Tax Court Rules Whistleblower Reward is Ordinary Income

Despite arguments from whistleblowers to the contrary, the government continues to demand whistleblowers pay taxes on money awarded under the False Claims Act as ordinary income.

On Monday, the United States Tax Court held in Patrick v. Commissioner, 142 T.C. No. 5 (2014) that a qui tam award does not qualify as capital gains. If the petitioner had been successful, tax liability would have been reduced from the ordinary income tax rate to the lower capital gains rate. The decision reaffirms an earlier opinion on the same issue. See Alderson v. United States, 686 F.3d 791 (9th Cir. 2012).

The Internal Revenue Code treats rewards as ordinary income similar to wages and salaries for the purpose of calculating tax liability. Treas. Reg. §1.61-2(a)(1). An award from a qui tam lawsuit is considered a reward included within gross income. Roco v. Commissioner, 121 T.C. 160, 164 (2003).

Petitioner argued a qui tam award is instead a “gain from the sale or exchange of a capital asset”. 26 U.S.C. § 1222(1), (3). The Tax Court analyzed both whether a “sale or exchange” occurred and whether it is a “capital asset.” It rejected both contentions.

The Tax Court disagreed with the argument that the government purchases information from the relator according to a contractual right established in the False Claims Act. The Petitioner analogized to the transfer of a trade secret which is considered a capital gain. However, the court rejected the notion there is a transfer of rights to the Government.

The Tax Court also declined to find the petitioner had a property right which would constitute a capital asset. Petitioner advanced the contention that relators have a property interest in the information they disclose to the Government. In rejecting the argument, the Court declined to consider the information the property of the relator because they did not demonstrate “a legal right to exclude others from use and enjoyment” of it.

The ruling reinforces the importance of seeking the advice of a qualified accountant or tax lawyer after receiving an award under whistleblower laws.

McEldrew Young helps whistleblowers report fraud and misconduct to the government through the SEC, CFTC and IRS whistleblower programs as well as the False Claims Act. If you would like to speak to Eric L. Young or another attorney at McEldrew Young about becoming a whistleblower, please call 1-800-590-4116 or complete our contact form.

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