Tax & Budgets
Tax Changes: Not in an Election Year
May 17, 2022 | Ryan Maness
May 18, 2022 | Mollie Jackowski
This year three states — New York, Michigan, and Connecticut — introduced legislation to expand the scope of False Claims Acts (FCA) to cover tax laws and tax fraud. This is largely unprecedented given that at the federal level, only the Internal Revenue Service (IRS) has the ability to investigate and enforce tax fraud against the government. While each bill impacts state tax laws differently, the inclusion of tax laws highlights an ongoing debate regarding whether FCAs should exclude tax actions.
The FCA imposes penalties on those who knowingly submit false claims to the federal government and allows private parties to bring actions against those that defraud the government, in other words, it allows third parties to report alleged misdeeds to the government, and may result in financial compensation. In technical terms, these private parties reporting alleged fraud are “whistleblowers,” and the reports they make are called “qui tam actions.” If the whistleblower’s action is successful, or if the government takes action based on the whistleblower’s information, the whistleblower may receive a portion of the government’s monetary award.
The federal FCA contains a “Tax Bar” excluding statements and claims made under the Internal Revenue Code. This gives the IRS sole enforcement power over tax laws. In other words, no other agency can investigate and enforce tax fraud against the government. Most states model their own state-level FCAs off of the federal FCA and exclude tax actions. That said, in recent years, several states have eliminated the Tax Bar to allow whistleblowers to report tax-related claims.
Proponents of the Tax Bar argue that its removal compromises tax agencies’ abilities to administer and enforce tax laws, allows for the disclosure of confidential taxpayer information, and creates opportunities for frivolous lawsuits. They also contend that it creates confusion and allows suits for instances that are not actual fraud. For example, corporations often take positions on unsettled law in an attempt to comply with tax laws, and they work together with tax agencies through audits, guidance letters, or other avenues to resolve disputes. State FCAs that allow tax actions could include these interpretations of unsettled law and other actions taken by corporations that tax agencies would typically resolve. Taxpayers can and have been sued under state FCAs for periods which have already been audited and closed by tax authorities, which proponents of the Tax Bar cite as fundamentally unfair, especially considering a successful action under an FCA typically results in the imposition of treble damages, which are three times the amount of actual damages.
Opponents of the Tax Bar argue that allowing tax actions to fall under state FCAs allows states to fight against tax fraud more effectively than tax agencies alone can, and they use successful cases with significant awards as examples. They also argue that including tax actions holds taxpayers more accountable.
There has been relatively little activity on FCAs in recent years, but in 2022 state lawmakers introduced three bills that highlight the diversity of thinking on this issue.
Lawmakers in New York have introduced a pair of companion bills (NY SB 8815/NY AB 9975) that would close an alleged “loophole” from the last amendment to the New York FCA. Specifically, the legislation would amend the intent standards for qui tam proceedings to include those who knowingly and improperly fail to file a tax return and provide for reasonable attorneys’ fees if a defendant prevails in an action that is clearly frivolous or vexatious. Notably, the language of these bills, except for the fee provision, copies two bills that passed during the last session and that the governor vetoed.
In introducing these bills, the sponsors hope that individuals will be held equally liable for knowingly filing false tax returns and knowingly failing to file tax returns. The Business Council of New York State opposes the bill and argues that the bill takes power away from the Department of Taxation’s ability to administer and interpret tax laws. It has concerns over the definition, or lack thereof, of the word “obligation” as it is used in the text. Finally, the Business Council worries that the expansion will create uncertainty and inconsistency. This session, the House bill advanced to a third reading, and the Senate bill is in committee. If the bills pass both chambers, it is unclear how Governor Kathy Hochul (D) would respond in light of last year’s veto.
Michigan’s bill (MI HB 6032) would establish the Michigan FCA. The Act applies to claims, records, or statements made under tax law if (1) the defendant has gross receipts of $1,000,000 and (2) the damages exceed $350,000. Before taking action for false claims, records, or statements made under the tax law, the Attorney general must consult with the state treasurer. Additionally, if the attorney general declines to participate in an action, a qui tam plaintiff must obtain approval from the attorney general before making a motion to compel the disclosure of tax records. The bill is currently in the Judiciary Committee, where it has been awaiting a hearing since April 14.
Connecticut’s bill (CT SB 426) would have significantly expanded the scope of the state’s FCA by removing language limiting the scope to a state-administered health or human services, allowing the state attorney general to pursue fraud in every state agency.
Some critics of the bill believe that it’s language singles out certain industries. Critics looking at the tax policy implications argue that the bill compromises the Department of Revenue Service’s ability to administer tax laws and allows for the disclosure of trade secrets and confidential information. However, Attorney General William Tong (D) strongly supports the bill and provided the Senate Judiciary Committee with testimony. He argued that the text provides a process for weeding out frivolous charges and that the text limits all of the potential actions of his office. Following his testimony, the bill received favorable reports from the Judiciary and Appropriations Committees but was not heard by the full Senate before the legislature adjourned on May 4 and has died.
It is unclear whether these states are outliers or if more states will introduce similar legislation, and the fate of the New York and Michigan bills is still unknown. Regardless, the expansion of FCAs to include tax actions is something to look for in the coming months and next session.
May 17, 2022 | Ryan Maness
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