Published — June 22, 2011 Updated — May 19, 2014 at 12:19 pm ET

IRS red tape, old guard slow whistleblowing on corporate tax cheats

Senator Charles Grassley, R-Iowa J. Scott Applewhite/AP

Only 1 award since IRS revamped its bounty program; new SEC whistleblower program modeled after the IRS one


For years, the Internal Revenue Service had a reputation as an unwelcoming place for whistleblowers who offered tips about corporate tax dodgers. They faced what Sen. Charles Grassley called a “culture of hostility” and intimidation.

In December 2006, the Iowa Republican tried to change that by pushing through a law expanding the IRS program paying cash awards to tax tipsters. Whistleblower advocates hailed the law as a way to empower whistleblowers and encourage a culture change within the IRS.

Things haven’t panned out as hoped.

The tipster program has been hampered by excessive secrecy and continuing animosity toward whistleblowers within the agency’s old guard, whistleblower advocates say. And recent IRS policy moves, they say, could further restrict the ability of informants to collect bounties for turning in corporations and wealthy individuals who stiff the government out of millions — and sometimes billions — in tax dollars.

The 2006 law championed by Grassley requires the IRS to pay whistleblowers a reward of 15 percent to 30 percent for identifying cases involving $2 million or more in unpaid taxes.

While the agency has fielded a flood of tips – more than 3,000 in the first two full years of the expanded bounty program – whistleblowers have been greeted with virtual radio silence from the IRS regarding awards in big evasion cases.

In the 4½ years since Congress moved to jump-start the program, just one cash award under the new rules has been made public — a $4.5 million payout to an accountant who reported a $20 million tax underpayment by an undisclosed Fortune 500 firm.

“The IRS is so concerned about the privacy of fraudsters that it seems like they’re almost unable to operate in the whistleblower arena,” said Patrick Burns of Taxpayers Against Fraud, a group that lobbies for whistleblowers and whistleblower attorneys.

New attention on the IRS tipster program comes at a time when the use and abuse of whistleblowers are the subject of much debate.

Corporate reformers say a wave of fraud on Wall Street and in the mortgage industry leading up to the 2008 financial meltdown might have been prevented had more whistleblowers been emboldened to come forward. The Dodd-Frank financial reform law required the Securities and Exchange Commission to create a whistleblower bounty program modeled on the IRS’s expanded program — which prompted some whistleblower advocates to plead with the SEC to be more aggressive than the IRS in implementing its new tipster awards program.

Meanwhile, the U.S. Government Accountability Office and the inspector general for the IRS are investigating the IRS’s whistleblower program. The GAO’s report is expected this summer, and the inspector general’s report is slated for release this fall.

Grassley has credited the IRS with making some strides recently in reducing bureaucratic hurdles, but he told iWatch News that he remains “concerned that the legal advice provided to the Whistleblower Office puts up more roadblocks than it clears.”

The senator said he’s concerned that proposed IRS rules will discourage awards to whistleblowers who prevent long-term losses to the Treasury by reporting tax dodges early, before the schemes have had a chance to fully play out. These would include cases in which companies have, on paper, artificially inflated their “net operating losses,” allowing them to claim tax write-offs for 15 years or more to come.

“Blowing the whistle on improper deductions, such as net operating losses, is just as important as blowing the whistle on unreported or underreported income. Both protect the Treasury,” Grassley said. “The IRS needs to put on its thinking cap and figure out a way to reward whistleblowers whose tips don’t result in immediate tax collections.”

Not doing so may “just discourage whistleblowers from coming forward at all,” the senator said.

The IRS refused to answer questions from iWatch News about its whistleblower program.

In public comments, IRS leaders have said they are committed to working with whistleblowers and that they have reduced red tape and delays. In a letter to Grassley in November, the IRS said it had “committed significant resources” to the whistleblower program and that the agency considers it “a critical part of the IRS strategy to uncover tax cheats and to vigorously and appropriately administer the nation’s tax laws.”

One former high-ranking IRS official counted himself among those who didn’t think the whistleblower program was a good idea.

“I don’t think we should have a system in America where one neighbor is encouraged to turn in his neighbor to the IRS,” Donald Korb, the IRS chief counsel from 2004 through 2008, told iWatch News.

Korb, who is now in private practice and represents companies and individuals with IRS disputes, said the agency never pushed for an expanded whistleblower program. “The Senate Finance Committee just did it,” he said. “The IRS didn’t ask for it.”

Tax probes can take 6-10 years

Korb said the complexity of tax cases — not IRS intransigence — explains why there hasn’t been a wave of bounties paid under the expanded whistleblower program.

“Some of these cases take six, seven, eight, 10 years. That’s what IRS audits take,” he said. “This program is relatively new, so it shouldn’t surprise anybody that there haven’t been many awards.”

Whistleblower attorneys say rewarding tipsters who help make big cases could create momentum that will bring in still more tips and help ease the logjams that have stalled the progress of cases through the system. “They’re going to get even better tips when they start paying out awards,” said Dean Zerbe, a former Senate staffer who drafted the 2006 whistleblower law on behalf of Grassley. “My hope is that we’re going to see a real breakthrough in the next few weeks or months in terms of making awards.”

The IRS’s Whistleblower Office, which vets tips as they come in and refers them to other units for investigation, is widely praised by attorneys representing whistleblowers. The problems, they say, come from hurdles erected by the IRS chief counsel’s office and others within the agency.

“The Whistleblower Office is great,” said Zerbe, who now represents whistleblowers as a private attorney. “But you obviously have people in the IRS and Treasury who, instead of trying to make this program work, wake up in the morning trying to put sand in the gears.”

Zerbe’s former boss, Grassley, said the Whistleblower Office appears to have the support of IRS Commissioner Douglas Shulman and top agency executives.

But Grassley said he was concerned, for example, that additional rules the IRS proposed in January aren’t enough to reward whistleblowers who prevent long-term losses to the Treasury by reporting tax dodges early.

During an IRS hearing last month on the proposed changes, Thomas Kane, a top official in the IRS chief counsel’s office, explained that the agency couldn’t pay out money based on “speculative future use” of deductions such as net operating losses. “We have to collect proceeds in order to pay out,” Kane said.

‘Closed process’

Deciding to blow the whistle on a suspected tax cheat is a tough choice.

Whistleblowers often get blackballed in their professions, endure years of fear and uncertainty, and are ignored by the government agencies that are supposed to embrace them. The SEC was roundly condemned for stiff-arming a tipster who spent years trying to get the SEC to investigate the $50 billion Madoff Ponzi scheme.

Whistleblower advocates say offering large bounties to informants helps encourage them to take the risk of coming forward. But delays in the process and uncertainty over whether the IRS is taking whistleblower claims seriously could have a chilling effect on informants who know about tax rip-offs. “I have cases that I filed in 2007 that don’t seem any closer to resolution,” Erika Kelton, a Washington, D.C., whistleblower attorney, said.

One stalled case, she said, involves hundreds of millions of dollars in tax cheating by a Wall Street bank she declined to identify. The case is “stuck in some review process, and it’s been like that for two years” even though the whistleblower has offered further help, she said. “He could help them break through some of the issues in a 45-minute meeting.” But the IRS has refused to meet with him, Kelton said.

IRS officials maintain that laws protecting taxpayer confidentiality prevent them from sharing much information with whistleblowers. “When you bring a case to the IRS, for most purposes, we are not at liberty to work with you or share information with you. It’s a closed process,” Stephen Whitlock, director of the IRS’s Whistleblower Office, said in an interview published in Taxpayers Against Fraud’s April 2009 quarterly legal review.

Eric Havian, a San Francisco whistleblower attorney said, though, that the law allows the agency to enter into confidentiality agreements with whistleblowers and their attorneys that would keep them updated on the status of their claims and allow a two-way communication between informants and investigators.

Such provisions, he noted, have been used with much success when it comes to another federal whistleblower law, the False Claims Act, which offers rewards to informants who expose federal contractors that are ripping off taxpayers. That law has returned an estimated $27 billion to the Treasury since it was amended in 1986.

Risk vs. reward

Assessing the IRS’s whistleblower program is difficult because the agency declines to release up-to-date data on claims and rewards.

Over a two-year span from October 2007 through September 2009, the agency said, it fielded whistleblower tips against 3,187 companies and individuals each alleged to have tax delinquencies involving $2 million or more.z — cases that could potentially qualify for awards under the 2006 law that expanded the whistleblower program.

But the IRS didn’t pay a single award during that time in cases that had been filed under the 2006 law, agency reports to Congress show.

The IRS refused to say how many tips in the $2 million-plus range it has received since September 2009.

The agency also refuses to confirm that it paid $4.5 million to a whistleblower earlier this year, in what appears to be its first award under the 2006 law.

The public knows about that case only because Blue Bell, Pa., attorney Eric Young issued a press release on April 8 announcing that the IRS paid $4.5 million to his client, an auditor at a Fortune 500 financial firm. The names of the accountant — and of the tax-cheating company — have not been disclosed by Young.

The accountant informed the agency in early 2007 about a $20 million-plus tax liability that the company never reported to the IRS, Young said. Four years later, the agency paid a bounty that amounted to 22 percent of its recovery in the case, the lawyer said.

No other whistleblower attorney has come forward to announce an award under the 2006 law. Young believes that, at this point, his client is the only whistleblower to have won an award under the law.

And despite the successful outcome, Young said the case highlighted serious problems with the IRS’s tipster program.The whistleblower’s claim was “in limbo” for years, Young said, and he had to resubmit all the paperwork in an effort to resurrect the process. The Whistleblower Office got things on track, Young said, but others within the agency worked to hamstring the process. The agency appears to have “a systemic aversion to whistleblowers,” he said.

Because of the delays and problems in the bounty program, Young said, three potential clients — each with information about alleged tax underpayments of $25 million or more — have hesitated to put their professional lives in jeopardy by coming forward.

“They just don’t know if the risk is worth it,” he said.

‘IRS purgatory’

Before the 2006 law was enacted, the IRS could pay bounties of up to 15 percent of the tax proceeds collected, but whether it paid any award was up to the agency’s discretion.

From October 2008 through September 2009, it paid 110 awards under the older bounty rules. Altogether, those whistleblowers received just under $5.9 million — less than 3 percent of the $206 million the agency collected, thanks to their tips.

Many cases filed prior to the 2006 law, meanwhile, continue to languish, according to whistleblower attorneys.

One older case that’s still pending involves a whistleblower who informed the IRS in 2003 that a New Jersey furniture chain owner was dodging taxes by pocketing money that came in from cash sales. In 2009, the furniture chain chief, Anthony Mehran, pleaded guilty to filing a false tax return and admitted that he had skimmed $3.8 million out of his stores.

Eight years after the initial tip — and nearly two years after the businessman was convicted — the IRS has yet to reward the whistleblower.

The whistleblower died of natural cases while he was waiting for a decision from the IRS, according to Michael Fitzgerald, an attorney who represented the man and now represents his widow. Fitzgerald, who won’t reveal his clients’ names, said that, even after the guilty plea, the IRS has refused to provide information about the status of the reward.

“This poor lady has been stonewalled,” Fitzgerald said. “My client is in IRS purgatory.”

‘Mr. ABC’

Concerns about the IRS and tipsters are nothing new.

In 2004, a Wall Street banker who blew the whistle on abusive tax shelters used by Enron and other big companies – testifying anonymously as “Mr. ABC” – told Congress that the biggest problem was “the agency’s resistance to take seriously outside information from knowledgeable insiders.”

His attorney, Kelton, said that if the IRS had moved quickly after her client reported the tax frauds in 1999, the government might have realized the depth of corruption at Enron well before the company collapsed.

A June 2006 inspector general’s report found lapses in IRS management of whistleblower cases. Many case files failed to explain why an award application was rejected or approved, and it took an average of more than 7½ years for a tipster to collect any reward, the report found.

After Congress passed the 2006 law expanding the whistleblower program, the IRS was slow to get going under the new rules. An inspector general’s report in 2009 again found deficiencies in how the IRS handled whistleblower claims. In June 2010, Grassley dispatched a blistering letter to Treasury Secretary Tim Geithner, complaining that the agency was writing policies behind closed doors that appeared to contradict the intent of the law.

Grassley said, for example, that new provisions in the agency’s internal policy bible, the Internal Revenue Manual, seemed to limit whistleblower awards to cases in which the IRS has collected a cash payment from the taxpayer — and provided no award when a tipster’s information prevented the agency from making an unwarranted refund.

Since Grassley’s letter, the IRS has put some of its whistleblower policies up for public comment, and backed off some of the policies that troubled Grassley and whistleblower attorneys. The agency now says it will give credit to whistleblowers for blocking refunds to tax cheats.

‘It takes a rogue’

But problems still remain, Grassley and other whistleblower advocates say.

One issue of contention is how the agency will handle whistleblowers who were themselves involved in the tax schemes.

The 2006 IRS whistleblower law says awards should be made even to whistleblowers who are culpable in the wrongdoing they expose. Zerbe, the former Senate staffer, said this reflects the reality that, often, “it takes a rogue to catch a rogue” — the people most likely to have inside knowledge of complex tax dodges are frequently involved in carrying out the schemes.

The 2006 law disqualifies from bounties any individuals who “planned and initiated” evasion schemes and are convicted of criminal conduct. Court rulings involving the False Claims Act have generally limited those who “planned and initiated” fraud to the principal wrongdoer, which means lieutenants involved in the schemes are free to collect awards for blowing the whistle on kingpins.

But last year, in an update to the Internal Revenue Manual, IRS lawyers seemed to come up with a new definition of “planned and initiated” — one that may disqualify whistleblowers from getting rewards not only if they were principal architects of a scheme, but also if they acted in a subordinate role.

In cataloging the factors that reflected on whether a whistleblower “planned and initiated” a scheme, for example, the manual lists whether “the whistleblower knew or should have known that tax noncompliance was likely to result from the course of conduct.”

The policy manual’s definition, Zerbe said, may create a Catch-22: To provide worthwhile information to the IRS, you need detailed knowledge of the scheme. But having that knowledge could disqualify you from collecting a reward.

For Zerbe, the concern is more than academic. One of his clients is Bradley Birkenfeld, the former UBS private banker who exposed how the Swiss bank enticed wealthy Americans hide their money from the IRS. Birkenfeld, who played a low-level role in UBS’s long-running scheme, was sentenced to 40 months in prison.

As the tipster who broke open the largest tax-evasion case in U.S. history, Birkenfeld could potentially claim a share of the $580 million the IRS garnered as part of the federal government’s $780 million settlement with UBS. Zerbe acknowledged that Birkenfeld has a pending claim with the IRS, but declined to elaborate.

America’s stolen money

The IRS has estimated the tax gap — the difference between the amount U.S. taxpayers owe and the amount they actually pay — could approach $300 billion a year.l Whether whistleblowers can help the IRS put a significant dent in that shortfall is a question that can’t be answered yet.

Burns, the Taxpayers Against Fraud spokesman, said the real question may be whether the Whistleblower Office has political muscle to push cases through the bureaucratic maze and “force the IRS to collect America’s stolen money.”

If the IRS gets serious about using whistleblowers to power its investigations, Burns said, the result “could be Carl Sagan numbers — billions and billions of dollars recovered for the U.S. Treasury.”

Read more in Inequality, Opportunity and Poverty

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