July 18 (Reuters) - The monetary reward a whistleblower
receives for exposing fraud on behalf of the government should
be taxed as ordinary income, not at the lower rate for capital
gains, a federal appeals court ruled on Wednesday.
Considering the issue for the first time, the U.S. Court of Appeals for the 9th Circuit concluded that the $27 million
bounty that whistleblower James Alderson reaped from a
government settlement with HCA Healthcare was properly treated
as regular income rather than profit from the sale of an asset.
The case dates to 1990, when Alderson was working as chief
financial officer for a Montana hospital. Upon being asked to
prepare two sets of books, one for auditors and one for Medicare
cost reports, Alderson refused and lost his job.
While suing his employer for wrongful termination, Alderson
uncovered evidence of widespread accounting fraud that he later
used to file a qui tam suit under the False Claims Act against
hospital operator HCA Healthcare and affiliated companies.
After intervening in the case, the government settled with
HCA in 2003 for $631 million, $27 million of which went to
Alderson as a reward for initiating the case and providing
crucial evidence. Alderson shared the reward with his two
children and his wife, all of whom reported the money as income
on their 2003 tax returns.
But four years later Alderson and his relatives tried to
amend their tax returns for 2003, reporting the money as capital
gains instead of ordinary income, to reclaim a total of $5
million in tax refunds. The IRS denied their request, prompting
Alderson and his family members to sue.
Federal tax law defines capital gains as money made on a
sale or exchange of an asset. Lawyers for Alderson argued that
he had exchanged documents and inside information for the cash
reward. But a unanimous three-judge panel of the 9th Circuit
disagreed, affirming the lower court's decision.
"If Alderson had offered simply to sell or exchange the
information to the government in return for a sum of money, the
government would almost certainly have refused the offer," Judge
William Fletcher wrote for the panel.
As an alternative, Alderson tried to claim that the
information he provided to the government was a capital asset
that increased in value as the case progressed, and the $27
million payout was a capital gain. But the panel remained
unconvinced, noting that the information was not Alderson's
exclusive property but known by other officials at the company.
Robert Wood, a lawyer for Alderson, said he was disappointed
with the ruling. "We respect the authority of the court but we
do not believe the court fully considered the facts of the
several taxpayers involved in this case nor the most pertinent
legal authorities," he said in an email.
Government lawyers argued that they could find no instance
where a whistleblower's award was treated as capital gains. But
they also cited no case where it was treated as ordinary income,
the panel noted.
The U.S. Attorney's Office did not immediately respond to a
request for comment.
The case is Alderson et al v. USA, U.S. Court of Appeals for
the 9th Circuit, No. 10-56007.
For Alderson et al: Robert Wood of Wood.
For the federal government: Thomas Coker of the U.S.
Attorney's Office for the Central District of California.
(Reporting By Terry Baynes)
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