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Is It Time for New York to Consider Augmenting Its Tax Whistleblower Laws to Include a Program Modeled on the Federal Statute?

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After years of complaints from whistleblowers and other interested parties, the IRS whistleblower program—which was enhanced in 2006—has finally begun to show some signs of success. Consider:

  • As my colleague John Sinatra reported, the IRS recently awarded a whopping $104 million to imprisoned UBS whistleblower Bradley Birkenfeld, the first award under the 2006 program
  • Just last month, the IRS awarded $38 million to another whistleblower

Can it be, as Forbes recently reported, that “the days ahead look bright for whistleblowers and the IRS whistleblower program”? With a backlog of significant whistleblower cases filed after 2006 slowly churning through the IRS process, it is a safe bet that more cases are edging closer to completion and that the slow trickle of announcements from whistleblower attorneys about awards will begin to pick up. As more awards are announced, more whistleblowers will come forward.

And there is little doubt whistleblowers will be emboldened by the $38 million dollar awarded in October. The whistleblower’s attorney said that his client exposed a corporate tax avoidance scheme involving “aggressive tax planning” by one of the nation’s largest corporations. Based on the size of the award, it is conservatively estimated that the IRS collected more than $126 million in federal corporate taxes from the company. Significantly, the whistleblower’s identity was never revealed nor was the identity of the public corporation. In fact, the target corporation did not even know that the IRS’s interest in its “aggressive” position was sparked by a tip from a whistleblower.

As corporate insiders realize that they can report their employer’s unpaid tax obligations and reap the rewards of the IRS whistleblower program without fear of disclosure, it is a sure bet that others with good information will come forward.

Can a company that has taken an “aggressive” federal tax position face penalties under the current New York tax whistleblower program as well? Maybe, but two key features of the New York system diminish the appeal that such cases might have for potential whistleblowers. First, the New York statute limits False Claims Act cases to those where the whistleblower can prove that the corporate taxpayer knew that its returns were false or where the taxpayer acted with reckless disregard or deliberate ignorance of the truth of those returns. In sharp contrast, the IRS program applies to all underpayments that meet the financial thresholds, including those that are the result of mistakes. An aggressive corporate tax position that turns out to be wrong but that was held in good faith can still result in an IRS award, as last month’s case demonstrates. That same case would only qualify in New York if the whistleblower can prove that the corporate taxpayer knew the return was wrong, or recklessly disregarded or deliberately ignored the truth of the return.

Second, a whistleblower in New York must be prepared for the likelihood that his or her identity will not be protected and that the target of their tip will learn who they are. Even with New York’s strong statutory whistleblower protections, many potential whistleblowers are reluctant to proceed with cases when their identities will likely become known.

Thus, in New York, tax whistleblowers have a higher burden of proof and they face greater risks than whistleblowers under the IRS program. Since taxpayers face much greater penalties under the New York whistleblower statute than under the IRS program, the higher burdens and risks that whistleblowers face under New York’s false claims statute make some sense. The New York false claims act penalties, equal to three times the taxes evaded, are so severe that it is understandable that the Legislature reserved these penalties for cases where the taxpayer engaged in knowing or reckless misconduct.

That said, some whistleblower attorneys have complained to me that New York is losing out by not having a program like the federal program that both rewards whistleblowers who report significant underpayments that are not based on knowing misconduct (but that are owed nonetheless) and that promises and delivers the ultimate protection to whistleblowers—anonymity. These attorneys have suggested that New York should once again take the national lead by expanding its tax whistleblower program to allow whistleblowers to choose whether to file a claim with the Tax Department under a program modeled on the IRS program or, if the facts establish a knowing violation of the tax law, to file a qui tam suit under the False Claims Act. Such a change would provide a mechanism for reporting liabilities that are not based on knowing misconduct while giving whistleblowers a choice to file a claim while preserving their anonymity. The end result would be that New York would have a dual statutory framework, which would cast the broadest possible net to encourage all whistleblowers with knowledge of substantial tax liabilities to come forward.

Does the idea have potential? It is hard to say. But given New York’s continuing financial problems, I don’t think that anyone should be too surprised if the folks in the Tax Department and the Legislature started to give serious thought to doing something like this to expand the reach of its whistleblower laws, especially if the IRS program continues to produce major recoveries.

Topics: Tax Fraud

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