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The False Claims Act Tax Bar is a rule that says that the FCA does not apply when someone commits tax fraud. The False Claims Act lets the government recover for any false or fraudulent requests or demands for money. This also includes fraud to avoid paying money to the government. But due to the Tax Bar, the law does not apply to money owed to the IRS.
This means that the FCA does not apply to some common types of fraud. While the IRS whistleblower program does apply to tax fraud, it lacks features that make the False Claims Act so valuable. Thus, some states have amended their state false claims acts to eliminate the tax bar. These include New York, Illinois, and Rhode Island. They have had great success in using their laws to target state tax fraud.
Importantly, the California senate is currently trying to eliminate the Tax Bar in the California False Claims Act. We think that would give the state a powerful new tool to fight fraud.
The FCA is written broadly and reaches all types of fraud that might result in financial loss to the United States. It provides a remedy for anyone who “presents,” or causes a false claim to be presented. It also applies when anyone uses a false record or statement, or conspires to violate the False Claims Act. Finally, it prohibits so-called “reverse false claims” or lying to avoid paying paying money to the United States. 31 U.S.C. § 3729(a).
Critical to the law is the definition of “false claim.” Generally the term means any request or demand for funds from the United States or its contractors. 31 U.S.C. § 3729(b). But, a separate part of the law, called the Tax Bar, makes clear that the FCA “does not apply to claims, records, or statements made under” the tax code. 31 U.S.C. § 3729(d).
Congress added the FCA tax bar in 1986. Before those amendments, Courts held that the FCA did not apply to tax fraud for two reasons. First, because the tax code required consent of the IRS commissioner to file suit. Second, because tax fraud consists of lying to avoid paying money to the United States, it did not fit into the earlier definition of “claim.” That definition included only requests or demands for money from the U.S.
However, in 1986 Congress included “reverse” false claims in the FCA. This change could reverse prior case law and lead to qui tam suits for unpaid taxes. But, Congress made clear that it did not intend this law to apply to income tax cases.
Courts most certainly apply the bar when a whistleblower alleges fraud to reduce income taxes or increase tax refunds. For example, when an employee claims that her employer used illegal strategies to avoid paying taxes to the IRS. Hardin v. DuPont Scandinavia, 731 F.Supp. 1202, 1204 (S.D.N.Y.1990). Courts also apply the tax bar when a case involves paying employees under the table to avoid tax withholding and FICA. See Lesnick v. Eisenmann, SE, (N.D. Cal., 2018).
Some courts have gone further and said that even if the case does not involve avoiding the payment of taxes, it can fall under the Tax Bar. U.S. ex rel. Lissack v. Sakura Global Capital Markets, Inc., 377 F.3d 145 (2d Cir. 2004) In that case, the whistleblower alleged that banks used a complex “yield-burning” scheme to obtain extra interest from government bonds. The Second Circuit determined that the claim was barred for two reasons. First, because it entirely depended on violations of the tax code as to the bonds’ tax-exempt status. Second, because the IRS could recover the same amounts claimed in the suit.
Some courts, following this case, have barred actions if false statements to the IRS are central to the claim. For example, one court dismissed claims that payroll processing companies kept interest earned on tax withholding rather than paying it to the government. U.S. ex rel. Barber v. Paychex, Inc., (S.D. Fla. July 15, 2010).
However, the better reasoned cases conclude that the tax bar does not apply unless taxes are avoided even if the case involves false statements contained in tax documents. For example, one court held the tax bar does not apply to fraudulent attempts to obtain grants in lieu of tax credits authorized by a non-IRS program. U.S. ex rel Calilung v. Ormat Industries LTD (D. Nev., 2015).
Often courts explain use of the FCA tax bar by noting that IRS has its own whistleblower program. For example, the Calilung Court cited the IRS whistleblower program as a reason for the existence of the False Claims Act tax bar. U.S. ex rel Calilung v. Ormat Industries LTD (D. Nev., 2015).
That program is valuable. In 2018, the IRS Whistleblower Office collected $1.4 billion from tax scofflaws due to whistleblower tips. It rewarded whistleblowers with over $300 million in awards.
However, the IRS Whistleblower program lacks important features of the False Claims Act. Most critically, it is not a qui tam statute. This means that a whistleblower may not pursue a fraud on behalf of the government. In addition, the program has been criticized for failing to provide timely updates to whistleblowers. Thankfully, the IRS has made changes to the program that will strengthen it going forward.
States and cities lose hundreds of millions of dollars when corporations and people fail to pay state taxes. This includes state income tax, sales tax, and other taxes. Several states, including New York, Illinois, and Rhode Island, have eliminated the tax bar from their state false claims acts. This allows whistleblowers to file a tax-related state False Claims Act qui tam complaint. As with the FCA successful whistleblowers can receive a substantial award.
Notably, in 2018, the State of New York settled the largest state sales-tax case in history. The case, brought by a whistleblower, charged that Sprint Nextel failed to collect and remit over $100 million in sales-tax. Sprint settled with New York for $330 million. The whistleblower received over $62 million.
Other successful state FCA tax cases include:
The clear trend is for more states to eliminate their tax bar to enlist whistleblowers in the fight against tax fraud. For example, the California Assembly has a bill that would eliminate the tax bar in the California False Claims Act.
We think it is a great thing if more states follow New York’s lead and end their tax bar. As Illinois and New York’s success demonstrates, enlisting whistleblowers in the fight against tax fraud provides huge benefits to taxpayers.