Deducting False Claims Act Damages

Dear Readers:

Among the nuggets contained in the recent Tax Bill passed by Congress is a provision that will have a tremendous impact on how damages in False Claims Act ("FCA") settlements must be characterized in the settlement documents if a defendant seeks to deduct any portion of its payment on its taxes.

As many of you have experienced, FCA settlements usually just list a settlement amount for the defendant to pay and normally do not attribute which portion constitutes damages and penalties. In fact, among the many provisions that the government insists on including in an FCA settlement, the government usually includes a provision stating that "nothing" in the FCA settlement "constitutes an agreement by the United States concerning the characterization of the Settlement Amount for purposes of the Internal Revenue laws, Title 26 of the United States Code." Stated simply, the government previously did not comment on whether the defendant could deduct any portion of an FCA settlement. To deduct the damages or restitution portion of an FCA settlement was something worked out between a defendant and its accountant.

As my colleague and friend Bob Warchola recently brought to my attention, the Tax Act changed the rules for deducting the damages portion of any FCA settlement by amending 26 U.S.C. § 162 which governs deductions of trade and business expenses.  

Previously, Section 162 of Title 26 prohibited the deduction "of any fine or similar penalty paid to a government for the violation of any law.” The Tax Act, however, expanded that prohibition, and it now generally prohibits "a taxpayer from deducting any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity in to the potential violation of any law."  With this general prohibition as a backdrop, Congress then carved out an exception for deducting restitution, so long as the taxpayer establishes that the amount at issue (1) "constitutes restitution . . . for damage or harm which was or may be caused by the violation of any law or the potential violation of any law, or . . . is paid to come into compliance with any law which was violated or otherwise involved in the investigation or inquiry . . . "; and (2) "is identified as restitution or as an amount paid to come into compliance with such law, as the case may be, in the court order or settlement agreement."(emphasis added). In addition, the revisions to Section 162 specifically prohibit a defendant from deducting "any amount [paid] as reimbursement to the government or entity for the costs of any investigation or litigation." Finally, the Tax Act imposed a requirement on the affected government agency to report to the IRS the settlement (or judgment) and to specify what portion of it is restitution or the costs to come into compliance with the law at issue in the settlement.

Latham & Watkins and Fried Frank have both done a helpful analysis of these changes arising from the Tax Bill which I commend to you as required reading if you are thinking about settling an FCA case.

A. Brian Albritton
April 29, 2018

Is there Hope for the IRS Whistleblower Program?

The IRS Whistleblower Program has been the subject of repeated criticism from several corners.  For example, in a Forbes article last March, "IRS Whistleblowers See Little Reward," Erika Kelton of the Phillips & Cohen firm, one of the leading relator firms, accused the IRS of "sitting on a mountain of whistleblower claims" and  asserted that the "real problem" in processing these claims is "the IRS itself and institutional resistance to whistleblowers within the IRS that is hobbling the whistelblwoer program and draining its enormous promise." In fact, Kelton quoted the former IRS Chief Counsel as saying, "The new whistleblower provisions Congress enacted a couple of years ago have the potential to be a real disaster for the tax system. I believe that it is unseemly in this country to encourage people to turn in their neighbors and employers to the IRS as contemplated by this particular program. The IRS didn’t ask for these rules; they were forced on it by the Congress."

Criticism of the IRS Whistleblower Program has not been limited to relators' counsel. As detailed in Whistleblower Protection Blog, Richard Renner discusses two recent reports prepared by the Treasury Inspector General for Tax Administration and the General Accounting Office that were critical of the IRS Whistleblower Program. See IG Report says IRS Whistleblower Office falls short and resists audit.

According to a recent article in Accounting Today, "IRS Plans to Fix Whistleblower Program," the IRS is responding to this criticism.  In a June 20th memo, the IRS Deputy Commissioner for Services and Enforcement pledged to work with "the Whistleblower Office and with internal and external stakeholders on a comprehensive review of operating guidelines and procedures . . . . . to improve the timeliness and quality of decisions as the Service evaluates and acts on whistleblower information."  Outlining proposed internal deadlines for reviewing whistleblower claims, the Commissioner stated: claims received by the Whistleblower Office "should be initially evaluated by the office within 90 days" and review by subject matter experts from the Operating divisions and Criminal Investigation "should be completed within 90 days of receipt."

The Accounting Today article, which I commend to readers, further discusses efforts by U.S. Senator Charles Grassley to pressure the IRS to improve the Whistleblower Program and highlights a recent Bloomberg article that was critical of the IRS Program as well, as it relates that "in the past five years, over 1,300 claims have been filed against nearly 10,000 companies and individuals, alleging tax underpayments of at least $2 million, but only three whistleblower awards have been paid so far under the new program." 

A. Brian Albritton
July 4, 2012

Does Receiving a Tax Benefit Make You a Grantee for False Claims Act Liability?

False Claims Act liability arises not simply for false claims presented to the federal government, but also false claims presented to "a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government's behalf or to advance a Government program or interest." 31 U.S.C. 3729(b)(2)(A)(i)-(ii).  So who is a "grantee" of government funds?  It can be an organization that has received some form of subsidy by the federal government.  But, does that mean that any so called false claim for payment presented to that organization which receives a federal benefit or subsidy gives rise to a false claim? The Third Circuit recently applied common sense when it refused to the extend the False Claims Act to every person or organization who enjoyed a federal tax benefit.

The Third Circuit Court of Appeals recently addressed whether a grantee can be an organization that enjoys tax benefits from the federal government, and it found that the False Claims Act simply did not stretch that far.  See U.S. ex rel Garg v. Covanta Holding Corporation et al., (3rd Cir. May 8, 2012).   In the Covanta case, the Court considered whether a state sponsored Utility Authority that issued tax exempt bonds qualified as a "grantee" under the False Claims Act ("FCA") because the tax exemption it enjoyed essentially functioned as a direct "financial subsidy" from federal government.   Faced with the Relator's argument that urged it to apply the FCA to "anyone who happens to receive money from the federal government," the Court balked, holding that the Utility Authority did not qualify as a grantee.

In Covanta, the Utility Authority had issued $280 million in tax exempt bonds to finance construction of a solid waste disposal facility, and it leased the facility to Covanta to control and operate the business and facility.  The Relator, the former executive director of the Utility Authority, alleged that Covanta failed to make two different types of payments that it owed to the Utility Authority and that it issued invoices to the Utility Authority containing false certifications.  The Relator argued that the Utility Authority qualified as a federal grantee under the FCA by "virtue of the fact that it receives a financial benefit from the deductibility of interest on the tax-exempt bonds it issued to finance the facility.  In other words, [the Relator] asserted that the federal government contributes tax revenue it otherwise would collect on interest paid to bondholders directly to the [Utility Authority]."

The Court found that the Covanta's alleged false claims and statements to the Utility Authority could not support a claim under the FCA. Citing cases that hold that tax exemptions are the functional equivalent of direct cash grants from the government, the Relator argued that the "grant of tax-exempt status to [Utility Authority's] bonds means the entity has more money in its proverbial pocket . . . than it would if it had to issue non-tax-exempt bonds at a regular rate" thereby making it a "federal grantee."   Acknowledging the Relator's point that tax exempt status may essentially qualify as a direct subsidy, the Third Circuit observed:

"In the tax realm alone, every taxpaying American receives some form of exemption or deduction, such as the home mortgage interest deduction, the charitable contributions deduction, or even simply the standard deduction.  Just like the tax-exempt bonds, the government's decision to grant these deductions is a matter of grace, and the money saved by these deductions goes straight to the bottom line of the American-taxpayer.  . . . . That does not mean, however, that every fraud against a government employee or taxpayer supports a claim under the FCA."

The False Claims Act, observed the Court, "only prohibits fraudulent claims that cause or would cause economic loss to government."  Covanta's alleged false claims, however, did not cause loss to the federal government but established only that the Utility Authority "had to pay money out of its general operating funds that it should not have had to pay."  The Court went on, "The fact that some unknown portion of those general operating funds might be tangentially attributable to a tax break from the federal government is irrelevant."

In contrast to this clear opinion by the Third Circuit, what is not clear is why the Court marked this opinion as "Not Precedential."

A. Brian Albritton
6/20/12