the relator’s share of a 2003 settlement was includable as gross income, and the portion of the amount paid by the whistleblower to his attorneys was then deductible as a miscellaneous itemized deduction. In this case, whistleblower Albert Campbell, a former defense industry financial analyst and chief cost control employee, commenced two related qui tam suits, which his former employer later settled for almost $38 million. Campbell’s share was $8.75 million (about 23 percent of the total), from which Campbell paid his attorneys their percentage pursuant to a contingent fee arrangement. Campbell filed his own tax return and tried to exclude his share from taxable income.

The court rejected Campbell’s various arguments and held that the entire relator’s share of $8.75 million was gross income. Campbell could, however, deduct the portion of the reward that was paid to his attorneys as a miscellaneous itemized deduction. Because Campbell’s approach was too aggressive, penalties against him were upheld.

Campbell received his proceeds in 2003. For more recent False Claims Act settlements, the law is different. The American Jobs Creation Act affects the outcome for proceeds received after the act’s October 2004 effective date. In particular, instead of including the gross amount and allowing a miscellaneous itemized deduction, relators now can adjust their gross income downward for the attorneys’ fees amount―a tax treatment that is generally better for the taxpayer.

In the second case, in May 2010, a federal court in California in Alderson v. United States determined that a False Claims Act reward was taxable at ordinary income tax rates, not the lower capital gains rates. Alderson, a former hospital CFO, had commenced a whistleblower case arising from a Medicare fraud that later yielded him a $27 million reward. Despite the taxpayer’s creative attempts to obtain capital gains treatment, the court ruled the proceeds were taxable as ordinary income.

The takeaway? As much as the government may be willing to reward its qui tam relators at settlement time, the income tax burden applies to those rewards just like most other forms of income.

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