Kyphon relator must pay taxes on whistleblower reward at ordinary, not capital gains, tax rate, 7th Circuit rules

by Ben Vernia | September 1st, 2015

On August 26, in Patrick v. Commissioner, the Court of Appeals for the Seventh Circuit took up the appeal of one of the relators in the Kyphon orthopedic device case, challenging the IRS’s determination that the total $6.8 million reward he received in the case against Kyphon and various hospitals as a result of a qui tam suit he and a fellow Kyphon coworker brought.

After receiving his reward, Patrick reported the income as a capital gain in 2008 and 2009, but the IRS sent him and his wife deficiency notices for both years, levying over $800,000 more in taxes than they had claimed. He petitioned the Tax Court for relief, but was denied, and took the case to the Seventh Circuit.

The Court agreed with the IRS and the Tax Court, reasoning:

Treating a relator’s reward as a capital gain would contravene the long-recognized rule that a “capital gain” generally
involves a “realization of appreciation in value accrued over a substantial period of time” of an initial investment of capital. Comm’r v. Gillette Motor Transp., Inc., 364 U.S. 130, 134–35 (1960); see also Alderson, 686 F.3d at 797. But here Patrick made no initial investment in some asset. Instead, he expended time and effort to discover and document Kyphon’s fraud, and that work was not an investment of capital. See Alderson, 686 F.3d at 797. Further, there was no “realization of appreciation in value” of an underlying investment that “accrued over a substantial period of time.” Gillette Motor Transp., Inc., 364 U.S. at 134. Patrick had an interest in a portion of the government’s recovery, but that interest did not grow in value over time. It did not even vest until the government received its recovery. See Vt. Agency of Natural Res., 529 U.S. at 772.

The Court rejected Patrick’s argument that he possessed a property right in either the information he gathered at Kyphon or his share of the recovery (which the Court characterized as analogous to an attorney’s interest in a contingent fee, which, as compensation for services, qualifies as ordinary income).

Leave a Reply

Recent Posts

Recent Comments