A reward (maybe) for ratting on a tax cheat

Know any tax cheats? The IRS would like to hear from you. Don't call, however, if you're just piqued at your neighbor with the flashy new car, or your ex-spouse for flaunting her latest relationship, or your old company for laying you off. The IRS wants names, Social Security numbers, documentation, and financial data before it will take a serious look.

But if the information proves valuable enough, you might get a reward.

It's a decades-old program that keeps a low profile, "because it sometimes doesn't get very good publicity," Jeaneen Heiskell, a senior analyst at Informant's Claims for Rewards, says diplomatically. Once referred to as the "Reward for Rats" program by Sen. Harry Reid, who wanted to legislate it out of existence in the late 1990s, it has quietly ticked along, recovering millions in taxes with the help of tips. [Editor's note: The original version misidentified Sen. Reid.]

The program's reputation hasn't been helped, however, by informants with shaky information that turns into a wild goose chase. Mike Faber, a tax attorney at Heller Ehrman in San Francisco, recalls a nasty IRS audit of a client some years ago that started with an informant's anonymous letter. It charged that a company had engaged in a series of large transactions for which it should have paid tax, based on some esoteric accounting theory.

"We spent almost two years fighting this with the IRS," Mr. Faber says, and in the end the IRS walked away without collecting a penny. "But whoever wrote the letter got their pound of flesh," he says. "It cost the client a lot of money."

It's that type of informant-triggered abuse that led to the congressional hearings and IRS Restructuring and Reform Act of 1998, laying out a series of safeguards otherwise known as the "Ten Commandments."

But the informant program is only a skinny slice of a staggeringly large pie - the tax-gap pie, which now hovers around $300 billion. In 2003, the IRS used tips to recover $62 million in taxes, and the year before that $66 million. Even the largest haul in the last 10 years, in 2000, still amounted to only $266 million.

Some critics say the program would be more successful if the rewards were larger and more consistent.

"They're pitiful little things," says James Moorman, president of Taxpayers Against Fraud. "This is not serious money."

Recently revised guidelines for informant award payments have bumped the limit from $2 million up to $10 million. But in 2003, for example, the IRS paid out a total of only $4 million in rewards.

"Some people are under the impression that if you inform on somebody you automatically get 10 percent," Faber says. But that's not the case. Less than 8 percent of claims are allowed, according to the IRS, and of those the average award is 2.74 percent of the taxes recovered.

The IRS breaks down the rewards according to the value of the information. It's 15 percent of the amount recovered for information that was "a direct factor," 10 percent for information "that was of value," and 1 percent for information classified as "general."

The number of those who actually receive rewards is also small. Of the 4,765 people who applied for a reward in 2003, just 190 got a check.

Reasons for rejecting a claim range from "the information was of no value" to "the service already knew the information" to "the payment of the reward would be inappropriate," says Mr. Moorman.

Faber agrees that "if [the IRS] took some of the discretion out of [paying rewards], maybe they would have more people come forward."

The program isn't advertised, although tax practitioners and attorneys know about it, the IRS's Ms. Heiskell asserts. And "only 1 out of 10 people who gives us information actually wants a reward," she adds. For most informants, the motivation isn't money.

• For more information call the IRS hot line at 1-800-829-0433 or go to www.irs.gov/pub/irs-pdf/p733.pdf.