Tax Court in Brief | Luu v. Comm’r | Whistleblower Awards, Procedure, and Tax Court Standard of Review

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The Tax Court in Brief – December 26th – December 30th, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation:  The Week of December 26th, 2022, through December 30th, 2022

Luu v. Comm’r, T.C. Memo. 2022-126| December 28, 2022 | Weiler, J. | Dkt. No. 714-20W

Short Summary: The story of this 22-page opinion regards a whistleblower’s (Felix Luu, referred to herein as Luu) contest of the Whistleblower Office’s (WBO) determination and calculation of a whistleblower award related to Luu’s family’s business operations, which included a retail supermarket and a poultry farm (the Companies).

Luu served as the general manager of the retail supermarket and was an equal shareholder with his six siblings in the Companies. WBO acknowledged receipt of Luu’s application for whistleblower award and Forms 211, Application for Award for Original Information. In a lawsuit filed in state court, Luu alleged causes of action against the Companies to compel the payment of a dividend, claiming that Luu had only recently learned that he had received a lesser dividend than other shareholders and that the other shareholders had been skimming profits from the Companies. The Companies’ six shareholders (excluding Luu) filed voluntary disclosures with the IRS. Luu submitted additional information regarding the shareholders’ unreported income. But, the IRS ultimately did not use the additional information in making its adjustments to the Companies’ unreported income.

The IRS then audited the Companies. The IRS interviewed the Companies’ officers, the six shareholders (excluding Luu) and their spouses. According to the investigation, cash funds were being skimmed from the Companies and distributed to all shareholders. And, it was apparently Luu who handled the cash distributions. The IRS proceeded with the assessment of additional federal income tax and employment taxes against the Companies and their shareholders. The assessments exceeded $2 million dollars and were directly related to the unreported income and payroll tax issues Luu identified.

The WBO sent Luu a preliminary award recommendation letter, including a summary report explaining the preliminary award recommendation of $368,289 and a proposed confidentiality agreement. In its evaluation of the recommended award, the WBO, in conjunction with an assigned IRS revenue agent, reflected that Luu took the first step that led to the examination that allowed the government to collect more than $2 million dollars in taxes, penalties and interest. The investigation also revealed that Luu likely was involved in or knew of the skimming scheme. Thereafter, Luu signed the response form and the confidentiality agreement and returned the forms to the WBO, indicating that he wanted to receive more detail on the explanation. So, the WBO furnished Luu a two-page memorandum entitled “Detailed Report,” which outlined the analysis used to determine Luu’s award percentage. The report included lists of positive and negative factors applicable to the award determination and Luu’s involvement with the Companies and timing of his report to the WBO. Ultimately, Luu disputed the WBO’s preliminary award recommendation. The WBO made a final determination, determining that Luu was entitled to an award percentage of 15% based on the taxes, penalties and other amounts collected by the IRS from the Companies and their shareholders. The determination report from the WBO to Luu included various details and supporting information (i.e., balance of the positive and negative factors) used to substantiate the determination.

Luu appealed the WBO’s determination to the Tax Court.

Key Issues: Whether the administrative record in the case showed, as a matter of law, that the WBO’s determination was not arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law?

Primary Holdings: The administrative claim file adequately reflected (1) how the WBO relied on evidence found in the administrative record in making its award determination; (2) how the WBO considered relevant positive and negative factors in making its award determination; (3) that the WBO followed proper administrative procedures and considered Luu’s arguments. The WBO’s determination was not arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; thus, the WBO’s determination was sustained.

Key Points of Law:

Whistleblower Awards. Section 7623(a) authorizes the IRS, under prescribed regulations, to pay discretionary whistleblower awards for detecting underpayments of tax or detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws. The amount payable is to be paid from the proceeds of the amounts collected. Id. Proceeds include tax, penalties, interest, additions to tax, and any proceeds arising from laws which the IRS is authorized to administer and enforce, including criminal fines and forfeitures. I.R.C. § 7623(c).

Whistleblower Procedure, Briefly. When the IRS proceeds with any administrative or judicial action using information furnished by the whistleblower, such an individual is entitled to receive an award of at least 15%, but not more than 30%, of the proceeds collected. I.R.C. § 7623(b)(1). The determination of the amount of such an award—as made by the WBO— depends on “the extent to which the individual substantially contributed to such action.” Id. However, if the WBO determines that the claim for an award is brought by an individual who planned and initiated the actions that led to the underpayment of tax, then the WBO may appropriately reduce the award; and if the individual is convicted of criminal conduct arising from the planned and initiated actions, the WBO is required to deny any award. See I.R.C. § 7623(b)(3).

Mandatory Awards. Section 7623(b) makes whistleblower awards mandatory if certain requirements are met. Some of the requirements are that the proceeds in dispute exceed $2 million and that for any targeted individual, his or her gross income exceed $200,000 for the taxable year subject to such action. I.R.C. § 7623(b)(5). Ultimately, however, the award amount is left to the IRS since the statutory authority provides for an award range of 15% to 30% dependent upon the level to which the whistleblower “substantially contributed” to the actions by the IRS. See I.R.C. § 7623(b).

Summary Judgment in Whistleblower Setting, briefly. The purpose of summary judgment is to expedite litigation and avoid unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). It is used to make rulings of law when there is no genuine dispute of material fact. Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C. 226, 238 (2002). Opposition to a motion for summary judgment must “set forth specific facts” (in contrast to “mere allegations or denials”) to raise a genuine issue of fact. However, in a “record rule” whistleblower case there is no trial on the merits. In a case involving review of final agency action under the Administrative Procedure Act, summary judgment serves as a mechanism for deciding, as a matter of law, whether the agency action is supported by the administrative record and is not arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law. Van Bemmelen v. Commissioner, 155 T.C. 64, 78–79 (2020). For this review, the Tax Court confines itself to ensuring that the determination remained within the bounds of reasoned decision making. Id. at 72. The scope of review in whistleblower cases is based on the administrative record with limited exceptions. Kasper v. Commissioner, 150 T.C. 8, 20-21 (2018).

Tax Court Jurisdiction Over Whistleblower Matters. Subsection (b)(4) of section 7623 gives the Tax Court exclusive jurisdiction to review “[a]ny determination regarding an award” under subsection (b)(1)–(3). See Li v. Commissioner, 22 F.4th 1014, 1017 (D.C. Cir. 2022). Section 7623(b)(4) does not grant the Tax Court jurisdiction over decisions by the IRS in its conduct of audits or collection activities. Cohen v. Commissioner, 139 T.C. 299, 302 (2012), aff’d, 550 F. App’x 10 (D.C. Cir. 2014).

Tax Court Review of WBO Award Determination. Under the administrative proceedings for award determinations, the WBO is to prepare a preliminary award recommendation to the whistleblower by sending (i) A preliminary award recommendation letter that describes the whistleblower’s options for responding to the preliminary award recommendation; (ii) A summary report that states a preliminary computation of the amount of collected proceeds, the recommended award percentage, the recommended award amount (even in cases when the application of section 7623(b)(2) or section 7623(b)(3) results in a reduction of the recommended award amount to zero), and a list of the factors that contributed to the recommended award percentage; (iii) An award consent form; and (iv) A confidentiality agreement. See I.R.C. § 7623(b)(4); Treas. Reg. § 301.7623-3(c)(2).

Whistleblower Response to WBO Preliminary Award Determination. The whistleblower has 30 days from the date the WBO sends the preliminary award recommendation letter to respond in one of four ways prescribed by Treas. Reg. § 301.7623-3(c)(3).

Opportunity to Inspect Administrative Claim File. The whistleblower has the opportunity to review information from the administrative claim file (not protected from disclosure by one or more common law or statutory privileges) supporting the award report recommendation at the WBO’s office in Washington, D.C. Treas. Reg. § 301.7623-3(c)(5). After participation in the whistleblower administrative proceeding has concluded and there is a final determination of tax (as defined in Treasury Regulation § 301.7623-4(d)(2)), the WBO will determine the amount of the award under section 7623(b)(1), (2), or (3), and Treasury Regulation §§ 301.7623-1 through 301.7623-4, on the basis of the WBO’s review of the administrative claim file. Treas. Reg. § 301.7623-3(c)(6).

Determining Appropriate Award Percentage. The WBO is to analyze an individual’s claim by applying the rules provided in Treasury Regulation § 301.7623-4(c) to the information in the administrative claim file to determine an appropriate award percentage. Id. at § 301.7623-4(a)(1). The WBO is required to consider all relevant factors in determining whether an award will be paid, and if so, the amount of the award. Id. at § 301.7623-4(a)(2); see Treas. Reg. § 301.7623-4(b)(1)-(2), (c)(1)(i)-(ii) (factors to consider and process for review and calculation). The WBO may decrease the award percentage on the basis of the presence and significance of any negative factors.

Insights: The Luu opinion provides a good statutory and regulatory roadmap for any taxpayer or tax practitioner involved in a whistleblower matter under section 7623(a) of the Internal Revenue Code. The opinion illustrates how the administrative record is critical to the Tax Court’s review of the WBO’s determination of whistleblower award percentage. The Tax Court will evaluate (1) whether the record in the administrative claim file reflects how the WBO relied on evidence found in the administrative record in making its award determination; (2) whether the record reflects how the WBO considered relevant positive and negative factors in making its award determination; (3) whether the record reflects that the WBO followed proper administrative procedures and considered the whistleblower’s arguments. If, in its review, the Tax Court finds that the WBO’s determination was not arbitrary, capricious, an abuse of discretion, or otherwise not in violation of law, the Tax Court will likely sustain the determination.