Whistleblower 11099-13W v. Commissioner

Voluntary Compliance Traps Whistleblower: No Award for LIFO-to-FIFO Switch

A whistleblower tip alleging massive LIFO inventory manipulation has ended in a Tax Court defeat, highlighting the narrow interpretation of "collected proceeds" under IRC § 7623(b)(1). This case involves potentially billions in income adjustments. The Tax Court, in Whistleblower 11099-13W v. Commissioner, granted Summary Judgment for the IRS, ruling that tax reported and paid voluntarily by a taxpayer—even if prompted by a whistleblower's tip—does not qualify as 'collected proceeds' for the purpose of calculating a whistleblower award. The decision sets the stage for a legal battle focusing on the distinction between 'causation' (the whistleblower's information led to a change) and 'administrative action' (the IRS independently assessed and collected additional taxes).

The Scheme, The Audit, and The Switch

Following the denial of his claim, the case Whistleblower 11099-13W v. Commissioner centered on the timeline of events following the whistleblower's initial tip. The petitioner alleged that the Target corporation had manipulated its last-in, first-out (LIFO) inventory accounting to artificially inflate its cost of goods sold (COGS) for tax purposes.

The timeline began in July 2008, when the petitioner's counsel filed Form 211, Application for Award for Original Information, with the IRS Whistleblower Office (WBO). The application described the alleged LIFO scheme, claiming that Target's practices allowed it to defer income tax indefinitely. The WBO assigned the application to an analyst, who forwarded it to the Large and Mid-Size Business Division (LMSB) for potential examination.

In March 2009, a revenue agent in LMSB, overseeing a team already examining Target's returns for the 2006 and 2007 tax years (the "06/07 audit cycle"), began investigating the whistleblower's information. However, the team suspended its investigation sometime after January 2010, deferring the investigation to another team examining Target’s 2008 and 2009 tax returns (the "08/09 audit cycle"). The revenue agent wrote a report detailing the team's actions before the suspension, noting difficulties in contacting former Target employees due to severance agreements and Target's insistence on adherence to agreed-upon audit procedures.

In February 2010, the petitioner's counsel informed the WBO that Target had terminated the LIFO scheme in 2009, believing this was a direct result of the information provided. The petitioner estimated that this termination would result in additional taxable income exceeding $1 billion for 2009, increasing Target's tax bill by up to $400 million.

The examination team investigating Target for the 08/09 audit cycle took up the whistleblower’s claim. In August 2012, after investigation, the team concluded that it could not substantiate the claim regarding the LIFO scheme, citing a lack of understanding of the internal mechanisms and collusion required to execute the scheme. The revenue agent concluded that "our investigation techniques failed to discover" any documentation of the alleged LIFO scheme.

In March 2012, Target filed Form 3115, Application for Change in Accounting Method, with the IRS to change its inventory accounting method from LIFO to first-in, first-out (FIFO), effective for the 2011 tax year. A taxpayer changing from LIFO to FIFO must, under Section 481(a), "recapture" (i.e., recognize as income) the LIFO reserve, which is the difference between their reported ending inventory and what their ending inventory would have been had they used FIFO. As a result of this change, Target estimated on its Form 3115 that it would recognize Section 481(a) income exceeding $9 billion.

The Battle Over 'Collected Proceeds'

The central point of contention revolved around the definition of "collected proceeds" under Section 7623(b)(1), which governs whistleblower awards. Section 7623(b)(1) mandates the IRS to pay a whistleblower an award of 15% to 30% of collected proceeds resulting from an administrative or judicial action based on the whistleblower's information.

The petitioner argued for a broad, causation-based interpretation. His position was that Target changed its behavior because of the IRS investigation initiated by his tip, and the resulting increase in tax payments stemming from the LIFO-to-FIFO switch constituted "collected proceeds." He emphasized that as long as Target's actions caused it to pay more tax—which it indisputably did—and he could tie that change to IRS action spurred by his information, the "additions to tax" paid by Target qualified for an award.

The IRS countered with a strict, statutory interpretation. The IRS argued that under Section 7623(b) and the precedent set in Whistleblower 16158-14W, 148 T.C. 300 (2017), "collected proceeds" requires an "administrative action" by the IRS, such as an assessment or a formal determination of tax noncompliance. The IRS contended that self-reported amounts on an original return or a Form 3115 (Application for Change in Method of Accounting) do not count as "collected proceeds," regardless of the taxpayer's motivation for making those self-assessments. The IRS emphasized that it must "detect tax noncompliance based on the whistleblower's information" for an award to be granted.

Applying the Lewis Doctrine

The IRS contended that self-reported amounts on an original return or a Form 3115 (Application for Change in Method of Accounting) do not count as "collected proceeds," regardless of the taxpayer's motivation for making those self-assessments. The IRS emphasized that it must "detect tax noncompliance based on the whistleblower's information" for an award to be granted.

Judge Halpern turned to Lewis v. Commissioner, 154 T.C. 124 (2020), and Whistleblower 16158-14W, 148 T.C. 300 (2017) to resolve the dispute. The Petitioner argued that Whistleblower 16158-14W was distinguishable. In Whistleblower 16158-14W, the court held that "collected proceeds" do not include self-reported amounts where a taxpayer changes its reporting after the IRS investigation concluded. The Petitioner here argued that Target changed from LIFO to FIFO "while the IRS' investigation was ongoing" because Target learned its inventory purchasing practices were under scrutiny. The Petitioner emphasized that Target submitted Form 3115 to apply for the accounting method change in March 2012, before the August 2012 conclusion of the 2008/2009 audit cycle examination.

The Tax Court disagreed, explaining that in Lewis, the court extended the holding in Whistleblower 16158-14W to exclude from collected proceeds self-reported tax paid with respect to a year to which an ongoing audit was extended. In Lewis, the whistleblower claimed the Whistleblower Office (WBO) abused its discretion in excluding reported, paid tax from collected proceeds when an ongoing audit was expanded to include the year of the reported, paid tax. The whistleblower in Lewis had provided information that his former employer was improperly deducting wages. Based on this, the IRS began an audit of the corporation’s 2010 tax year. The corporation, aware of the IRS's position on the wage issue, did not deduct those wages when it filed its 2011 return. The IRS expanded the audit to include 2011 and ultimately entered into a closing agreement for 2010 and 2011.

The Tax Court in Lewis articulated the question as whether the WBO abused its discretion in excluding from the collected proceeds used to determine the whistleblower's award the tax proceeds resulting from the corporation’s decision not to deduct the wages for 2011. The court in Lewis recognized that, in Whistleblower 16158-14W, it had held that collected proceeds do not include proceeds from a target’s change in reporting for a future tax year that was not under audit at the time of the whistleblower award determination. The whistleblower in Lewis sought to distinguish Whistleblower 16158-14W because the change in reporting was not a voluntary act. It was involuntary because the IRS was auditing the corporation’s 2010 return, and the corporation knew of the wage issue before it filed its 2011 return, changing its reporting.

The court in Lewis rejected the whistleblower's argument. It stated that while the whistleblower information likely contributed to the corporation's decision not to deduct the wages for 2011, "the same can be said about the target’s decision to change its reporting in Whistleblower 16158-14W." The court in Lewis held that "reported, paid tax is not collected proceeds" and saw "no need to narrow that holding in this case on the basis that an ongoing audit was expanded to include the year of the reported, paid tax.”

Judge Halpern explained that the core of the Lewis decision stems from Lewis v. Commissioner, 758 F.3d 822 (7th Cir. 2014), which established the "Lewis Doctrine." This doctrine provides that for a whistleblower award to be based on "collected proceeds," the IRS must "proceed with an action" that results in collection, not just a taxpayer fixing their own errors. Simply put, reported, paid tax is not collected proceeds. The statute requires an administrative action by the IRS resulting in collection.

Final Judgment: The High Bar for 'Proceeds'

Ultimately, the Tax Court granted summary judgment for the IRS. The court addressed the Petitioner's motions to supplement the record and determine the scope of discovery, but denied them as moot. It explained that even if Target pursued the LIFO scheme before the IRS investigated and switched to FIFO because of that investigation, resulting in Target paying more tax, the Petitioner still would not be entitled to an award.

The court reiterated its holding in Lewis v. Commissioner, 154 T.C. 124 (2020), that "reported, paid tax is not collected proceeds." It explained that the core of the Lewis decision stems from Lewis v. Commissioner, 758 F.3d 822 (7th Cir. 2014), which established the "Lewis Doctrine." This doctrine provides that for a whistleblower award to be based on "collected proceeds," the IRS must "proceed with an action" that results in collection, not just a taxpayer fixing their own errors. Simply put, reported, paid tax is not collected proceeds. The statute requires an administrative action by the IRS resulting in collection.

This ruling reinforces a high bar for whistleblowers seeking awards. It underscores that 'catalyzing' compliance is not enough to warrant an award under Section 7623(b)(1), which mandates awards of 15 to 30 percent of collected proceeds. The IRS must affirmatively detect the tax deficiency and then undertake administrative or judicial action that results in the collection of taxes, penalties, or interest. This decision serves as a reminder that a whistleblower's information, even if instrumental in prompting a taxpayer to correct its accounting methods and pay additional taxes, may not lead to an award if the IRS does not take its own enforcement action.