Expert Opinion: The Looming Threat of Tax Whistleblower Lawsuits for Retailers

As big retail adjusts to the tax complexities resulting from the Supreme Court’s Wayfair ruling, there is one unintended consequence that is getting little attention, but will likely become a significant risk to the sector in the years to come. For executives tasked with ensuring their organizations are compliant with the proliferation of economic nexus and tax liabilities, it is critical that they anticipate the very real possibility of predatory “qui tam” lawsuits targeting their companies. 

What are “qui tam” lawsuits?
Also known as whistleblower or false claims cases, “qui tam” cases are lawsuits alleging fraudulent conduct, which are filed by an individual against a defendant on behalf of the government in exchange for a portion of the recovery that the government receives (often 20% – 35%). These cases have been around for years in various forms, such as Medicare and Medicaid fraud, government spending and contracts, and regulatory oversight of pharmaceuticals.  However, more recently, states are updating their laws that will allow individuals to apply these types of cases against retailers in a tax context. 

Qui tam cases are especially concerning because they involve a highly technical and complex area of law, have lookback periods that extend far beyond the general statute of limitations for state taxes and often impose treble (triple) damages in addition to interest. Retailers must collect or remit perfectly or face potential legal action seeking reward against underpayment (qui tam) or over collection (class action). Depending on the compliance infraction, qui tam cases can be extremely lucrative for the whistleblower.

Of course, many of these types of lawsuits do not contain fraudulent activity, but are instead raised by opportunistic plaintiffs (referred to as “relators”) who know that the severe penalties and costs incurred to defend the lawsuit can result in favorable settlements.  Most frequently, we see these lawsuits in the sales tax area as state laws are painfully nuanced (e.g., try understanding why Snickers and Twix have different sales tax treatment in Illinois—the reason relates to flour).  These claims are relatively simple to advance because a company’s sales tax policies are easily identified, and the relator generally requires no insider knowledge to initially put a case together.

New York and Illinois are the two most prolific states in terms of tax qui tam lawsuits.  In fact, there is a plaintiff firm in Illinois that has filed over 1,000 whistleblower lawsuits on behalf of the state against retailers, alleging the improper failure to collect sales tax, receiving at least $10 million in proceeds over the last 15-plus years (almost entirely through settlement).  In 2010, New York entered the qui tam arena for tax purposes, with the Sprint Nextel Corporation case being one of the first cases filed.  Just last year, this case set new records when Sprint Nextel Corporation and the New York State Attorney General’s Office reached a $330 million settlement in a New York False Claims Act case for an alleged sales tax violation. The whistleblower, who filed the lawsuit under an anonymous LLC, walked away with $62.7 million.  

As illustrated by Sprint, retailers could face substantial liabilities from state tax qui tam claims, and the cost of litigating a case can be expensive.  Moreover, “relators” have strong incentives to bring these types of lawsuits.  Although New York and Illinois are the two primary states where we see tax qui tam cases, Arkansas, California, the District of Columbia, and Michigan have all recently considered bills that would allow tax-related qui tam claims.  In fact, the District of Columbia is considering legislation this month.  The reason is clear:  these lawsuits can result in substantial financial recovery for the state with minimal effort, particularly if the Attorney General does not intervene.

How is Wayfair Related to Qui Tam Lawsuits?
The U.S. Supreme Court’s decision in Wayfair permits states to impose economic nexus on out-of-state companies with no physical presence.  Since Wayfair, almost every state that has a sales tax amended its laws to require economic nexus.  Although many brick-and-mortar retailers will already be filing in states where they have a physical presence, Wayfair now requires all retailers to file in nearly every jurisdiction once the retailer surpasses the state’s minimum economic nexus requirements.  Opportunistic plaintiffs are likely to monitor retail transactions to determine whether companies are collecting sales tax on goods shipped to each state. If the retailer is not properly collecting sales tax (e.g., as a result of not complying with a state’s economic nexus rules), and the state permits individuals to file qui tam lawsuits on behalf of the state, material risk could exist. Additionally, retailers may need time to digest the complex sales tax rules in each jurisdiction where they are now required to file. Even if a retailer is compliant with Wayfair, risk could still exist if the retailer is not properly collecting sales tax on each specific transaction (e.g., the Snickers-Twix example above).

Steps to Protect Your Company 
With stakes being high, retailers should consider precautionary methods to reduce the risk of a qui tam lawsuit and assist in the potential defense of such a claim. Unfortunately, the obvious thought of taking a “conservative” approach, such as defaulting to collecting sales tax, may not solve the problem as many states permit class action lawsuits on taxpayers who over collect sales tax, not just claims against taxpayers who may under collect. Therefore, the first step is to shore up any uncertain positions by confirming the appropriate tax treatment and documenting any research in arriving at your conclusions.  

Remember, qui tam cases are “fraud” cases, requiring a “scienter,” or a “knowing” violation of a state’s tax laws (e.g., if you, in good faith, considered a state’s laws and simply arrived at the wrong conclusion, that should not satisfy the scienter element). As many qui tam cases involve sales tax, having a trusted advisor review your sales tax collection and remittance policies becomes increasingly important.  We also recommend having a plan in place if a qui tam lawsuit does arise. Consider whether the case will be handled out of your tax department, your general counsel’s office, or both. Have a trusted advisor on hand to contact immediately as many states have as short as a 30-day turnaround to respond to the lawsuit. And, consider whether you will fight the claim as a matter necessity, fight the claim as a matter of principle to deter others from raising similar suits, or settle based on risk or nuisance value. 

The financial incentive and protections offered by qui tam cases will drive more intense scrutiny of business tax practices, leaving taxpayers with heightened liability risks both from state taxing authorities, and potentially from relators seeking a payout.  The holding in Wayfair could jumpstart an entire new class of claims in states if retailers are not careful with their compliance practices and the state allows qui tam tax lawsuits.

David Pope is a partner and Rob Galloway is an associate at Baker & McKenzie LLP, respectively. They both focus on state and local income tax, sales and use tax, property tax, payroll tax, personal income tax and unclaimed property. They represent clients in the retail, financial, insurance, energy, media, telecommunication, and manufacturing industries across the U.S. on all aspects of state and local tax, including controversy, litigation, planning and restructuring matters.