The Tax Court held that "amounts in dispute" for purposes of the $2 million threshold in whistleblower cases are the total amount of the liability that the IRS proposed with respect to a taxpayer's examination that was begun using the information provided by a whistleblower.
Background
Ian Smith filed an application for a whistleblower award in 2008. Smith claimed (based on personal experience) that a business (B) was exchanging its products or services for gift certificates and that these barter transactions were not included as part of B's income. He also contended that B gave customers' gift certificates to its employees as compensation and that the gift certificates' value was not treated as includible in the employees' income (i.e., not included on Forms W-2, Wage and Tax Statement).
Based on Smith's submission, the IRS began an employment tax and an income tax examination of B. The employment tax exam ended with B agreeing to pay $3,853,345 in taxes, penalties, and interest. The income tax exam resulted in B's agreeing to pay a deficiency of $14.5 million. However, after reviewing the employment tax and the income tax adjustments, the IRS's whistleblower analyst determined that only $1,777,912 of the employment tax liability was attributable to information provided in Smith's whistleblower claim, and none of the income tax adjustments were attributable to information in the claim.
Sec. 7623(a) authorizes the IRS to pay whistleblower awards in the amount it "deems necessary." Thus, if a whistleblower claim falls under Sec. 7623(a), the IRS has unlimited discretion to pay whatever amount it wants as an award.
However, under Sec. 7623(b)(1), if the requirements of Sec. 7623(b)(5) are met, the IRS must pay an award of "at least 15 percent but not more than 30 percent of the collected proceeds" from any administrative or judicial action to the extent to which the whistleblower substantially contributed to the action. Sec. 7623(b)(5) states that Sec. 7623(b) will apply to any action the IRS brings:
(A) against any taxpayer, but in the case of an individual, only if such individual's gross income exceeds $200,000 for any taxable year subject to such action, and
(B) if the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $2,000,000.
In determining the amount in dispute for purposes of Sec. 7623(b)(5), the IRS took the position that the amount in dispute was limited, based on the language of Secs. 7623(b)(1) and (2), to the amount of the collected proceeds. In Smith's case, the IRS thus determined that the amounts in dispute were $1,777,912. Consequently, the $2 million threshold in Sec. 7623(b)(5) was not met, so Sec. 7623(b) did not apply to Smith's claim. Applying Sec. 7623(a), the IRS found that Smith was entitled to an award of 10% of the $1,777,912 of employment tax liability collected that was directly attributable to information he provided, and 1% of the $2,081,434 of employment tax liability collected that was not directly attributable to information he provided, for a total award of $198,006.
Smith interpreted the "amounts in dispute" to be the combined amount of the employment and income tax deficiencies and penalties in dispute between B and the IRS because of examinations commenced on account of Smith's whistleblower claim in the case, which was $19,989,467. Under this interpretation, the $2 million threshold in Sec. 7623(b)(5) was met, and the IRS should have determined his award under Sec. 7623(b), rather than Sec. 7623(a), resulting in a larger award. Smith challenged the IRS's decision in Tax Court.
The Tax Court's decision
The Tax Court held that Smith had met the $2 million threshold of Sec. 7623(b)(5) and that the IRS should have determined his whistleblower award under Sec. 7623(b) rather than Sec. 7623(a).
The court first addressed the IRS's rationale for limiting the scope of "amounts in dispute" in Sec. 7623(b)(5) to collected proceeds. The IRS argued that the use of the words "any" and "action" in Sec. 7623(b)(1) defined the scope of "any actions" for purposes of Sec. 7623(b) and thus governed its use in Sec. 7623(b)(5). The Tax Court rejected this idea and concluded that the use of "action" in the introductory phrase of Sec. 7623(b)(5) or in Sec. 7623(b)(5)(A) was "in no manner linked to the concept of 'collected proceeds' or substantial contribution."
Having dismissed the IRS's rationale, the Tax Court undertook its own interpretation of "amounts in dispute," starting with the statute itself. It found that Sec. 7623(b)(5) has a clear meaning. The court explained that Congress had intended to limit the nondiscretionary whistleblower award regime in Sec. 7623(b) to larger cases and that the amount in Sec. 7623(b)(5) is simply a monetary threshold for application of the less discretionary whistleblower award regime. The court stated that "[t]he factors of section 7623(b)(1) and (2) limiting the award to a particular portion of collected proceeds focuses upon the usefulness of the whistleblower's claim and should not be a refinement of the 'amounts in dispute' as used in section 7623(b)(5)."
The Tax Court then considered the regulations. In Regs. Sec. 301.7623-2(e)(2)(i), amount in dispute is defined as:
the greater of the maximum total of tax, penalties, interest, additions to tax, and additional amounts that resulted from the action(s) with which the IRS proceeded based on the information provided, or the maximum total of such amounts that were stated in formal positions taken by the IRS in the action(s).
The IRS's whistleblower analyst had relied on this regulation to find that the $2 million threshold was not met. The Tax Court disagreed, noting that the regulation provides that the amounts in dispute are the amounts that resulted from the actions with which the IRS proceeded based on the whistleblower information. It therefore did not follow that the limiting standards of Secs. 7623(b)(1) and (2) would also apply in determining whether the initial $2 million threshold has been met. According to the Tax Court, conceptually, Sec. 7623(b)(5) is a threshold to ensure that Sec. 7623(b)(1) is applied to taxpayers with a certain minimum amount of annual income or with a significant amount of tax liability and, in effect, the IRS had "backed into the subsection (b)(1) and (2) limitations to interpret the subsection (b)(5) threshold."
Reflections
The IRS might be forgiven for making an exceedingly weak argument for its interpretation of "amounts in dispute," except that its own regulation clearly does not support its litigating position. The IRS, since the enactment of Sec. 7623(b), has worked hard to prevent taxpayers from benefiting from the provision. But Congress enacted Sec. 7623(b) to encourage whistleblowers to come forward, so a more liberal interpretation of the provision by the IRS would seem to be warranted.
Smith, 148 T.C. No. 21 (2017)
