Tax Court blows the whistle on whistleblower claim

By James A. Beavers, CPA, CGMA, J.D., LL.M.

Although the IRS proceeded with an examination against an affiliated group based on a whistleblower's tip that the group had underreported income, the whistleblower was not eligible for an award for amounts collected related to an erroneous deduction taken by the group that the IRS independently discovered during the examination opened by the IRS based on his underreported income claim.


In 2009, Michael Lissack filed a claim for a whistleblower award under Sec. 7623. Lissack knew of an affiliated group of entities (Target) that developed condominiums and offered golf and beach club memberships to condominium residents. The residents of the condominiums paid substantial upfront membership fees, which Target treated as nontaxable deposits in the year received. Lissack claimed that, in November 2008, Target changed its refund policy such that the group acquired "complete control over" the fees received and therefore was required to include the membership fees in gross income in 2008.

Lissack's claim was reviewed by an analyst in the IRS Whistleblower Office, who assigned the claim to a revenue agent (RA) in the IRS's Large Business and Industry group for review. The RA reviewed Lissack's allegations by researching Target and analyzing the group's tax returns and IRS account transcripts. Based on his review, the RA found that the information Lissack had submitted was sufficient to begin an examination, but after examining the facts and relevant law, he concluded that Target had properly reported the income in question and proposed no adjustment be made related to the membership deposits issue. However, during his examination of the income issue, the RA found that there was possibly another issue — namely a deduction in excess of $60 million that Target had claimed "for intercompany bad debt." The RA indicated in his report to the analyst from the Whistleblower Office that while the bad debt issue would take some time to examine, it was "unrelated to the subject of the whistleblower claims."

The RA soldiered on with his examination and completed it in 2013. As a result of his findings, the IRS issued Target notices of proposed adjustment. In those notices, the IRS disallowed the intercompany bad debt deduction. The RA then forwarded the entire case file to the analyst in the Whistleblower Office. The documents in the file showed that none of the adjustments had anything to do with the membership deposits issue reported by Lissack, and when asked for confirmation of this by the analyst, the RA emphatically replied they had not. After reviewing the report, the analyst agreed with the RA's determination.

The analyst recommended to the Whistleblower's Office that it deny Lissack's claim. She explained that, although "there was an assessment for additional taxes," the information Lissack had provided "was not relevant to those issues." The Whistleblower's Office accepted the analyst's recommendation and issued a final determination letter denying Lissack's claim. The letter stated that the claim had been denied because, although the IRS did assess additional tax against Target, the information Lissack had provided was not relevant to those issues, and the IRS had taken no action on the issues he raised.

Lissack challenged the IRS determination in Tax Court. There he claimed that he was entitled to an award under Sec. 7623 because, although his claim about underreported income did not result in the assessment of taxes, the administrative action started as a result of his claim did result in an assessment. He also argued that the Sec. 7623 regulations, on which the IRS relied, were invalid. The IRS moved for summary judgment.

The Tax Court's decision

The Tax Court granted the IRS's motion for summary judgment. Although the IRS had proceeded with an administrative action as a result of Lissack's whistleblower claim, he was not eligible for a whistleblower award because the IRS did not collect any proceeds "as a result of the action." The court determined that the IRS's examination of the erroneous deduction issue constituted a separate administrative action that was not initiated on the basis of Lissack's claim and that the relevant regulations under the whistleblower statute, Sec. 7623, were valid.

As the Tax Court related, under Sec. 7623, a taxpayer that provides information to the IRS may be entitled to an award. However, under Sec. 7623(b)(1), an award can be paid only if the IRS "proceeds with an[] administrative or judicial action . . . based on information brought to the Secretary's attention," and the whistleblower is entitled to an award only if the IRS collects money "as a result of the action."

The IRS has issued regulations under Sec. 7623 that apply to information submitted on or after Aug. 12, 2014. The regulations, in part, define the phrase "proceeds based on." The regulations state that the IRS "proceeds based on" the whistleblower's information when the information "substantially contributes to an [administrative or judicial] action against a person identified by the whistleblower." That occurs when the IRS "initiates a new action, expands the scope of an ongoing action, or continues to pursue an ongoing action, that the IRS would not have initiated, expanded the scope of, or continued to pursue, but for the information provided." However, the IRS does not "proceed based on" the whistleblower's information when it merely "analyzes the information provided or investigates a matter raised by the information provided."

The court found that Regs. Sec. 301.7023-2(b)(2), Example 2, was relevant to Lissack's situation. In Example 2, a whistleblower provides facts about how a taxpayer underpaid tax in year 1, the IRS initiates an examination to investigate those facts, and it later expands the examination to determine if the taxpayer also underpaid tax in year 2 by engaging in the same acts that the whistleblower identified in year 1. While carrying out its examination, the IRS also obtains additional facts that are unrelated to the activities described in the information provided by the whistleblower. Based on its discoveries, the IRS further expands the scope of the examination for years 1 and 2.

The example concludes that the IRS "proceeds based on" the whistleblower's information by initiating the year 1 examination and expanding it to include the same issue for year 2. The portions of the IRS's examination of the taxpayer in both year 1 and year 2 relating to the additional facts, however, are not actions with which the IRS proceeds based on the information provided by the whistleblower because the information provided did not substantially contribute to the action. In short, the Tax Court stated, the regulation concludes that the portion of the examination that is unrelated to the facts and issue identified by the whistleblower is a separate "administrative action."

The Tax Court found that the regulation squarely applied to Lissack's situation and that the IRS had discovered an entirely separate issue (the intercompany bad debt deduction), solely based on the RA's independent review of Target's tax returns, and the Service expanded the audit because of this information. Therefore, that portion of the audit was not an action the IRS proceeded with based on information provided by Lissack. Furthermore, after reviewing the work done by the RA and his supervisor as described in the administrative record, the court found the Whistleblower Office did not abuse its discretion in denying Lissack's claim.

Validity of the regulation: Lissack, as a fallback position, argued that the regulations under Sec. 7623 were invalid. The Tax Court analyzed whether the regulations were valid by applying the two-step test from Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). Under the first step, the court asks "whether Congress has directly spoken to the precise question at issue." If the statute unambiguously expresses Congress's intent, there is no need to consider the agency's interpretation; the court and the agency must give effect to the unambiguously expressed intent of Congress.

Under step two of the test, the court considers whether the agency regulation is a permissible construction of the statute. The construction is permissible if it is a reasonable interpretation that is not arbitrary, capricious, or manifestly contrary to the statute. In determining whether a construction is permissible, a court is not required to find that the agency's construction was the only one the agency permissibly could have adopted, or even that the construction of the statute is the one that the court would have chosen if the question initially had arisen in a judicial proceeding. If the court determines that the agency's construction of the statute is permissible, the court is required to follow the agency's interpretation of the statute.

With respect to step one, Lissack argued that Sec. 7623 is unambiguous and that the challenged regulations are inconsistent with Congress's intent, emphasizing the word "any" in the statute's opening clause, which asks whether the Secretary has proceeded with "any administrative or judicial action . . . based on information brought to the Secretary's attention by" the whistleblower.

In Lissack's view, this language means that the proceeds on which the award is determined do not have to flow directly from the whistleblower's information. Rather, if the IRS initiates "any" action, then that action in its entirety constitutes the "action" for purposes of Sec. 7623. In his case, the IRS did initiate an action based on his identification of Target as a possible audit candidate, so under Lissack's interpretation of Sec. 7623's meaning, the IRS proceeded with the entire action, including the investigation of the intercompany bad debt deduction "based on information" he provided.

The Tax Court, however, found that Sec. 7623 is ambiguous. First, it observed that while Sec. 7623(b)(1) refers to an administrative action described in "subsection (a)," Sec. 7623(a) does not define or even refer to the term "action." It further noted that while Sec. 7623(b) initially refers to commencement of "any . . . action," it defines the allowable award by reference to proceeds collected "as a result of the action" (emphasis added). For both reasons, the court reasoned that the statute leaves ample room for the IRS to define the term "administrative or judicial action," which the IRS did in the regulations, defining an "administrative action" to mean "all or a portion of" an IRS civil or criminal proceeding.

In addition, the court found the statute's reference in Sec. 7623(a) (flush language) to "amounts collected by reason of the information provided" is ambiguous. The phrase "by reason of" may plausibly be interpreted to require a substantive contribution by the whistleblower, i.e., the furnishing of factual information that actually helps the IRS identify the issue giving rise to an assessment. On the other hand, the "by reason of" requirement might be deemed satisfied if a whistleblower provides no useful factual information but only the name of an allegedly noncompliant taxpayer. The court stated that this is precisely the sort of statutory ambiguity that may usefully be dispelled by regulation.

In support of his position, Lissack pointed to a statement in the technical explanation of the statute in the Blue Book for the Tax Relief and Health Care Act of 2006 (Joint Committee on Taxation, Technical Explanation of H.R. 6408, The "Tax Relief and Health Care Act of 2006" (JCX-50-06), at 88 (Dec. 7, 2006)). The Tax Court found this statement unpersuasive because Blue Books have been held by the Supreme Court to not be legitimate tools of statutory interpretation and, furthermore, the statement, which merely noted that under previous administrative guidelines that an award could be given for information that merely caused an investigation, was not evidence that Congress intended to incorporate this guideline into Sec. 7623(b).

Regarding step two of the Chevron test, Lissack did not dispute that a multi-issue examination might comprise more than one administrative action. However, he argued that Example 2 of the regulations added "new limiting rules" that were an unreasonable interpretation because they were "manifestly contrary to the plain language" of the statute and the rest of the Sec. 7623 regulations.

The Tax Court concluded that this was not the case. It found Example 2, in conjunction with Regs. Secs. 301.7623-2(a)(2) and (b)(1), had the effect of ensuring that a whistleblower is rewarded only for providing information that substantially contributes to a distinct "administrative action." If this were not the case, whistleblowers would have the incentive to file multiple claims as "mere fishing expeditions, hoping that the IRS will find something wrong with those taxpayers' returns (related to the information they supplied or not)." According to the court, there was no evidence that Congress wished to encourage this sort of behavior, and thus the regulation was a valid interpretation of Sec. 7623.


While rewarding whistleblowers provides an incentive for people with knowledge of wrongdoing to come forward, as the Tax Court points out in its opinion, providing rewards for information that is not directly connected to taxes collected would have the practical effect of encouraging the unscrupulous to submit spurious claims in the hopes that something will show up if the IRS conducts an investigation. Thus, the IRS's rule serves a very important purpose, although to some it might seem to unfairly cut against whistleblowers like Lissack, who have pointed the IRS in the direction, if not the exact location, of the pot of gold.

Lissack, 157 T.C. No. 5 (2021)

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