Tax Whistle-Blowers Can Reap Rewards

The Internal Revenue Service looses about $345 billion annually from people cheating -- underreporting or underpaying -- on their taxes. Now the IRS is making new efforts to close the "tax gap," and if you provide the right information, it can be a serious boon for both you and the feds.

"For the first time a tax whistleblower, someone with knowledge of a significant tax fraud, has an enforceable right to get a reward," says Michael A. Sullivan, a whistleblower attorney with Finch McCraine in Atlanta. Before the Federal Whistleblower Office was established in 2007, "it took forever, claims were lost in the process and there wasn't much incentive to turn someone in."

Things have dramatically changed since then, and now a whistleblower is entitled to 15% to 30% of the total proceeds the IRS recovers, including interest and penalties. But there's a small catch. In order to make a whistleblower claim, there must be more than $2 million in tax liabilities. And while individuals do report other individuals, the majority of cases are brought by a company insider.

"A company might cheat on payroll taxes and treat full-time employees as independent contractors," says Sullivan. "Or, someone at a hedge fund might know about some large scale improprieties where there's a great temptation to hide income by treating it as if it were earned by some off-shore entity that's not subject to U.S. tax law." Most of the time whistleblowers are individuals who are genuinely disturbed by improprieties.

To bring a valid claim, it must be based on more than a hunch. "A strong informant is an insider with a close perspective on what's been going on," says Erika Kelton, a whistleblower attorney with Phillips & Cohen in San Francisco, Calif. When considering whether you have a case, "as a general rule of thumb, you want to know significant dollar amounts involved, have documentary evidence, potential witnesses to corroborate what you're going to say," says Kelton.

But, you don't always need to come armed with a dossier of documents. "There are times when saying, 'I work at this company and I know this is happening' would be enough." If you work in the purchasing department and know first hand that your company is hiding expenses, having corroboration could suffice. "The more documentary materials the better," says Kelton, "but it's not always the case."

Because it takes several years for an investigation, this new IRS office has not yet paid out any whistleblower cases. If you are considering making a claim, consider hiring a lawyer. It might be tempting to report it yourself, but the IRS is historically slow with investigations and receives hundreds of potential claims.

A whistleblower attorney usually works on contingency, taking a portion -- often 30% -- of whatever money you're rewarded in the end of the investigation. "We can package the entire thing nicely for the IRS and can hand it to them on a platter," says Sullivan, "because you really have to be able to get your case to the top of the pile to get it noticed."

It's also too early to determine how the IRS calculates what a whistleblower's contribution is worth. But with the potential payoff starting at $300,000, it would be worthwhile for many bean counters to be on the lookout for tax evaders. "Where you fall in the range is going to be agreed upon through negotiation with the IRS," says Sullivan.

"If it can't be there's a procedure to go to tax court, but the law is too new to see how it's going to play out." If you do receive a reward, don't even think about not paying taxes on it. A whistleblower's compensation is considered income, and subject to federal income tax rates. (Be sure to pay them, or someone might blow the tax-evasion whistle on you!)