Whistleblower case is not stayed by taxpayer’s bankruptcy case

The Tax Court held that a bankruptcy filing does not preclude the court from determining if a taxpayer is entitled to a whistleblower award.

Facts: John F. Carter filed a whistleblower claim with the IRS against a target taxpayer in May 2015 for a transaction he and the target engaged in together during 2012. Carter claimed in his whistleblower action that the target reported the transaction incorrectly. The IRS Whistleblower Office (WBO) referred the case to an operating division as part of an ongoing audit of the target involving other tax years. In January 2022, the WBO denied the whistleblower award, stating that the information Carter provided did not result in the collection of any proceeds and no assessment resulted regarding any issues he raised.

Carter filed a petition with the Tax Court in February 2022 for review of the award denial. Subsequently, in May 2023, he filed for bankruptcy. The IRS filed a proof of claim in the bankruptcy case.

The Tax Court then ordered the parties to address if the automatic stay under Bankruptcy Code Section 362(a)(8) applied. The IRS opposed a stay.

Carter argued that an automatic stay applied, claiming that the whistleblower action concerned his tax liability since the whistleblower claim and his tax liability arose from the same transaction and “involve[d] the same operative facts.” Carter further contended that the potential setoff of his whistleblower award against his tax liability meant that the case ultimately concerned his tax liability.

Issues: A taxpayer’s bankruptcy filing generally triggers an automatic stay of any Tax Court proceedings “concerning a taxpayer’s tax liability” (Kovitch, 128 T.C. 108 (2007)). Tax Court proceedings are stayed under the Bankruptcy Code if they are “concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief” (31 U.S.C. §362(a)(8)). The Tax Court has jurisdiction to determine whether the case is automatically stayed under Bankruptcy Code Section 362(a)(8).

A previous version of Bankruptcy Code Section 362(a)(8) stayed a proceeding if it “[concerned] the debtor,” which the court “narrowly interpreted” to mean that the stay would not apply unless it affected the “tax liability of the debtor in bankruptcy” (Kovitch, 128 T.C. at 112).

In Kovitch, the Tax Court found that in an innocent-spouse case, the bankruptcy of the “non-requesting, intervenor-spouse does not result in an automatic stay.” The court has also held that the bankruptcy of a member of a limited liability company (LLC) did not stay the LLC’s Tax Court proceedings (People Place Auto Hand Carwash, LLC, 126 T.C. 359 (2006)). Similarly, a partnership’s bankruptcy did not stay the partnership’s Tax Court case since partnerships bear no tax liability (1983 Western Reserve Oil & Gas Co., 95 T.C. 51 (1990)). Congress amended Section 362(a)(8) of the Bankruptcy Code, removing “the debtor” and replacing it with “concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief” (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, P.L. 109-8).

The Tax Court stated that the amendment to Section 362(a)(8) did not change its interpretation of the statute. The court saw it more as a clarification that an automatic stay applies only if “the case before us concerns the tax liability of the debtor-taxpayer,” and that both the prior and amended version of Section 362(a)(8) focus on the tax liability of the debtor.

The court reasoned that its decision in whistleblower cases did not affect the taxpayer’s tax liability even if the claim involves the “same transaction and facts as [their] tax liability.” The court has jurisdiction to review whistleblower awards. However, the court does not have the jurisdiction to review or determine a target’s tax liability, nor does the court review why the IRS did not proceed with its administrative action, including its decision not to audit the target (Cooper, 136 T.C. 597 (2011)). The court instead reviews the WBO’s determination to deny a claim due to abuse of discretion, making sure not to substitute its judgment with that of the WBO (Kasper, 150 T.C. 8 (2018)). Based on its jurisdiction, the Tax Court concluded that its decision in Carter’s whistleblower case did not involve “any factual findings about the target and [Carter’s] transaction or its proper tax treatment.”

The court also held that Carter’s contention that the potential for setoff made an automatic stay appropriate was misguided. Section 362(a)(7) of the Bankruptcy Code imposes an automatic stay on a creditor’s setoff rights. Therefore, the Bankruptcy Code stayed the IRS’s right to offset Carter’s whistleblower award against his tax liability, which is separate from the stay applicable to Tax Court cases concerning the debtor’s tax liability. For the IRS to exercise a right to set off a whistleblower award against any unpaid tax liability, the IRS must obtain relief from stay from the bankruptcy court (In re Dominguez, 67 B.R. 526 (Bankr. N.D. Ohio 1986)). Thus, there was no need for the bankruptcy filing to prevent the Tax Court from determining whether Carter was entitled to a whistleblower award.

Holding: A taxpayer’s bankruptcy filing does not automatically stay a whistleblower case filed by the taxpayer, the Tax Court held.

■ Carter, 163 T.C. No. 6 (2024)

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business, and Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy, both at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor.