Not only should companies worry about the Internal Revenue Service (IRS) auditing their returns, but they also have to be aware of a potential assault from within. Indeed, current and former employees have an incentive to air all of your tax issues with the hope of being rewarded for the information.

Section 7623(b) was added to the Internal Revenue Code (IRC) in 2005, and pays potentially large monetary rewards for so-called tax whistleblowers. To qualify for remuneration, a whistleblower must meet several conditions to qualify for the Section 7623(b) award program: (1) submit the confidential information under penalties of perjury to the IRS’s Whistleblower Office; (2) the information must relate to a tax issue for which the taxpayer (if the IRS found out) would be liable for tax, penalties and/or interest of more than $2 million; and (3) involve a taxpayer whose gross income exceeds $200,000 the tax year at issue. If the information substantially contributes to an administrative or judicial action that results in the collection, the IRS will pay an award of at least 15 percent, but not more than 30 percent of the collected proceeds resulting from the administrative or judicial action (including related actions).

Section 7623(b) has spawned a collection of law firms around the country dedicated to signing up scores of whistleblowers who are hoping to cash in big! Our clients routinely ask us how to best protect themselves. We typically tell our clients that the best defense is a good offense. Consider the following:

1. Use of non-disclosure agreements with employees who work on sensitive projects like mergers and acquisitions;
2. Limit employee access to the companies tax accrual workpapers and other documents that indicate the tax savings involved in a transaction or a position claimed on a return;
3. Review your procedures to ensure that privilege and confidentiality is maintained (this would include training employees and managers);
4. Review company’s internal procedures for employee complaints to ensure that you have robust procedures in place that offer an independent review and allow for anonymous submissions; and
5. Be vigilant, and look for signs that an employee is “disgruntled.”

Practice Point: If you are under examination by the IRS, you may be able to discern a whistleblower issue based on the questions being asked by the IRS and whether those questions could only be formed based on information provided by a whistleblower. If this situation exists, it is important to determine whether you should raise the issue with the IRS, particularly if you believe that any confidential and/or privileged information has been provided to the IRS without your consent. To make sure you are protected and adequately prepared, consult with your tax controversy lawyer.