Whistleblowers play an important role in exposing fraud and misconduct in government and corporate settings. However, the tax implications of whistleblower rewards can be confusing. This article will examine whether money received from whistleblowing is considered taxable income.
What is a whistleblower?
A whistleblower is an employee, former employee, or member of an organization who reports misconduct occurring within that organization. Some common examples of whistleblowing include:
- Reporting fraud or falsification of financial records
- Exposing safety or health violations
- Revealing breaches of consumer privacy
- Disclosing violations of securities laws
Whistleblowers may report misconduct internally to people within their organization or externally to regulators or law enforcement. Whistleblowers take significant personal and professional risks when speaking out against their employers. However, many whistleblower laws offer protections against retaliation.
What types of whistleblower rewards are available?
U.S. federal and state governments, as well as some companies, offer financial incentives or rewards to whistleblowers. Some major whistleblower reward programs include:
- IRS whistleblower rewards – The IRS offers rewards to people who blow the whistle on tax fraud. Rewards can range from 15% to 30% of the total amount collected if the taxes, fines, and penalties exceed $2 million.
- SEC whistleblower program – The Securities and Exchange Commission (SEC) offers rewards between 10% and 30% of monetary sanctions collected to whistleblowers who provide original information about securities law violations. Awards have ranged from $50,000 to over $50 million.
- False Claims Act – The False Claims Act allows whistleblowers who report fraud against the U.S. government to collect between 15% to 30% of the amount recovered. Many successful whistleblowers have received multimillion-dollar awards.
- State false claims acts – Many states have enacted their own false claims acts that include qui tam provisions allowing whistleblower rewards for reporting fraud in state programs. For example, California has awarded millions of dollars to Medicaid fraud whistleblowers.
- CFPB whistleblower program – Whistleblowers disclosing violations of consumer financial protection laws may be eligible for awards via the Consumer Financial Protection Bureau’s program.
- Corporate whistleblower programs – Some corporations, like General Electric, have set up internal whistleblower programs that provide financial incentives for reporting legal or compliance issues.
In addition to financial rewards, whistleblowing can lead to reformed business practices, safer workplaces, and changes that benefit society. However, one downside to whistleblowing rewards is the complicated tax situation.
Are whistleblower rewards taxable?
The short answer is yes, whistleblower rewards are considered taxable income by the IRS and state tax authorities. This means you are required to pay income taxes on any whistleblower money you receive.
According to the IRS, any funds you receive for providing information, even if designated as an “award,” are includable in your gross income. The taxability applies whether you receive money from the IRS, SEC, Department of Justice, federal or state False Claims Act programs, or a company’s internal whistleblower program.
IRS whistleblower rewards
All rewards received from the IRS Whistleblower Office are considered “gross income” under the U.S. tax code (Internal Revenue Code Section 61) and therefore must be reported as taxable income. The IRS will not automatically withhold taxes from whistleblower payments. You are responsible for paying estimated taxes and calculating any additional taxes owed when you file your tax return for the year you received the award.
SEC whistleblower awards
According to information provided by the SEC, whistleblower awards issued by their program are subject to U.S. federal income tax. The SEC will withhold applicable taxes before issuing payment. If additional taxes are owed beyond the withheld amount, you must report the additional income and pay any additional taxes due.
False Claims Act whistleblower rewards
Proceeds from qui tam cases under the False Claims Act are considered gross income for federal tax purposes. The Department of Justice does not automatically withhold taxes from False Claims Act awards. Whistleblowers must pay taxes on these rewards as part of their gross income for the year the award was issued.
Tax considerations for whistleblower rewards
When you receive a financial reward for whistleblowing, you should be prepared for the tax implications, including:
- Paying income taxes on the reward at your top marginal tax rate
- Making quarterly estimated tax payments on the reward income
- Increasing taxable income may impact eligibility for certain tax credits
- Considering any applicable state income tax liability
- Documenting whistleblower income and taxes paid in case of future audit
Work closely with a tax professional to ensure you comply with all IRS requirements and avoid interest and penalties on whistleblower rewards.
Claiming legal fees as deductions
Many whistleblowers incur substantial legal, investigative, and other professional fees over the course of assisting with a government investigation and claim. Upfront costs are often needed to put together evidence and work with attorneys on filing a whistleblower complaint.
The good news is these fees may be tax deductible. You can generally deduct legal fees, court costs, and other ordinary and necessary professional expenses paid to prosecute a whistleblower award claim as miscellaneous itemized deductions. However, deductibility of these expenses can get complicated in certain situations, so consult a tax advisor about your specific circumstances.
Using whistleblower proceeds to pay taxes
A common question whistleblowers have is whether they can or should use a portion of their monetary award to pay the taxes owed on the reward income. This is permissible – you can use reward money to pay income taxes on the reward itself. Just be sure to properly report the full amount of the reward on your tax return before subtracting out any amounts used for tax payments.
Whistleblower rewards are taxable – What this means for you
Before blowing the whistle and proceeding with an official complaint, it is important to think through the tax implications. Here are some steps whistleblowers should take:
- Realize rewards will be taxed at your top income tax rate – Federal rewards are subject to a top 37% tax rate. State and local taxes may apply too.
- Calculate estimated taxes – Consider making quarterly estimated payments to stay ahead of your tax liability.
- Anticipate tax impact on credits – Additional income from a reward could affect certain tax credit eligibility.
- Keep detailed records – Maintain documentation to prove your reward income and related deductions.
- Work with a tax pro – Consulting a CPA or tax attorney can help you minimize taxes owed.
Although whistleblower rewards spur people to speak out against misconduct, the downside is the complexity added to your taxes. With proper planning and guidance from tax professionals, you can reduce stress come tax time. Just make sure to set aside a portion of the award to pay the taxes you’ll owe on this taxable income.
Table summarizing key whistleblower programs and tax treatment
| Program | Tax treatment |
|---|---|
| IRS whistleblower rewards | Considered taxable income |
| SEC whistleblower awards | Subject to federal income tax |
| False Claims Act rewards | Taxed as gross income |
| State false claims acts | Taxable income |
| CFPB whistleblower awards | Taxable income |
| Corporate whistleblower programs | Taxable income |
Conclusion
In conclusion, whistleblowers provide a valuable public service by reporting misconduct, often at great personal risk. The financial rewards offered by some government and corporate whistleblower programs provide incentives and help offset risks. However, these rewards are considered fully taxable income. When claiming awards, whistleblowers should budget for income taxes and work with tax professionals to ensure compliance and optimal filing.
