State’s Tax Informants Might Get a Piece of the Infraction

Got a neighbor bragging about using the Nevada address of his weekend ski condo to avoid paying California taxes?

State tax authorities want you to rat him out. And soon they may be able to make it worth your while.

The Franchise Tax Board, California’s version of the IRS, is proposing to offer snitches cash rewards for stepping forward. Under the plan, which is part of Gov. Arnold Schwarzenegger’s proposed budget, tax officials would give confidential informants as much as 10% of the unpaid taxes collected from their neighbors, bosses, spouses or any other scofflaws they report.

It is part of the state’s continuing effort to get at the roughly $6.5 billion in taxes that authorities say is owed each year but not paid.

“We have tax cheats who are taking money out of the pockets of people who are paying their fair share,” said state Controller Steve Westly, California’s top elected tax official. “This program for whistle-blowers is one way we can get the money that is owed.... It won’t collect billions. But I think we will have the chance to collect millions.”

Privacy advocates say the plan is more than a little creepy.

“The government shouldn’t be paying people to snoop into the tax filings of other people,” said Teresa Casazza of the California Taxpayers Assn., a business advocacy group. “Based on a hunch that you are going to make some money, you might look through someone’s garbage, monitor conversations or maybe try to blackmail them.”

The state’s proposal is modeled after an IRS program in place for more than a decade. Informants who help the feds recover unpaid taxes are entitled to as much as 15% of what the government collects. In fiscal 2004, their tips brought in more than $74 million. The IRS paid 259 confidential informants nearly $4.6 million for their help.

Officials don’t want hunches based on the spending habits of the guy next door. They want bank account numbers, canceled checks and receipts that help them go after big fish: people and companies hiding more than $50,000 in income.

Perhaps aware of the Big Brother implications of such a program, the IRS says it does not go out of its way to encourage snooping or snitching.

“It is a very low-key program,” said Jeaneen Heiskell, the program’s senior analyst at the IRS. “It is nothing that we advertise.”

She adds that “most of the tips aren’t very good.” Though the IRS paid rewards to 259 people in 2004, an additional 5,121 who asked for money that year received nothing.

“A lot of people just say, ‘I think someone isn’t paying their taxes,’ ” Heiskell said. “Or: So-and-so bought a new car, and we think he isn’t reporting income.’ ”

The federal program has generated plenty of controversy. In the late 1990s, there was an effort in the U.S. Senate -- ultimately unsuccessful -- to abolish the IRS reward system. Taxpayers, accountants and lawyers testified about excruciating audits based on false leads.

Times have changed. Now the federal government and some big states are running multibillion-dollar deficits. The use of tax shelters and other accounting schemes drives treasuries deeper into the red. There is renewed interest in more aggressive enforcement of tax laws.

The U.S. Senate passed a bill last year that would have guaranteed payments to whistle-blowers whose tips to the IRS were used and doubled the amount of the awards. The measure, championed by Sen. Charles E. Grassley (R-Iowa), died in the House but could be revived again this year.

“The IRS doesn’t really grant enough rewards to amount to spit in a bucket,” said Jim Moorman, president of Taxpayers Against Fraud, a Washington, D.C., advocacy group for whistle-blowers. He points to several lawsuits filed by informants who claim they helped the IRS collect millions in taxes but never received any of it, and he says more incentive is needed for informants to step forward.

If California creates a reward program, other states -- which often follow the Franchise Tax Board’s lead -- may do the same. An official at the Federation of Tax Administrators, a research group for state tax agencies, said Florida was the only state the group knew of where a reward program was in place.

Dave Bruns, a spokesman for the Florida Department of Revenue, said the state received 510 tips in 2004, leading to the collection of $5.2 million in unpaid taxes. Rewards totaling $88,865 were paid to 230 of those tipsters. But the program is very different from the one California is pondering.

Florida doesn’t give informants anonymity, excluding a whole class of tipsters who may have inside information but fear losing their jobs or being sued if they step forward. Florida has no income tax. That limits tips mostly to issues involving businesses that aren’t paying all the sales or corporate tax they owe.

In California, where there are income taxes and where informants would remain anonymous, Bruns predicts that a lot more money could come in. State officials have conservatively estimated $1.2 million in revenue a year, after rewards are paid, but Westly says the number is just a starting point and that the program could generate many, many times that.

Last year, one state program to crack down on tax evaders was projected to generate $90 million; it brought in $1.4 billion.

The tax board is hoping by the end of the summer to have legislative approval for giving out rewards, as well as funding for three hires to receive, document and screen tips. The Franchise Tax Board and the governor want the plan, which has significant bipartisan support, approved as part of the state budget, which is due July 1.

The trend toward rewarding informants is leading to much brooding about how far government should go to hunt down tax cheats.

“It is an ethical mixed bag,” said Michael Josephson, president of the Josephson Institute of Ethics, a Los Angeles nonprofit. “It is not a very savory thing to turn someone in for the money.

“But there are so many tax cheats that this kind of thing could be considered justifiable,” he said. “I wish more people at Enron had turned their bosses in.... It’s part of a new culture that says, ‘We are cracking down on bad guys.’ ”

Tax professionals who have experience with the programs say many informants are not in it for the reward. Some want revenge.

“There are a lot of spiteful people trying to cause trouble for someone else,” said David Nolte, a principal at Fulcrum Financial Inquiry, a forensic accounting firm that has clients who have been informants and collected rewards.

San Francisco lawyer Mike Faber said clients have asked him from time to time how they might go about reporting an adversary to the government.

“It is usually in the context of a dispute they are having with someone else over something completely unrelated to taxes,” he said. “You know, ‘I want to burn their house down ... and then inform on them.’ ”

Faber also said one of his clients was on the receiving end of an informant’s report. The informant sent the IRS a letter with specific information about how revenue from a business deal was misreported. The IRS investigated for a couple of years before abandoning the case.

“It was fairly onerous and cost the client a lot of money,” he said.

Faber and other tax attorneys say there is no guarantee that the government won’t turn its focus on the informant.

“You better go with clean hands,” said Martin Press, a Florida tax attorney.

In one case he was involved with, the informant turned in his business partner to both the state and the IRS. The state gave him a check, but the IRS gave him nothing.

Press recalled: “They said, ‘Thank you. But we knew about the issue with your partner already. Now, why haven’t you been filing returns?’ ”