Commentary

Rat out Your Employer on Taxes. Win Cash Rewards!

A former employee has filed a lawsuit charging that Vanguard Group, the gigantic ($2 trillion under management) and very successful mutual fund company, provides services to the funds it manages at “artificially low,” “at-cost” prices, which may be beneficial to investors in those funds but (the suit argues) results in lowering the federal and state income taxes it pays.

New York’s False Claims Act, under which the employee is suing, entitles him to a generous share of any tax proceeds as well as attorneys’ fees if successful.

The Philadelphia Inquirer and Wall Street Journal have more; the complaint is here courtesy of TaxProf. The company denies wrongdoing, and the general question of transfer pricing on which the claim hinges is very well aired in the tax and accounting literature, which makes it seem unlikely that auditors would have neglected the issue.

If it sounds like you’re hearing about more cases where discontented employees are turning in their bosses on tax charges for a share of the bounty, you’re right. Bradley Birkenfeld got a $104 million check for informing on his employer, Union Bank of Switzerland, on charges of helping Americans conceal overseas accounts; the prize was presented when he got out of jail, since he had been part of the scheme. Will the spread of a culture of informants sow distrust and disloyalty in the workplace, while encouraging dissident executives and their lawyers to shake settlements out of risk- and publicity-averse targets by seizing on doubtful, gray-area legal theories? That’s part of the game too. Lately hedge funds and litigation finance firms have moved in to bankroll the filing of likely “whistleblower” cases.

It’s worth noting that the action against Vanguard, like most of the new wave of litigation, does not rest on the IRS’s own tipster program. Instead, clever lawyers are turning to pro-plaintiff state versions of the federal False Claims Act, charter for bounty-hunting litigators. As the Vanguard complainant’s attorney explained to the Philadelphia paper, he filed in New York because it’s “the only jurisdiction that allows False Claims Act complaints to be filed for unpaid federal taxes”; it also allows the litigant to collect a share of the unpaid taxes. (Both Vanguard and the complaining employee are based in Philadelphia.) The Attorney General of New York, incidentally, had a choice whether to prosecute Vanguard himself but decided not to.

If it sounds like you’re hearing about more cases where discontented employees are turning in their bosses on tax charges for a share of the bounty, you’re right.”

So by getting pro-plaintiff laws through the legislature in just a few states—New York liberalized its law four years ago—advocates can set the stage for a nationwide informant push.

In Illinois, a single Chicago lawyer was reported in 2012 to have used that state’s whistleblower law to file at least 238 lawsuits against retailers, pocketing millions in settlements, over alleged failure to charge sales tax on shipping-and-handling. The state’s revenue director, to quote Greg Hinz of Crain’s Chicago Business, said the episode “ ‘has given Illinois a black eye’ and victimizes those who have made only an ‘inadvertent mistake.’”

Inevitably, efforts are mounting in Washington, D.C. to build direct litigation rights and bigger bounties into the IRS’s own tipster program, which is said to be languishing and thus inadequate by comparison with the hot action in the states. If you think the situation is ominous now, watch out then:

“Anyone with a political ax to grind could use the full force of the IRS” to settle scores, said Matt Webb, senior vice president at the U.S. Chamber of Commerce Institute for Legal Reform. “It’s a horrible, horrible idea.”
Walter Olson is a senior fellow at the Cato Institute’s Center for Constitutional Studies.