                                             CRAIG PATRICK AND MICHELE PATRICK, PETITIONERS v.
                                              COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
                                                       Docket No. 16387–12.                  Filed February 24, 2014.

                                                     P–H received two monetary awards for bringing qui tam
                                                   complaints filed under the False Claims Act (FCA), 31 U.S.C.
                                                   sec. 3730 (2006). Ps reported the awards as capital gains. R
                                                   issued a deficiency notice that disallowed capital gains treat-
                                                   ment and characterized the awards as other income. R con-
                                                   tends that a qui tam award does not result from the sale or
                                                   exchange of a capital asset, citing I.R.C. sec. 1222(1) and (3).
                                                   Ps contend that under the FCA the relator sells information
                                                   to the Government in exchange for a share of any recovery.
                                                   Ps further argue that the right to receive a share of the
                                                   recovery and the information provided to the Government
                                                   each constitute a capital asset. Held: A qui tam award is not
                                                   the result of a sale or exchange as required under I.R.C. sec.
                                                   1221(b)(3). Held, further, a qui tam award is ordinary income
                                                   and is therefore not a capital asset under I.R.C. sec. 1221(a).
                                                   Held, further, the information P–H provided to the Govern-
                                                   ment was not his property and therefore was not a capital
                                                   asset.

                                           Dashiell C. Shapiro and Jonathan Van Loo, for petitioners.
                                           Andrew R. Moore, for respondent.

                                                                                   OPINION

                                       KROUPA, Judge: Respondent determined deficiencies of
                                     $716,883 1 and $94,714 in petitioners’ Federal income tax for
                                     2008 and 2009, respectively (years at issue). We must decide
                                     whether a qui tam award qualifies for capital gains treat-
                                     ment under section 1222. 2 We hold that a qui tam award
                                     does not satisfy the capital gains requirements.

                                                                                Background
                                       The parties submitted this case fully stipulated pursuant
                                     to Rule 122, and the facts are so found. The stipulation of
                                     facts and its accompanying exhibits are incorporated by this
                                     reference. Petitioners resided in Wisconsin when they filed
                                     the petition.
                                           1 All
                                            monetary amounts are rounded to the nearest dollar.
                                           2 All
                                            section references are to the Internal Revenue Code (Code) in effect
                                     for the years at issue, and all Rule references are to the Tax Court Rules
                                     of Practice and Procedure, unless otherwise indicated.

                                     124




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                                     (124)                          PATRICK v. COMMISSIONER                                        125


                                        Petitioner husband served as a reimbursement manager
                                     for Kyphon, Inc. (Kyphon). Kyphon designed, manufactured
                                     and marketed minimally invasive equipment to treat certain
                                     spinal conditions. The equipment allowed for treatment by
                                     outpatient procedure. Kyphon feared that medical providers
                                     would avoid purchasing the equipment because performing
                                     the procedure on an outpatient basis would no longer gen-
                                     erate revenue from overnight hospital stays. Kyphon there-
                                     fore instructed its sales representatives to market the proce-
                                     dure as inpatient. Certain medical providers that purchased
                                     the equipment had patients admitted when undergoing the
                                     treatment. Some medical providers billed this expense to the
                                     Government under Medicare.
                                        Petitioner husband and another Kyphon employee, Charles
                                     Bates, believed that Kyphon’s practices violated Federal law.
                                     Petitioner husband and Mr. Bates agreed to file a qui tam
                                     complaint and to split any relator’s award. Petitioner hus-
                                     band had collected various documents he had helped create
                                     during his employment that demonstrated Kyphon’s prac-
                                     tices. Petitioner husband also kept some internal Kyphon
                                     documents and external marketing material.
                                        Petitioner husband and Mr. Bates filed a qui tam com-
                                     plaint alleging Kyphon had defrauded the Government.
                                     Kyphon eventually settled the matter for $75 million. The
                                     Government intervened after Kyphon agreed to the settle-
                                     ment.
                                        Petitioner husband and Mr. Bates then filed additional qui
                                     tam complaints against various medical providers. Those
                                     entities also entered into cash settlements to resolve the com-
                                     plaints.
                                        Petitioner husband received a relator’s share of $5,979,282
                                     in 2008 and $856,123 in 2009. The Government issued to
                                     petitioner Forms 1099–MISC, Miscellaneous Income, for the
                                     years at issue reflecting those amounts.
                                        Petitioners jointly filed Forms 1040, U.S. Individual
                                     Income Tax Return, for the years at issue. Petitioners
                                     reported the awards (less attorney’s fees) as capital gains.
                                     Respondent issued petitioners a deficiency notice that dis-
                                     allowed capital gains treatment for the awards and
                                     characterized the amounts as other income. Petitioners
                                     timely filed a petition challenging respondent’s determina-
                                     tions.




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                                     126                 142 UNITED STATES TAX COURT REPORTS                                     (124)


                                                                                Discussion
                                       We are asked to decide whether a qui tam relator’s share
                                     award is entitled to capital gains treatment. Petitioners
                                     argue that petitioner husband sold information to the
                                     Government in exchange for a share of any recovery.
                                     Respondent, on the other hand, argues that the relator’s
                                     share is similar to a reward and does not satisfy the require-
                                     ments for capital gains treatment. We will consider qui tam
                                     actions and the requirements for capital gains treatment. 3
                                     I. Qui Tam and the False Claims Act
                                        We begin with a qui tam action. The phrase ‘‘qui tam’’ is
                                     short for a Latin phrase 4 meaning one ‘‘who pursues this
                                     action on our Lord the King’s behalf as well as his own.’’ See
                                     Vt. Agency of Natural Res. v. United States ex rel. Stevens,
                                     529 U.S. 765, 768 n.1 (2000). Congress has enacted multiple
                                     qui tam provisions, including the False Claims Act (FCA), 31
                                     U.S.C. secs. 3729–3733, in 1863. Id. at 768–769. The FCA
                                     imposes civil liability on any person who knowingly presents
                                     a false or fraudulent claim for payment or approval. 31
                                     U.S.C. sec. 3729(a) (2006).
                                        The FCA authorizes a person, referred to as the relator, to
                                     file under seal a complaint seeking reimbursement on the
                                     Government’s behalf. Id. sec. 3730(b)(1). The relator must
                                     serve on the Government the complaint and all supporting
                                     information the relator possesses before the action may pro-
                                     ceed. Id. sec. 3730(b)(2). The Government may intervene and
                                     prosecute the matter. Id. sec. 3730(c)(1), (d)(4). The Govern-
                                     ment may request dismissal or settle the action with the
                                     court’s approval. Id. sec. 3730(c)(2)(A) and (B). Further, the
                                     Government may seek to limit the relator’s participation in
                                     the litigation. Id. sec. 3730(c)(2)(C). The relator is responsible
                                           3 The
                                             taxpayer generally bears the burden of proving the Commissioner’s
                                     determinations are erroneous. Rule 142(a). The burden of proof may shift
                                     to the Commissioner if the taxpayer satisfies certain conditions. Sec.
                                     7491(a). Resolving all factual issues here is based on a preponderance of
                                     the evidence. Therefore, we need not consider which party has the burden
                                     of proof. See Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
                                       4 The entire phrase is ‘‘qui tam pro domino rege quam pro se ipso in hac

                                     parte sequitur.’’ See Vt. Agency of Natural Res. v. United States ex rel. Ste-
                                     vens, 529 U.S. 765, 768 n.1 (2000).




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                                     (124)                          PATRICK v. COMMISSIONER                                        127


                                     for litigating the matter if the Government does not inter-
                                     vene. Id. sec. 3730(b)(4)(B).
                                       If the Government prosecutes the complaint, then the court
                                     shall award a relator between 15% and 25% of any amount
                                     recovered. Id. sec. 3730(d)(1). The court shall award a relator
                                     between 25% and 30% of any amount recovered when the
                                     Government does not intervene. Id. sec. 3730(d)(2). The court
                                     may decrease the award if the relator relied primarily on
                                     publicly available information or choose to award nothing if
                                     the relator planned or participated in the underlying con-
                                     duct. Id. sec. 3730(d)(1), (3).
                                     II. Whether a Qui Tam Award Is a Capital Gain
                                        We now consider whether a qui tam award is a capital
                                     gain. Petitioners argue that their qui tam awards are enti-
                                     tled to capital gains treatment. A capital gain is a ‘‘gain from
                                     the sale or exchange of a capital asset.’’ Sec. 1222(1), (3).
                                     Petitioners consequently must demonstrate that a qui tam
                                     award resulted from a ‘‘sale or exchange’’ of a ‘‘capital asset’’
                                     as those terms are intended. Petitioners theorize that the
                                     FCA forms a contract under which the relator sells informa-
                                     tion to the Government in exchange for a share of the
                                     recovery. See United States ex rel. Russell v. Epic Healthcare
                                     Mgmt. Grp., 193 F.3d 304, 309 (5th Cir. 1999). Respondent
                                     disputes that there was a sale or exchange or that petitioners
                                     held a capital asset. We agree with respondent. We address
                                     each requirement in turn.
                                           A. Sale or Exchange Requirement
                                       We first consider whether petitioners received the qui tam
                                     awards through a transaction considered to be a sale or
                                     exchange. See sec. 1222. Petitioners argue that a relator sells
                                     his information to the Government. Respondent contends
                                     that the relator’s statutory obligation to provide all sup-
                                     porting information does not constitute a sale or exchange.
                                     We agree with respondent.
                                       Transactions involving the transfer of capital assets must
                                     be ‘‘in the nature of a sale’’ to qualify for capital gains treat-
                                     ment. Freda v. Commissioner, 656 F.3d 570, 577 (7th Cir.
                                     2011), aff ’g T.C. Memo. 2009–191. We have applied the ordi-
                                     nary meaning of the phrase ‘‘sale or exchange’’ because it is
                                     not defined in the Code. Nahey v. Commissioner, 111 T.C.




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                                     128                 142 UNITED STATES TAX COURT REPORTS                                     (124)


                                     256, 262 (1998), aff ’d on other grounds, 196 F.3d 866 (7th
                                     Cir. 1999). The phrase, however, is interpreted narrowly as
                                     not every disposition constitutes a sale or exchange. See, e.g.,
                                     Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247
                                     (1941) (demonstrating that the term ‘‘sale or exchange’’ is
                                     narrower than the term ‘‘sale or other disposition’’); Barr v.
                                     Commissioner, T.C. Memo. 2009–250 (surrender of an insur-
                                     ance policy not a sale or exchange). A sale is a transfer of
                                     property for a fixed price in money or its equivalent.
                                     Commissioner v. Brown, 380 U.S. 563, 571 (1965). An
                                     exchange occurs when property is transferred in return for
                                     other property. Guest v. Commissioner, 77 T.C. 9, 24 (1981).
                                        Petitioners argue the sale or exchange requirement is met
                                     because the qui tam complaint establishes the relator’s
                                     contractual right to a share of the recovery. We disagree.
                                     Absent a legislature’s clear indication to contractually bind
                                     the government, a law does not create private contractual
                                     rights. Tempel v. Commissioner, 136 T.C. 341, 348 (2011)
                                     (citing Nat’l R.R. Passenger Corp. v. Atchison, Topeka &
                                     Santa Fe R.R. Co., 470 U.S. 451, 465–466 (1985)). The
                                     Government does not purchase information from a relator
                                     under the FCA. Rather, it permits the person to advance a
                                     claim on behalf of the Government. The award is a reward
                                     for doing so. No contractual right exists.
                                        Petitioners analogize the relator’s provision of information
                                     to the sale of a trade secret. A transfer of trade secret rights,
                                     however, constitutes a sale for capital gains purposes only
                                     when all substantial rights are transferred. Freda v.
                                     Commissioner, T.C. Memo. 2009–191. Petitioner husband did
                                     not transfer any rights to the Government.
                                        Put simply, a relator does not sell or exchange his informa-
                                     tion for a fixed amount of money or in return for other prop-
                                     erty. The sale or exchange requirement is not met.
                                           B. Capital Asset Requirement
                                        We now turn to the capital asset requirement. The term
                                     ‘‘capital asset’’ means property held by the taxpayer. 5 Sec.
                                     1221(a). Respondent contends that petitioners have not dem-
                                     onstrated the existence of a capital asset. Petitioners contend
                                       5 Eight categories of property are excluded from this definition. See sec.

                                     1221(a)(1)–(8). The parties agree that those exclusions do not apply.




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                                     (124)                          PATRICK v. COMMISSIONER                                        129


                                     that the capital asset was the right to future income that
                                     vested when petitioner husband filed the qui tam complaints.
                                     Petitioners alternatively argue that the documents and
                                     information provided to the Government were capital assets.
                                     We agree with respondent.
                                           1. Ordinary Income Doctrine
                                       We now focus on whether petitioners’ right to a share of
                                     the recovery was a capital asset. The definition of capital
                                     asset under section 1221 is bound by the ordinary income
                                     doctrine. Tempel v. Commissioner, 136 T.C. at 346. The ordi-
                                     nary income doctrine excludes from the definition of a capital
                                     asset ‘‘property representing income items or accretions to
                                     the value of a capital asset themselves properly attributable
                                     to income.’’ United States v. Midland-Ross Corp., 381 U.S.
                                     54, 57 (1965). The right to future payments of ordinary
                                     income is not a capital asset. Commissioner v. P.G. Lake,
                                     Inc., 356 U.S. 260, 265–266 (1958); Davis v. Commissioner,
                                     119 T.C. 1, 6–7 (2002).
                                       A qui tam award is a reward for the relator’s efforts in
                                     obtaining repayment to the Government and is includible in
                                     a taxpayer’s gross income. Campbell v. Commissioner, 134
                                     T.C. 20, 26 (2010), aff ’d, 658 F.3d 1255 (11th Cir. 2011);
                                     Roco v. Commissioner, 121 T.C. 160, 164 (2003); sec. 1.61–
                                     2(a)(1), Income Tax Regs. Petitioners did not receive a right
                                     to the relator’s share in exchange for an underlying invest-
                                     ment of capital. See Alderson v. United States, 686 F.3d 791,
                                     796–797 (9th Cir. 2012). Petitioners’ right to income is attrib-
                                     utable to a reward. A reward, as stated above, is treated as
                                     ordinary income. Thus, the right to receive a portion of the
                                     recovered amount is not a capital asset. 6
                                           2. Property
                                       The parties also dispute whether the information petitioner
                                     husband provided constitutes a capital asset. Petitioners
                                     argue that petitioner husband had a property interest in the
                                       6 Petitioners also argue that the qui tam award is entitled to capital

                                     gains treatment under sec. 1234A. The gain or loss attributable to the can-
                                     cellation, lapse, expiration or other termination of a right or obligation for
                                     property that is a capital asset of the taxpayer will be treated as the sale
                                     of capital asset. Sec. 1234A. As stated, petitioners have not demonstrated
                                     the existence of a capital asset, and sec. 1234A does not apply.




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                                     130                 142 UNITED STATES TAX COURT REPORTS                                     (124)


                                     information and documents he disclosed to the Government.
                                     Respondent contends the documents and information are not
                                     a capital asset because petitioner husband did not have a
                                     legal right to exclude others from use and enjoyment of that
                                     property. We agree with respondent.
                                       Information supporting a qui tam complaint and provided
                                     to the Government does not constitute a capital asset. Id. A
                                     general characteristic of property is that an owner has the
                                     legal right to exclude others from use and enjoyment of that
                                     property. Id. at 796. The most significant rights held by the
                                     owner of a trade secret are the rights to prevent both the
                                     unauthorized use and the disclosure of the secret. Freda v.
                                     Commissioner, T.C. Memo. 2009–191. Petitioner husband
                                     obtained documents through his employment. The FCA obli-
                                     gated petitioner husband to give the Government all sup-
                                     porting documentation. Petitioner husband did not dem-
                                     onstrate any right to prevent Kyphon or the medical pro-
                                     viders from using or disclosing the information. See Alderson,
                                     686 F.3d at 796–797. Thus, we hold that petitioners did not
                                     demonstrate that the information provided to the Govern-
                                     ment was a capital asset.
                                           C. Conclusion
                                        Petitioner husband helped bring to light systematic fraud,
                                     causing the recovery of tens of millions of dollars. Those
                                     efforts are to be applauded and were rewarded. Rewards,
                                     however, are treated as ordinary income, and the qui tam
                                     award is subject to tax as such. Petitioners have not dem-
                                     onstrated that either requirement for capital gains treatment
                                     was met.
                                        We have considered all the arguments of the parties, and,
                                     to the extent we have not addressed them, we find them to
                                     be irrelevant, moot or meritless.
                                        To reflect the foregoing,
                                                                           Decision will be entered for respondent.

                                                                               f




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