The Basics

IRS pays informants to squeal on tax cheats

While it may seem Orwellian, thousands of people each year take advantage of the IRS program. Here's how it works.

By Jeff Schnepper

http://moneycentral.msn.com/articles/tax/basics/5399.asp

"He's dead meat if he doesn't pay me. I won't sue him . . . I'll destroy him with one phone call!"

Don't make Dave Cohen angry.

Dave is a New Jersey tax attorney. His clients pay their bills or they suffer the hell of an IRS civil and criminal investigation. What Dave does is clearly unethical (that's why we can't use his real name), but he can't be caught. Dave is a snitch for the IRS.

Dave had a client who was a restaurant owner. He gave Dave a $1,000 cash deposit, but refused to pay the balance of his bill. The restaurant owner was pocketing lots of cash income that never made it to his tax return -- a clear civil and criminal violation. As an attorney, Dave couldn't publicly violate attorney-client privilege, so he had a friend call the IRS with enough information to start an investigation.

Swarms of agents descend

Tips are important to the IRS. Annually, it collects more than $100 million and pays out from $2 million to $5 million to snitches. If you've ever heard the horror stories about the invasiveness of a normal IRS audit, they pale in comparison to a criminal investigation.

In the case of the not-so-innocent restaurant owner, swarms of agents descended upon and paralyzed his business. For the next nine months, the owner endured the torture of Treasury agents peeling away every layer of his financial life, resulting in multiple thousands of dollars in taxes, fines, penalties and interest.

He avoided jail only by hiring another attorney to negotiate a settlement with the IRS. The non-paying owner ended up spending more money on legal fees than on the tax he should have paid originally.

Dave's friend even received a substantial reward for the information. And, of course, Dave's legal bill was finally paid.

Motive isn't profit but revenge

While the Internal Revenue Service doesn't publicly encourage tax informers, its representatives admit that many investigations couldn't be successfully conducted, or even started, without the use of paid informants or the direct purchase of evidence.

Most informants are former employees of a business that has been underreporting its income. A disgruntled employee who doesn't inform on the business itself may squeal on its owner or a disliked manager.

But a neighbor who objects to your loud stereo at midnight or becomes jealous of your new car each year may just as quickly turn informer. The emotional whirlpool of divorce is another great breeding ground for IRS informants, so be kind to your former spouse.

Anyone who provides information that leads to the detection and punishment of any violation of the tax laws may be eligible for a reward (except for federal workers who get the information in pursuit of their duties). However, don't think this is the path to riches. Since 1960, only about 8% of filed claims have resulted in rewards.

How to claim a reward

IRS Publication 733 details the regulations for claiming a reward. You must complete Form 211, Application for a Reward for Original Information, which can be requested from the IRS by calling (800) TAX-FORM. Neither document is available on the IRS Web site. Your information can be delivered personally to any IRS office, or in writing to:

Head of the Criminal Investigation Division
Internal Revenue Service
Washington, DC 20224

If a recovery is made as a direct result of information you provided, you may qualify for a reward of 15% of the amount recovered including taxes, fines and penalties, but not interest -- with a maximum payment of $2 million.

If your information was valuable, although not specific, in determining liability, you may be rewarded with as much as 10% of the amount recovered, again with a $2 million cap.

If your information was the originating cause of the investigation, but had no direct relationship to the determination of tax liability, the reward is 1% of the amount recovered, again with that $2 million limit.

Using an assumed name

If you're not claiming a reward for the information, you can use an assumed name. But if you want to claim a reward, you must use your own name. The IRS is legally prohibited from disclosing the identity of an informer to unauthorized persons.

The IRS heard from 9,530 informants and paid out 650 rewards totaling $3.5 million in the fiscal year ending Sept. 30, 1996, the most recent year for which statistics were available. In that year, the IRS collected an extra $102.7 million in taxes, fines and penalties because of the informants.

No matter what you tell the IRS, and no matter how much they collect, all rewards are discretionary, not mandatory. The IRS is never obligated to pay a reward, unless you negotiate a signed contract in advance of providing the information. Moreover, all rewards are taxable income.

Reasons why a reward might not be paid include:

• The information was of no value, or
  
• The information was already known by the IRS, or
• The information was available in public records.

Rewards are paid only after the tax is recovered, and that can take as long as five years or more. The informant isn't kept posted as to the progress of the investigation, but can check to see if the claim for a reward is still under active IRS consideration.

The idea of informing on neighbors, colleagues or business associates is distasteful to most people; it's Orwellian. Yet, it's the honest taxpayer who winds up paying for tax fraud, and it's not just nickels and dimes. The IRS estimates that the gap between taxes owed and taxes paid is $127 billion. That's $1,000 extra in taxes for every individual return filed last year.

And by the way, I always pay "Dave."