Qui tam award held taxable
The Eleventh Circuit Court of Appeals affirmed a Tax Court determination that a qui tam whistleblower award to a taxpayer under the federal False Claims Act (FCA) was taxable.
Under the FCA, a person may bring a civil action, in which the U.S. government may intervene, against a party that defrauds the government. The FCA also provides for a qui tam award to the plaintiff of between 15% and 25% of the proceeds of an action in which the government intervenes (25% to 30% if the government does not intervene) (31 U.S.C. §3730(d)).
The taxpayer, Albert Campbell, filed a civil action under the FCA against Lockheed Martin, his former employer. From a settlement of the suit, the taxpayer received an award of $8.75 million, which was wired to his attorneys. They deducted their fees of $3.5 million, sending the balance of $5.25 million to Campbell.
Campbell self-prepared his 2003 federal income tax return, omitting the $3.5 million in attorneys’ fees. He listed the $5.25 million as other income on line 21 but did not include it in taxable income on line 40. He attached Form 8275, Disclosure Statement, and wrote on it, without citing any particular case, that the Court of Appeals for the Eleventh Circuit had held that attorneys’ fees were not taxable income.
In addition to including the entire qui tam award in taxable income, the IRS assessed an accuracy-related penalty under Sec. 6662 of $608,800.
In the Tax Court, the taxpayer contended the entire qui tam payment was nontaxable, as it represented a nontaxable portion of the government’s settlement. The taxpayer argued that, because Lockheed Martin paid the full amount of the settlement to the government, he was an assignee of the government. Because the settlement would not be taxable to the government as a reimbursement, it was not taxable to a whistleblower as the government’s assignee.
The taxpayer relied on Vermont Agency of Natural Res., 529 U.S. 765 (2000), and a footnote in Roco, 121 T.C. 160 (2003), in which the Tax Court had reserved judgment on whether a qui tam award was a nontaxable share of a recovered reimbursement. However, the Tax Court noted that its central holding in Roco had been that qui tam payments were similar to rewards, which are included in gross income. Campbell also argued that Vermont Agency supported his position that the award was nontaxable because he was the government’s assignee, but the Tax Court said this was a misreading of the case.
The Tax Court allowed Campbell to deduct the $3.5 million in fees as a miscellaneous itemized deduction and, although it upheld the accuracy-related penalty, the court reduced it with respect to the attorneys’ fees because he adequately disclosed them on Form 8275.
The taxpayer appealed to the Eleventh Circuit. The issue of whether qui tam payments are includible in gross income was one of first impression for the Eleventh Circuit. The other circuits that have addressed the issue have agreed qui tam payments are includible in gross income. In this case, the Eleventh Circuit agreed with the Tax Court that the award was in the nature of a reward and the net amount of the qui tam award of $5.25 million was includible in the taxpayer’s gross income. The Eleventh Circuit also upheld the accuracy-related penalty as redetermined by the Tax Court.
Prepared by Gary Rider, J.D., clinical assistant professor of business law, and Darlene Pulliam, CPA, Ph.D., Regents Professor and McCray Professor of Business, both of the College of Business, West Texas A&M University, Canyon, Texas.
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