Tax Court Denies Whistleblower Award Despite IRS Investigation Triggered by Tip

Today's date is 10/1/2026.

Whistleblower’s $5M Gamble: Why the IRS Walked Away with No Proceeds

The stakes could not have been higher when William M. Scott, a 25-year tax compliance veteran, filed a whistleblower claim alleging that a nonprofit correctional corporation had violated federal tax laws by improperly structuring $5 million in tax-exempt bonds issued in 2006. Scott’s tip triggered a multi-year IRS investigation that ultimately closed with no tax, penalties, or interest collected—leaving him with a $0 whistleblower award. The Tax Court’s October 1, 2026, review of the IRS’s denial in William M. Scott v. Commissioner (T.C. Memo. 2026-104) raises a critical question: When does a whistleblower tip justify a payout under Section 7623(b), and how far does the IRS’s discretion extend in defining “collected proceeds”?

At the heart of the dispute is the IRS’s refusal to award Scott any portion of the $5 million bond issuance, despite his claim that the nonprofit’s tax treatment of the bonds violated IRC § 103, which exempts interest on state and local bonds from federal income tax. Section 103 provides that interest on bonds issued by state and local governments is not included in gross income for federal tax purposes, provided the bonds meet certain requirements. Scott argued that the bonds were improperly classified as tax-exempt, triggering an estimated $1.2 million in unpaid federal taxes, plus penalties and interest. The IRS, however, closed the case without assessing any liability, leaving Scott with no award—and no recourse under the whistleblower statute unless the court redefines what constitutes “collected proceeds.” The case tests the boundaries of Section 7623(b)(1), which authorizes awards only when the IRS collects proceeds “as a result of” the whistleblower’s information. If the IRS’s discretion to define “collected” is absolute, whistleblowers face a Catch-22: their tip must lead to a collection, but the IRS controls whether any collection occurs.

The Tax Court’s opinion explicitly cites Lissack v. Commissioner, 157 T.C. 63 (2021), aff’d 125 F.4th 245 (D.C. Cir. 2025), for the principle that whistleblowers must “identify underpayments and provide information that advances to some substantial degree the IRS’s recovery of those underpayments.” The court quoted Lissack directly: “whistleblowers must ‘identify underpayments and provide information that advances to some substantial degree the IRS’s recovery of those underpayments.’”

The Tip That Launched an IRS Investigation: A 25-Year Tax Pro’s Crusade

The IRS’s decision to close its examination of Correctional Corp. without collecting a dime hinged on a single, fateful pivot: the bondholders’ willingness to convert $100 million in tax-exempt 2006 Bonds into taxable 2017 Bonds. That conversion, approved by a state court in May 2017, stripped the IRS of its leverage—and left whistleblower Scott, a 25-year veteran of the tax-exempt bond industry, with no award and no recourse unless the Tax Court redefines what it means for the IRS to “collect” proceeds under Section 7623(b)(1). The case tests the boundaries of the IRS’s discretion to define “collected proceeds,” a term the statute leaves deliberately vague.

Scott’s saga began in December 2014, when he filed Form 211 with the IRS Whistleblower Office (WBO), alleging that Correctional Corp. had misclassified its 2006 Bonds as tax-exempt despite housing a majority of federal inmates—a violation of IRC § 141, which governs private activity bonds. Section 141 defines when a bond issued by a state or local government is treated as a private activity bond, meaning its interest is not tax-exempt. Bonds that finance facilities used primarily for private purposes, such as prisons housing federal inmates, may lose their tax-exempt status under this section. Scott’s claim was no casual tip: it came with five pages of detailed analysis, exhibits, and a résumé boasting roles as Director of the IRS Office of Tax Exempt Bonds, bond liaison for the IRS District Counsel, and attorney in the IRS Office of Chief Counsel. The WBO took notice. By February 2015, it had assigned Subject Matter Expert Randy Torres to conduct a taint review, followed by Tax Law Specialist James Held and Senior Tax Analyst Joel Calandreli. On November 17, 2015, Torres interviewed Scott, who reiterated his allegations and provided additional documentation.

The IRS’s internal machinery ground into motion. The claim, initially classified under Section 7623(a) (the discretionary informant program), was reclassified as a Section 7623(b) claim—reserved for cases where the IRS collects proceeds exceeding $2 million. Group Manager Derek Knight in the IRS’s Tax-Exempt and Government Entities/Tax-Exempt Bonds group (TEGE–TEB) took over, and on December 15, 2015, Held emailed the WBO recommending Correctional Corp. for examination based on Scott’s information. The file landed on the desk of Revenue Agent Abdullah Saleh, who was tasked with a field examination of the bonds and the facility.

Saleh’s investigation uncovered what Scott had alleged: Correctional Corp. had improperly classified the 2006 Bonds as tax-exempt, violating IRC § 141 by using the bonds to finance a private prison facility with a majority federal inmate population. But the IRS’s path to collecting proceeds hit an unexpected obstacle. During discussions with the bondholders’ representative, Saleh raised the possibility of closing the examination if the bondholders converted 100% of the outstanding principal of the 2006 Bonds into taxable bonds—a move that would retroactively trigger tax liability under IRC § 150, which governs bond conversions. Section 150 defines key terms for tax-exempt bonds, including the circumstances under which a bond’s tax-exempt status may change, such as through a conversion to taxable status. The bondholders’ representative responded on November 14, 2016, proposing a conversion but demanding no payment of tax on the 2006 Bonds’ interest to date. Saleh forwarded the email to Group Manager Janae Lemley for review, who consulted Tax-Exempt Bonds Field Operations Manager Allyson Belsome. Belsome approved the plan.

The bond conversion became a fait accompli. On March 24, 2017, the trustee of the 2006 Bonds filed a trust petition in a state district court to convert the bonds to taxable 2017 Bonds. The state court approved the conversion on May 5, 2017, and by June 6, the bondholders’ representative informed Saleh that the 2006 Bonds had been closed and exchanged for the 2017 Bonds. The representative sent the new trust indenture to Saleh on June 12, and the IRS closed the case with a “No Change Advisory Letter” on June 13, 2017. The IRS’s discretion to define “collected proceeds” had just been exercised—and Scott’s claim for a whistleblower award was left in the dust.

The Whistleblower’s Claim: Did the IRS Collect Proceeds or Let Taxpayers Off the Hook?

The IRS closed its examination of the bond conversion on June 13, 2027, with a “No Change Advisory Letter” issued to the bondholders’ representative. But Scott, the whistleblower, refused to accept that the matter was settled. On October 11, 2022, he fired back a three-pronged response to the preliminary denial letter (PDL) that the Whistleblower Office (WBO) had issued on September 19, 2022. Each argument targeted a different pillar of the IRS’s position, forcing the court to dissect not only the meaning of “collected proceeds” under Section 7623(b) but also the IRS’s own enforcement practices.

Scott’s first argument accused the IRS of operating a “quid pro quo scheme” that discouraged whistleblowers from reporting tax-exempt bond violations. He alleged that when the IRS detects a bond structure that violates the arbitrage rules of Section 148 or the private-activity restrictions of Section 141, it routinely allows the issuer to convert the bonds into taxable instruments without assessing any tax on the bondholders. In Scott’s view, this conversion effectively extinguished the IRS’s ability to collect tax on the bond interest, leaving no “proceeds” to share with the whistleblower. The IRS countered that the bondholders’ exchange of 2006 tax-exempt bonds for 2017 taxable bonds did not generate any tax liability because the bondholders had not realized taxable income at the time of conversion. The IRS maintained that any future tax payments by the bondholders would be based on their own investment decisions, not on the IRS’s enforcement action.

Scott’s second argument turned on his interpretation of Section 7623(b) and the Treasury regulations that define “collected proceeds.” He argued that the IRS’s decision to permit the bond conversion itself constituted a collection of proceeds because it forced the bondholders to recognize taxable income when the bonds were exchanged. Scott relied on Treasury Regulation § 301.7623-2, which provides that “collected proceeds” include “amounts collected as a result of any administrative or judicial action.” He contended that the conversion was an administrative action that produced taxable income for the bondholders, thereby creating a future stream of tax revenue that the IRS could collect. The IRS rejected this reading, asserting that the regulation requires actual collection of tax, not merely the creation of a potential future tax liability. The IRS emphasized that the bondholders had not yet sold the 2017 bonds or otherwise triggered a taxable event, so no tax had been collected.

Scott’s third argument challenged the IRS’s interpretation of its own discretion under Section 7623(b)(4). He claimed that the IRS had misapplied the statute by refusing to consider the bond conversion as a basis for an award, even though the conversion was a direct consequence of the whistleblower’s information. Scott argued that the IRS’s refusal to treat the conversion as a “related action” under Treasury Regulation § 301.7623-2(c)(1) was arbitrary and capricious. The IRS responded that the bond conversion was not a “related action” because it did not result from an administrative or judicial proceeding initiated by the IRS. The IRS also argued that monitoring the bondholders’ future tax payments would be impractical and beyond the scope of its whistleblower program. The IRS’s position left Scott with no award, despite what he viewed as a clear causal link between his tip and the IRS’s decision to allow the bond conversion.

Section 7623(b) Under the Microscope: Why the Court Sided with the IRS

The Tax Court’s decision in Scott v. Commissioner hinged on a single, dispositive question: Did the IRS “proceed with an administrative or judicial action” based on Scott’s information, resulting in “collected proceeds”? The court answered no, siding with the IRS in denying Scott’s whistleblower claim under Section 7623(b). The ruling underscores the Tax Court’s deference to the IRS’s discretion in whistleblower matters, particularly when the agency’s actions do not align with the whistleblower’s expectations of direct causation.

Section 7623(b) governs mandatory whistleblower awards, requiring the IRS to pay between 15% and 30% of “collected proceeds” when a whistleblower’s information leads to an administrative or judicial action. The statute defines “collected proceeds” as the total amounts recovered by the IRS, including taxes, penalties, interest, and other recoveries. Treasury Regulation § 301.7623-2 further clarifies that the IRS “proceeds” based on a whistleblower’s information only when the information substantially contributes to an action against a specific taxpayer identified by the whistleblower. The regulation explicitly states that the IRS does not proceed based on information when it merely analyzes the information or investigates a matter raised by it.

The court’s analysis relied heavily on Lissack v. Commissioner, 125 F.4th 245 (D.C. Cir. 2025), aff’g 157 T.C. 63 (2021), which held that for a whistleblower to be entitled to an award, the IRS must take “action on the discrete tax issue or issues the whistleblower’s information identifies.” The D.C. Circuit emphasized that a whistleblower cannot claim an award merely by raising plausible concerns that later lead to unrelated findings of noncompliance. Instead, the whistleblower’s information must substantially contribute to the recovery of underpayments tied to the specific issues identified in the tip. The court quoted Lissack directly: “whistleblowers must ‘identify underpayments and provide information that advances to some substantial degree the IRS’s recovery of those underpayments.’”

In Scott’s case, the IRS did not initiate an examination or take any administrative action based on his information about the bond conversion. The bond conversion was not a “related action” because it did not result from an IRS-initiated proceeding, and the IRS did not investigate the bondholders or calculate future tax payments. The court found that Scott’s information did not substantially contribute to the collection of proceeds, as the IRS’s decision to allow the bond conversion was not based on his tip. The court held that the IRS’s discretion in determining whether to proceed with an action was not arbitrary or capricious, and thus, Scott was not entitled to an award.

The court’s deference to the IRS’s discretion was evident in its refusal to second-guess the agency’s audit decisions. The Tax Court emphasized that its review is limited to whether the IRS’s determination was an abuse of discretion, and the record showed no evidence of bad faith or failure to consider relevant factors. The court cited Berenblatt v. Commissioner, 160 T.C. 534, 545–46 (2023), for the principle that whistleblower award determinations are reviewed under an abuse of discretion standard, with the scope of review limited to the administrative record. The court found that Scott failed to make a significant showing of bad faith or an incomplete record, and thus, discovery was not warranted.

The ruling highlights the high bar whistleblowers must clear to secure an award under Section 7623(b). The Tax Court’s reliance on Lissack and its deference to the IRS’s discretion signal that whistleblowers must provide information that directly leads to IRS action on specific tax issues—not merely raise concerns that later align with unrelated findings. The decision reinforces the IRS’s authority to define the scope of its investigations and underscores the limited role of the Tax Court in second-guessing those decisions.

The Bondholders’ Black Box: Why the IRS Couldn’t (or Wouldn’t) Track Future Taxes

The IRS’s refusal to identify the Bondholders—despite the potential for future tax collections—was not an oversight but a deliberate acknowledgment of operational impossibility. In its review, the Tax Court accepted the IRS’s argument that tracking the Bondholders over decades was impractical, if not impossible, given the uncertainty of their tax status and the likelihood of offsetting net operating losses (NOLs). The court emphasized that the IRS’s IRM’s approved method for bond conversions, which requires issuers to reissue bonds as taxable instruments and close prior-year audits without further investigation into the bondholders’ identities.

The IRS’s position hinged on the practical realities of auditing a dispersed group of bondholders who may include tax-exempt entities or taxpayers with NOLs that would neutralize any potential tax liability. As the court noted, the IRS’s Tax Exempt and Government Entities (TEGE) division concluded that the conversion of the 2006 Bonds to taxable 2017 Bonds rendered prior-year audits moot, as the bondholders’ tax obligations would arise in future years—years the IRS had no authority to reopen under the examination’s scope. The IRS’s TEGE-04-1016-0020 guidance explicitly permits this approach, stating that when bonds are converted to taxable status, the IRS may close examinations with a "no change" determination without investigating the bondholders’ identities.

The court’s deference to the IRS’s operational discretion was decisive. In its analysis, the court cited Kennedy v. Commissioner, 142 F.4th 769, 779 (D.C. Cir. 2025), which held that the IRS’s decision to commence or close an audit rests in the Secretary’s "unfettered discretion." The court further noted that the Tax Court lacks the practical means to evaluate the IRS’s audit priorities or resource allocation, reinforcing that the IRS’s decision to forgo tracking the Bondholders was not subject to judicial second-guessing. The court’s reliance on Cline v. Commissioner, T.C. Memo. 2020-35, at *15, underscored this point, stating that the Tax Court’s jurisdiction is limited to reviewing the Whistleblower Office’s (WBO) conduct after it receives information from operating divisions—not the operating divisions’ audit decisions themselves.

The IRS’s argument that identifying the Bondholders would require independent investigation beyond the whistleblower’s information was particularly damaging to the petitioner’s claim. The court found that the petitioner provided no information in his Form 211 identifying the Bondholders, meaning any future taxes paid by them would not qualify as "collected proceeds" under Section 7623(b). The court emphasized that the IRS must proceed based on the whistleblower’s information, and since the petitioner failed to identify the Bondholders, the IRS had no basis to initiate an action against them. This interpretation aligns with Treas. Reg. § 301.7623-2(b)(1), which requires that the IRS’s action be "based on information" provided by the whistleblower.

The court also rejected the petitioner’s argument that the Bondholders’ future tax payments could constitute a "related action" under Treas. Reg. § 301.7623-2(c)(1). The regulation defines a related action as one where the IRS proceeds against an unidentified person based on the same facts provided by the whistleblower. However, the court held that the petitioner’s information did not identify the Bondholders or provide any basis for their identification. As the court stated, "Any Bondholders that were identified would have been identified from information independently obtained by the IRS," meaning the petitioner’s claim failed the "related action" test. The court’s reasoning here underscored that the IRS’s discretion extends to determining whether an action qualifies as a related action, and the petitioner’s failure to provide identifying information stripped the court of any basis to intervene.

The court’s deference to the IRS’s operational decisions was further reinforced by its citation to Shands v. Commissioner, 160 T.C. 388, 396 (2023), which held that voluntary taxpayer changes do not constitute "collected proceeds" because they do not result from an administrative or judicial proceeding. The court noted that even if the IRS had collected future taxes from the Bondholders, those amounts would not be attributable to the administrative action taken against Correctional Corp., as the Bondholders were never subject to the examination. This distinction was critical, as it highlighted that the IRS’s decision to close the examination with a "no change" determination was consistent with the statutory framework governing whistleblower awards.

No Award, No Problem? The Court’s Deference to IRS Discretion

The Tax Court’s October 1, 2026, opinion in William M. Scott v. Commissioner (T.C. Memo. 2026-104) delivers a blunt message to whistleblowers: the IRS’s discretion to deny awards under Section 7623(b) is nearly absolute. The court upheld the IRS Whistleblower Office’s (WBO) denial of Scott’s claim, finding no abuse of discretion despite his 25-year career in tax-exempt bonds and his detailed Form 211 submission alleging Correctional Corp.’s bond compliance failures. The ruling underscores the Tax Court’s reluctance to second-guess the IRS’s operational decisions, particularly when it comes to defining what constitutes "collected proceeds" under the whistleblower statute.

The court’s deference to the IRS’s discretion was not incidental—it was the linchpin of the decision. Judge Guider, writing for the court, emphasized that the WBO’s denial was "within the bounds of reasoned decisionmaking" and that the IRS’s interpretation of Section 7623(b)—while narrow—was not arbitrary or capricious. The opinion explicitly rejects Scott’s argument that the IRS’s handling of the bond conversion process amounted to a quid pro quo scheme designed to avoid paying whistleblower awards. Instead, the court deferred to the IRS’s operational priorities, including its decision to close the examination with a "no change" determination after the bondholders converted the 2006 Bonds to taxable bonds.

The implications for future whistleblowers are stark. The court’s ruling narrows the definition of "collected proceeds" to exclude future tax collections from bond conversions, even if those conversions were triggered by the whistleblower’s information. This interpretation shifts the burden of proof to whistleblowers to demonstrate that the IRS’s actions directly resulted in immediate, quantifiable tax recoveries—a standard that may prove difficult to meet in complex financial transactions. The court’s reluctance to challenge the IRS’s audit priorities further signals that whistleblowers in the tax-exempt bond industry face an uphill battle in securing awards, particularly when the IRS’s enforcement actions do not yield immediate tax proceeds.

The court’s reasoning hinged on the administrative record and the IRS’s reasoned explanation for denying the award. The WBO’s final determination letter (FDL) stated that the examination "didn’t result in an assessment with respect to the issues [Scott] raised" and that "the information provided didn’t result in the collection of any proceeds." The court found this explanation sufficiently justified under the abuse of discretion standard, which requires whistleblowers to prove that the IRS’s decision was "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law." The court rejected Scott’s argument that the IRS’s decision was inconsistent with its own guidance, noting that the WBO’s interpretation of Section 7623(b) was "within the bounds of reasoned decisionmaking."

The court’s deference extended to the IRS’s operational decisions, including its handling of the bond conversion process. The IRS argued that the bondholders’ conversion of the 2006 Bonds to taxable bonds eliminated any potential tax proceeds from the examination, as the bonds were no longer in circulation. The court accepted this argument, stating that "any subsequent bonds issued would not be included in the information petitioner submitted." This reasoning narrows the scope of "collected proceeds" to exclude future tax collections, even if those collections were a direct result of the whistleblower’s information.

The court’s ruling also highlights the power dynamic between whistleblowers and the IRS. The Tax Court’s reluctance to second-guess the IRS’s audit priorities means that whistleblowers have limited recourse when the IRS closes an examination without collecting proceeds. The court’s opinion explicitly states that it will not "substitute [its] judgment for that of the agency" unless the IRS’s decision is "clearly erroneous." This standard favors the IRS, making it difficult for whistleblowers to challenge denials of awards.

The broader implications for future taxpayers are significant. The court’s narrow interpretation of "collected proceeds" and its deference to the IRS’s discretion may discourage whistleblowers from reporting complex tax violations, particularly in industries like tax-exempt bonds where enforcement actions often involve protracted investigations and uncertain tax recoveries. The ruling also underscores the need for clearer guidance from the IRS on what constitutes "collected proceeds," as the current regulatory framework leaves significant room for interpretation. Without such guidance, whistleblowers may continue to face arbitrary denials of awards, even when their information leads to meaningful IRS enforcement actions.

The court’s decision in Scott is a warning shot to whistleblowers: the IRS’s discretion is broad, and the Tax Court’s deference is near-total. For whistleblowers in the tax-exempt bond industry, the message is clear—proving entitlement to an award requires more than just providing valuable information; it requires demonstrating that the IRS’s actions directly resulted in immediate, quantifiable tax recoveries. Until the IRS provides clearer guidance or Congress amends Section 7623(b), whistleblowers will remain at the mercy of the IRS’s operational decisions.