Friday, July 20, 2012

Relator's Share Found to be Ordinary Income for Tax Purposes

On July 18, the 9th Circuit, Judge Fletcher, writing for the panel, issued an unsurprising opinion in Alderson v. United States, No. 10-56007, 2012 U.S. App. LEXIS 14680 (9th Cir. July 18, 2012) holding that the relator's qui tam award under the False Claims Act is ordinary income, and cannot be characterized as capital gain.  In Alderson, the relator, who received some $27,105,035 (a 16% share of a $631 million settlement after fees and costs were deducted) filed a tax return reporting his share as ordinary income.  Thereafter, he filed an amended return characterizing it as capital gain, seeking a refund of about $5 million. 

Relator had no case law to support his contention, nor did the government apparently have any case law to support its position that such awards have been consistently treated as ordinary income.  Thus, the court, in a brief opinion, discussed relator's argument that he had exchanged documents, information, and know-how, and that that exchange constituted a "sale or exchange,” for the purposes of capital gains treatment under the tax code.  The Court rejected this argument out of hand, stating: "If Alderson had offered simply to sell or exchange the information to the government in exchange for a sum of money, the government would almost certainly have refused the offer."  The Court went on to state, "In the unlikely event the government accepted the offer, it would have done so based on some authority other than the FCA."

Alderson then argued that the information and papers were a capital asset. Alderson’s position was not entirely unprecedented – trade secrets were found to be a capital asset by the Federal Claims Court in E.I. du Pont de Nemours & Co. v. United States, 288 F.2d 904, 912 (Ct. Cl. 1961).  However, in this case, the Ninth Circuit found that the information and papers were not Alderson’s “property”, as required for treatment as a capital asset, reasoning that Alderson had no legal right to exclude others from the use of the information. 

Finally, Alderson argued that his relator's share itself was a capital asset, contending that the increase in value between 1993 when he filed his FCA case and 2003 when he received his $27,105,035 was a capital gain.  The Court, while recognizing that the share can be property for some purposes and is assignable, found it not to be property, and not a capital asset, as Alderson did not receive his share in return for an "underlying investment of capital."  Moreover, the increase in value was not the sort of "accretion in value" that characterizes a capital gain. 

Accordingly, the Ninth Circuit affirmed the holding of the Central District of California (718 F. Supp. 2d 1186 (Wilson, J), finding the relator's share to be ordinary income).

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