United States: A Decade Of Lessons Learned From State Tax False Claims Act Cases

Last Updated: December 5 2013
Article by Mary Kay McCalla Martire and Lauren A. Ferrante

The last decade has witnessed a large upswing of False Claims Act (FCA) cases filed in the state tax arena.  New York, particularly in the last few years with Attorney General Eric Schneiderman at the helm, has sharpened its tools and upped its enforcement efforts.  The New York False Claims Act was amended in 2010 to allow private citizens acting on behalf of the state to bring a tax claim alleging fraud against taxpayers who met a certain financial threshold.  The amendments provide for treble damages, rewards of up to 30 percent of liability and a 10-year statute of limitations, which is years beyond the statute of limitations governing state tax audits.  In Illinois, hundreds of state tax FCA cases have been filed by a single plaintiff law firm, triggering a State House Revenue and Finance Committee hearing on the abuse of the Illinois FCA, as well as proposed legislation that would put significant limitations on the filing of such claims.  Across the United States, unclaimed property laws also have seen their fair share of FCA litigation.

At present, 29 states, the District of Columbia, New York City, Chicago, and Allegheny County, Pennsylvania, have FCA statutes.  Of those jurisdictions, eight (Delaware, Florida, Nevada, New Hampshire, New York, Washington, Wisconsin and Chicago) permit state tax FCA claims involving any type of tax.  Three others (Illinois, Indiana and Rhode Island) bar only income tax FCA actions; any other type of state or local tax is fair game.  The remaining jurisdictions either bar all tax-related claims or are limited to Medicaid-related claims.

FCA laws, also referred to as qui tam or whistleblower laws, allow third-party private citizens ("whistleblowers" or "relators") acting on behalf of a government to sue persons who knowingly make or use a false statement material to an obligation to pay money to the government.  In the tax arena, such claims frequently are brought as "reverse" false claims, alleging a knowing concealment or avoidance of a tax obligation.  "Knowingly" is broadly defined by the FCA laws as actual knowledge, deliberate ignorance of the truth or falsity of information, or acting in reckless disregard of the truth or falsity of information.

The penalties associated with an FCA violation are severe, and the potential reward to a whistleblower is significant.  Persons found to have violated a state FCA may be found liable for three times the amount of unpaid tax, interest and penalties, plus per-occurrence civil penalties (up to $11,000 per false claim in Illinois) and costs.  Up to 30 percent of the proceeds of any judgment or settlement may be awarded to the whistleblower, together with its costs, expenses and reasonable attorneys' fees.

The groundswell of such litigation appears to be rising.  Although one state (Tennessee) amended its statute to bar the use of FCA cases in the tax arena, proposed legislation to amend the Illinois statute to limit tax-related claims has stalled in committee.  Recently, the Multistate Tax Commission Income and Franchise Tax Uniformity Subcommittee formed a working subcommittee to begin drafting a model provision for state false claims acts.

With no universal shutdown of state tax FCA actions on the horizon, this article offers the following practical recommendations to the taxpayer community for defending against third-party FCA claims.  A subsequent article will offer practical tips for guarding against FCA claims brought by insiders, including employees. 

1.  Oppose the enactment of these laws.  Be a strong voice against the use of FCA litigation in the tax arena.  Emphasize the powerful enforcement mechanisms that already are present and available for use by state tax departments against tax cheats.  Explain the risks created when private citizens, with no tax experience, are armed with legislation that gives them the power to drive tax policy by filing whistleblower claims.  Do not accept any assurance that a state statute is a copy of the federal FCA, which "has a tax prohibition."  Smart whistleblowers recognize that there is ample opportunity to bring tax-related state FCA litigation under such statutes, because they only prohibit income-tax-related claims.  See, e.g., the Illinois FCA and related litigation, all of which involve sales and use tax-related claims under a state statute modeled on the federal FCA.  The Indiana and Rhode Island statutes are similarly worded.

2.If you are sued, expect a healthy dose of skepticism for your point of view, even if the case filed against you is, from your perspective, completely without merit.  Generally speaking, the general public, judges included, believe whistleblower lawsuits serve a useful purpose because they ferret out fraud against the government.  Rightly or wrongly, many people view fraud on the government as a rampant problem.  In the tax arena, these views are exacerbated by the fact that everyone hates a tax cheat.  These ingrained beliefs can present a significant hurdle that must be overcome in order to prevail in the defense of FCA litigation.

3.Be prepared to present your case to the court, and perhaps also the state lawyer assigned to the matter, in a simplistic manner.  Because FCA litigation typically arises outside the context of a traditional state tax proceeding, such lawsuits often are assigned to courts and state's lawyers with little or no tax background.  In fact, the state taxing authority may not even be named as a party to the litigation.

Individuals without a background in taxation frequently take frivolous claims more seriously than would a more experienced opponent or jurist (see "everyone hates a tax cheat," above).  As a result, it is critical for you to explain your tax position clearly and succinctly.  It is difficult for a judge to agree to dismiss a case as meritless if he or she does not understand the defect in the whistleblower's tax claim.

If your jurist also lacks experience with FCA litigation, analogize your arguments to other legal concepts that the jurist frequently addresses in other types of litigation.  For example, in a motion to dismiss, argue that FCA litigation is like fraud litigation, in that a relator's claims must be pled with specificity.

4.Recognize that the state has competing interests in the litigation.  In all likelihood, the state did not initiate the FCA litigation.  The state's lawyers may even agree with you, at least privately, that the whistleblower's claim lacks merit.  Despite this fact, the state may not have the resources to take an active role in the matter.  It may simply decline to intervene, which frees the whistleblower to proceed with the litigation on its own.  This is cheaper for the state, but it does not relieve the litigation expense for the taxpayer defendant.

Even more importantly, recognize that a state's interest in helping taxpayer defendants named in unworthy cases is compromised by the fact that the state will benefit if the cases are settled rather than dismissed.  At least 70 percent of the dollars paid in any settlement go to the state's coffers.  In some states, a portion of the funds collected in FCA litigation go straight to the budget of the state attorney general, rather than to the general revenue funds into which tax payments typically are deposited.  As a result, you may find it far easier to persuade a state official to support a nominal settlement of an unworthy FCA case than to publically support your claim that the lawsuit is meritless.

Be aware also that states must analyze their actions in the broader context of all state FCA litigation, not just tax cases.  A state's lawyer may be unwilling to publically express a view that a case lacks merit for fear that it may compromise the state's ability to use the FCA in other, more worthy disputes.

5.  Be wary of the power of the state.  It is the "real party in interest," with strong rights of control over the litigation, even when it does not intervene, including the right to control discovery and a preferential dismissal standard.  In addition, the state's approval is essential to the settlement of any FCA matter.  Cultivate a strong working relationship with the state's lawyer(s) assigned to your FCA case, even if the state doesn't intervene, so you can call on the state's lawyers for assistance when needed.

6.  Use joint defense groups when appropriate.  If multiple lawsuits have been filed against a number of defendants on the same issue, consider forming a joint defense group to share ideas and work together on common issues.  Be prepared, however, to stand out from the pack in order to emphasize the more favorable aspects of your case.

7.  Call the whistleblower's bluff on unworthy cases.  If the case filed by the whistleblower is meritless and, from your perspective, is worthy of a fight, aggressively defend your position.  Seek to have the case dismissed.  Issue discovery requests that require the whistleblower to disclose evidence supporting the required elements of its claim, including that the whistleblower is an original source, that there was no prior public disclosure of the tax issue, and any evidence of deliberate misconduct.  Consider filing a counterclaim seeking your attorneys' fees and expenses on the ground that the whistleblower's claim is frivolous.  Many whistleblowers file these suits hoping for a quick settlement.  If you make it apparent that you intend to aggressively defend your litigation, the whistleblower may back away, focusing instead on less bothersome opponents.

8.  Be prepared to settle, but recognize that you may be required to pay the whistleblower's attorneys' fees, costs and expenses.  FCA lawsuits can be expensive to defend, even when the underlying tax claims are without merit.  When the amount at issue is small and/or the defense to the underlying tax claim is weak, it may be cheaper for a taxpayer defendant named in FCA litigation to negotiate a settlement. 

Most FCAs provide that a whistleblower that "prevails" in the litigation is entitled to its reasonable attorneys' fees, costs and expenses.  Courts have ruled that a whistleblower is deemed to have "prevailed" when it enters into a court-approved settlement.  In the event you decide to settle, be prepared to compensate the whistleblower for its reasonable attorneys' fees, costs and expenses, without regard to the merits of the underlying claim.  Fees and expenses also can be awarded to the state.

9.  Use state audits for protection.  Take steps now to keep yourself from being named in this type of litigation.  Disclose your "no tax" positions to state auditors and get their approval, in writing if you can (or preserved in an internal memo if you cannot).  Evidence of a state's favorable review of an issue on audit is extraordinarily helpful in defeating a whistleblower's subsequent claim of a deliberate, knowing failure to collect and remit a particular tax.

10.  Recognize the inherent limitation of relying upon secondary sources.  Secondary sources can provide a good overview of a state's tax structure.  Do not assume, however, that such sources are always up to date or accurate, or that your reliance on information contained in such sources can absolve you from any whistleblower claim.  Secondary sources do miss new developments, as well as the nuances that may be created by case law.

Make sure that someone in your organization is responsible for following new state tax developments.  If your organization prepares a regular survey of state tax obligations, keep the document up to date.  Conduct your reviews as frequently as the title (for example "annual survey") of the document suggests.

11.  Consider the risk of FCA litigation in your tax planning.  When deciding whether to take a particular tax position, consider not just the possible penalties and interest associated with an adverse audit determination, but also the risk of FCA or class action litigation.  Risky tax positions can be fodder for such litigation.

12.  Lobby for the amendment of bad laws.  Speak up in favor of the amendment of existing state FCAs to exclude tax claims, or other modifications designed to limit a whistleblower's right to file tax-related claims.  The proposed amendment to the Illinois FCA statute was introduced after the House Revenue and Finance Committee held a public hearing on FCA abuse in the tax arena at which taxpayers testified about the expense and disruption caused by the litigation.

While most would agree that there are contexts in which whistleblower claims are useful in ferreting out government fraud and abuse, the use of such claims in the state tax arena is problematic at best, especially as many of such laws are currently enacted.  If you have the misfortune of being named in one of these suits, rely on the above principles to guide you through the litigation. 

A version of this article originally appeared in State Tax Notes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mary Kay McCalla Martire
 
In association with
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.