The use of False Claims Act (FCA) statutes with qui tam provisions as a basis to challenge a taxpayer’s tax return filing position continues to be a disturbing trend in state and local taxation. Such statutes permit private individuals (i.e., ‘whistleblowers’) to sue taxpayers on behalf of the government by alleging that the taxpayer ‘knowingly’ failed to comply with a state or local tax obligation.

When a whistleblower files an FCA lawsuit, it is done ‘under seal’, which means it is not publicly disclosed. This gives the state’s attorney general time to issue subpoenas for testimony and records, investigate the claim, and decide whether the state wishes to prosecute the case itself. If the attorney general declines to prosecute the case personally, the attorney general may still permit the whistleblower to proceed with the lawsuit.

In addition to other penalties, taxpayers found liable under an FCA statute may be penalised for damages of up to three times the taxes that are allegedly owed, along with fines for specific violations. Most FCA statutes contain an expansive statute of limitations (frequently up to 10 years) that allows the whistleblower or state to pursue damages even if the time period for the state to conduct an audit has expired. Moreover, FCA statutes provide a financial incentive for whistleblowers to come forward by rewarding them with a portion of the damages recovered, along with attorneys’ fees and expenses.

Supporters of FCA statutes claim they are a vital tool to the government in identifying and prosecuting ‘fraud’. FCA statutes are not, however, limited to fraud. While such statutes require proof that the defendant ‘knowingly’ made a false tax claim, the term ‘knowingly’ is often broadly defined to include acts involving a ‘deliberate ignorance’ or ‘reckless disregard’ of the truth or falsity of information. In other words, taxpayers may be found liable even if their allegedly incorrect tax return position was not the result of an actual intent to defraud the government. This frequently leads to FCA actions being used against taxpayers who have taken reasonable positions regarding ambiguous areas of the tax law.

Oct-Dec 2014 issue

Reed Smith LLP