You may have a friend who you know is raking it in, earning large amounts of mostly cash income. But you also know he is not being completely honest in reporting it to the IRS. In fact, he siphons off a big chunk and hides it in an account in a tax haven jurisdiction with strict bank secrecy laws. Or you may know somebody who immigrated to the United States but retains extensive business operations in his native country. This person knows that as a green card holder or naturalized citizen, he is subject to U.S. taxes on his worldwide income, but figures there is no way the IRS can find out about his overseas dealings and bank accounts.
You, on the other hand, have always played by the rules. Not having the luxury of cash earnings that you can hide from the IRS and stash offshore or extraterritorial connections enabling the generation of foreign wealth in foreign lands, you will dutifully report all your income and pay all your taxes this year as you have done every year. But the unfairness of it all weighs on you. And then somebody points out that the IRS rewards whistleblowers. Indeed, in large recoveries, the law requires the Service to pay out at least 15 percent of collections attributable to a whistleblower’s information. Should you squeal on your friend’s secret offshore bank accounts in the hopes of a handsome reward from the IRS? A recent Tax Court decision suggests that you would do well to resist that temptation.
Rewarding tax snitches is nothing new. Since 1867, Congress has authorized the Treasury Secretary to make discretionary payments to those who help detect tax underpayments. But in 2006, Congress added a provision to the tax code mandating awards of between 15 and 30 percent of “collected proceeds” from an action or settlement based on information provided by a whistleblower in some cases. Among other requirements, “the tax, penalties, interest, additions to tax, and additional amounts in dispute” in such a case should have exceeded $2 million.
In an anonymous whistleblower action decided by the Tax Court in March, Judge Albert G. Lauber held that a penalty for failing to file a foreign bank account report (FBAR) doesn’t count toward that $2 million threshold. FBAR penalties can quickly add up. A non-willful failure to file an FBAR is subject to a penalty of as high as $10,000 a year. A willful failure can attract a maximum annual penalty of $100,000 or half the value of the foreign bank account, whichever is greater. Even though the FBAR regime was set up outside the IRS, authority to administer it was delegated to the Service in 2011.
Although Lauber’s holding to exclude FBAR penalties from the $2 million disputed amounts threshold rests on sound statutory construction, it does open up avenues for the government to structure settlements with a view to depriving whistleblowers of their legitimate due. For example, by demanding and accepting a large FBAR penalty in exchange for a small or no tax-related penalty, the IRS could squirm out of the requirement of a mandatory award, leaving the whistleblower at the mercy of the Service’s discretion.
That is exactly where the whistleblower in the case before Lauber found himself. He had sought a mandatory award based on amounts the government had collected from a former client of Swiss banker Renzo Gadola. In December 2010 Gadola had pleaded guilty to a criminal conspiracy to defraud the United States, admitting he had serviced hundreds of secret Swiss accounts, first as a private banker at Zurich-based UBS from 1995 to 2008 and later as an independent investment adviser. One of Gadola’s former clients, in turn, pleaded guilty in August 2011, agreeing to pay an FBAR penalty of $6.8 million, as well as a small amount of restitution, reflecting unpaid taxes on income derived from his undisclosed Swiss bank accounts. The whistleblower claimed a mandatory award based on the aggregate amounts, including the FBAR penalty, paid by Gadola’s former client. The government argued that the plain text of the statute excluded the FBAR penalty. Without it, the amounts in dispute were at most $50,000, well short of the $2 million threshold, rendering the whistleblower ineligible for a mandatory award. Lauber sustained the government’s position.
In amending the whistleblower statute and establishing a mandatory award in 2006, Congress evidently sought to provide greater incentives for whistleblowers by promising them more certain payments. But the statutory text does not seem to have anticipated FBAR penalties. That, combined with the subsequent delegation of administering the FBAR regime to the IRS, means that whistleblower awards largely continue to remain acts of administrative grace.
Ratting out your friend’s secret foreign bank accounts for an award that lies within the IRS’s discretion may well mean the end of a beautiful friendship with little to show for it by way of monetary gain. Until Congress fixes the whistleblower statute to explicitly include FBAR penalties, pretending that you don’t begrudge your friend his undeclared hoard in foreign bank accounts may be the best policy.