Case — Taxability of Whistleblower Award

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TL Case Summ

THE QUESTION

Is an award received under the Federal False Claims Act taxable income?

THE DISPUTE

Taxpayer Says: The award is a recovery of money due to the US government. Since the recovery would not be taxable to the government, and he stands in the shoes of the government in filing the suit, the recovery is not taxable.

Internal Revenue Service Says: The award is taxable as a reward.

THE LAW

From Internal Revenue Code Section 61(a): Gross income is “all income from whatever source derived”.

From Roco v. Commissioner, 121 T.C. 160 (2003): Rewards are included in gross income pursuant to section 1.61-2(a), Income Tax Regs., and the qui tam payment received in this case was the equivalent of a reward and, therefore, includable in the taxpayer’s gross income.

From Vt. Agency of Natural Res. v. United States ex rel. Stevens, 529 U.S. 765 (2000): The Supreme Court considered whether a private individual has standing to bring a qui tam suit in Federal court against a State agency. On that issue, the Court held that the relator had standing because the FCA effected a partial assignment of the Government’s claim to the relator and, as the assignee of such a claim, a relator has standing to assert the injury in fact suffered by the Government. (Editorial note: A “relator” is the legal term for the private individual who brings the FCA lawsuit.)

THE CAUSE OF THE DISPUTE

Under the Federal False Claims Act (FCA), if you learn of fraud committed against the government, you can file suit on behalf of the government to recover the money. If your “qui tam” (a Latin phrase generally pronounced “key tam”) lawsuit is successful, you can receive a portion of the recovered damages, as well as costs and attorney fees.

Prior to the Roco case mentioned above, there was little or no guidance in the Internal Revenue code or regulations regarding the taxability of qui tam, or whistleblower, payments. Though the court decided the qui tam payment received in Roco was taxable, the theory that the payment represented a nontaxable share in the recovery of a reimbursement was not considered.

In this case, the taxpayer makes the argument an $8.75 million dollar recovery received from two lawsuits filed against Lockheed Martin is not taxable because the payment was part of a non-taxable reimbursement assigned to him by the government.

The IRS says the payment is a reward for exposing the fraud, and is taxable.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 32KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. Although the FCA effects a partial assignment of the claim for the purposes of [legal] standing, the assignment of the claim does not change the character of the proceeds to the taxpayer. The qui tam payment is the equivalent of a reward, and is taxable income.
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