Tuesday, September 8, 2015

Whisteblower's Award Is Ordinary Income

The taxpayer and one of his former associates filed a qui tam action (i.e., whistleblower suit) against their former employer, a medical device company, alleging that the company was involved in a Medicaid fraud scheme. After reviewing the case, the government reached a settlement with the company, requiring it to pay over $75 million. The taxpayer and his former colleague received a portion of the recovery, with the taxpayer's share being nearly $7 million. On his tax return, the taxpayer reported the award as a capital gain. The IRS sent deficiency notices, explaining that the recoveries were ordinary income, not capital gain. The taxpayer challenged the deficiencies in Tax Court, which sided with the IRS. On appeal, the Seventh Circuit upheld the Tax Court's decision, concluding that a qui tam award isn't the result of a sale or exchange of a capital asset. Instead, it's a reward intended to compensate the whistleblower for his or her work in bringing the suit, which is effectively payment for services and, thus, ordinary income. Craig Patrick, 116 AFTR 2d 2015-XXX (CA 7).

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