Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca7-14-02190/USCOURTS-ca7-14-02190-0/pdf.json

Parties Involved:
Commissioner of Internal Revenue
Appellee
Craig Patrick
Appellant
Michele Patrick
Appellant

Document Text:

In the 

United States Court of Appeals 

For the Seventh Circuit ____________________ 

No. 14-2190 

CRAIG PATRICK and

MICHELE PATRICK, 

Petitioners-Appellants, 

v. 

COMMISSIONER OF INTERNAL REVENUE, 

Respondent-Appellee. 

____________________ 

Appeal from the United States Tax Court. 

No. 16387-12 — Diane L. Kroupa, Judge. 

____________________ 

ARGUED JANUARY 7, 2015 — DECIDED AUGUST 26, 2015 

____________________ 

Before RIPPLE, WILLIAMS, and SYKES, Circuit Judges. 

WILLIAMS, Circuit Judge. This case concerns the proper tax 

treatment of nearly $7 million that the government paid 

Craig Patrick for uncovering a Medicaid fraud scheme 

where the government paid in excess of $75 million in phony 

billings. Patrick and an associate filed a qui tam suit under 

the False Claims Act against Kyphon, Inc. alleging that the 

company induced hospitals to file claims for Medicare reimCase: 14-2190 Document: 24 Filed: 08/26/2015 Pages: 7
2 No. 14-2190 

bursement “for unnecessary inpatient hospital stays.” The 

United States intervened and settled the case. For his role in 

initiating the suit Patrick received a relator’s share of the 

government’s recovery, totaling $5.9 million. Patrick also received $900,000 from the settlement of related qui tam actions 

against hospitals that overbilled Medicare. 

Patrick and his wife, Michele, filed joint tax returns for 

2008 and 2009 reporting his share of the qui tam recoveries as 

capital gains. The Commissioner of Internal Revenue issued 

deficiency notices, notifying the Patricks that the relator’s 

shares must be reported as ordinary income. The Tax Court 

upheld that determination. We agree with the Commissioner 

and the Tax Court that the relator’s share of a qui tam recovery is not the result of a “gain from the sale or exchange of a 

capital asset.” Rather, Patrick’s relator’s shares are a reward 

for filing the suit against Kyphon and the hospitals and must 

be treated as ordinary income. 

I. BACKGROUND 

Craig Patrick worked as a reimbursement manager for 

Kyphon, a company that designs, manufactures, and sells 

medical equipment to treat spinal conditions. The company 

developed a procedure called a “kyphoplasty” that could be 

performed on an outpatient basis. But Kyphon feared that 

medical providers would be reluctant to purchase the 

equipment if they could not bill for an overnight hospital 

stay. As a result, Kyphon marketed its treatment as an inpatient procedure that required the patient to stay overnight, 

thereby allowing providers to collect larger reimbursements 

from Medicare for the unnecessary hospital stays. 

Case: 14-2190 Document: 24 Filed: 08/26/2015 Pages: 7
No. 14-2190 3

In 2005, Patrick and a former Kyphon salesperson jointly 

filed a qui tam action under the False Claims Act, 31 U.S.C. 

§§ 3729–33, alleging that Kyphon had defrauded the government. The False Claims Act imposes liability on any person who presents to the United States “a false or fraudulent 

claim for payment or approval,” see id. § 3729(a)(1)(A), and 

permits a private person—called a “relator”—to bring suit 

on behalf of the government, see id. § 3730(b)(1). The relator 

must serve the government with a copy of the complaint and 

supporting evidence so that the government may decide 

whether to intervene in the suit. See id. § 3730(b)(2), (4). If the 

government intervenes and wins the suit using primarily 

non-public information provided by the relator, the relator is 

entitled to receive between fifteen and twenty-five percent of 

the recovery. See id. § 3730(d)(1). 

After reviewing Patrick’s qui tam suit against Kyphon, 

the government exercised its option to intervene and 

reached a settlement with Kyphon that required the company to pay it over $75 million. Because the government had 

obtained the recovery based primarily on non-public information provided by Patrick and his co-relator, they received 

a portion of the recovery, with Patrick taking home more 

than $5.9 million. 

After the settlement, Patrick and his co-relator filed similar suits under the False Claims Act against hospitals that 

had billed Medicare for the kyphoplasty procedure as an inpatient treatment. The hospitals settled those suits, and Patrick received almost $900,000 for his involvement as a relator. 

When tax season arrived, Patrick and his wife jointly 

filed a 2008 return that reported Patrick’s share of the setCase: 14-2190 Document: 24 Filed: 08/26/2015 Pages: 7
4 No. 14-2190 

tlement with Kyphon as a capital gain. The couple also filed 

a 2009 tax return that reported the money Patrick received 

from the hospital settlements as capital gains. 

The Commissioner sent the couple deficiency notices for 

both tax years. The notices explained that Patrick’s qui tam

recoveries were “other income rather than a capital gain,” 

and thus, were taxable at the higher rate applicable to ordinary income. Using that higher tax rate, the Commissioner 

determined that the Patricks owed an additional $716,883 for 

2008 and $94,714 for 2009. 

The Patricks petitioned the Tax Court for redetermination of the tax deficiencies. But the court concluded that the 

qui tam recoveries were properly characterized as ordinary 

income, not capital gains. This appeal followed. 

II. ANALYSIS 

Resolution of the appeal requires this court to decide 

whether a relator’s share is a “gain from the sale or exchange 

of a capital asset,” 26 U.S.C. § 1222(1), (3) (defining “capital 

gain”), or a reward intended to compensate the relator for 

his work in bringing the qui tam suit. If the relator’s share 

constitutes a payment for services, the Patricks must claim 

the award as ordinary income. See Canal-Randolph Corp. v. 

United States, 568 F.2d 28, 32 (7th Cir. 1977); Bouchard v. 

Comm’r, 229 F.2d 703, 704 (7th Cir. 1956). This court has never addressed the question of how a relator’s share of a recovery must be characterized under the Internal Revenue Code. 

The only other circuit to resolve the issue concluded that a 

relator’s share is ordinary income because it operates as a 

bounty for the relator’s work in filing the qui tam suit, 

Case: 14-2190 Document: 24 Filed: 08/26/2015 Pages: 7
No. 14-2190 5

see Alderson v. United States, 686 F.3d 791 (9th Cir. 2012), and 

we agree. 

Courts have consistently described a relator’s share as a 

“bounty” or “reward” for the efforts a relator puts forth to 

gather evidence and file a qui tam suit. See Vt. Agency of Natural Res. v. United States ex rel. Stevens, 529 U.S. 765, 772 (2000) 

(stating that relator’s “bounty is simply the fee he receives 

out of the United States’ recovery for filing and/or prosecuting 

a successful action on behalf of the Government.”) (emphasis 

in original); U.S. ex rel. Chovanec v. Apria Healthcare Grp. Inc., 

606 F.3d 361, 364 (7th Cir. 2010) (explaining that relator’s 

award compensates for relator’s “services” and “work to uncover fraud”); Roberts v. Accenture, LLP, 707 F.3d 1011, 1016 

(8th Cir. 2013) (referring to relator’s share as “finder’s fee”); 

Alderson, 686 F.3d at 795; Riley v. St. Luke’s Episcopal Hosp., 

252 F.3d 749, 752 (5th Cir. 2001) (describing relator’s share as 

“reward”). This line of cases suggests that a relator’s award 

is a payment for services performed, and therefore, that the 

award must be claimed as ordinary income. See CanalRandolph Corp., 568 F.2d at 32; Bouchard, 229 F.2d at 704. 

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 investCase: 14-2190 Document: 24 Filed: 08/26/2015 Pages: 7
6 No. 14-2190 

ment 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. 

When we turn to the Internal Revenue Code’s definition 

of “capital gain”—a “gain from the sale or exchange of a 

capital asset,” 26 U.S.C. § 1222(1), (3)—we reinforce our conclusion that a relator’s award does not qualify for that status. 

The Internal Revenue Code defines a “capital asset” as 

“property held by a taxpayer,” 26 U.S.C. § 1221, and courts 

agree that an item is property only if the owner has the right 

to exclude others from using it, see Kaiser Aetna v. United 

States, 444 U.S. 165, 179–80 (1979); Minn. Mining & Mfg. Co. v. 

Pribyl, 259 F.3d 587, 609 (7th Cir. 2001). The Patricks offer 

two ways to regard them as having invested a “capital asset” 

or “property,” but neither is persuasive. 

First, they maintain that Patrick’s “property” was the information that he gathered at Kyphon and, they contend, he 

had a right to stop others from using it. We do not see it that 

way. True, Patrick compiled documents that he transferred 

to the government. But the information contained in those 

documents—information about Kyphon’s fraudulent practices—was available to many other Kyphon employees who 

could have used the knowledge to file their own qui tam suit. 

The Patricks reply by comparing the information to a trade 

secret, which may have multiple owners. But even if the information Patrick gathered was secret in the sense that it 

was nonpublic information, he had no right to stop anyone 

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No. 14-2190 7

else from using it, and, thus, the information and documents 

cannot be his “property.” See Kaiser Aenta, 444 U.S. at 179–80. 

Second, the Patricks contend that Patrick’s right to a 

share of the recovery constitutes a “capital asset,” but this 

argument fares no better. Patrick’s award was a payment for 

his efforts to collect documents and file the qui tam suit. 

See Vt. Agency of Natural Res., 529 U.S. at 772; Apria Healthcare 

Grp. Inc., 606 F.3d at 364. The Commissioner aptly analogizes 

this situation to an attorney’s interest in payment under a 

contingency fee arrangement. The attorney’s interest in future compensation for legal work, and Patrick’s interest in a 

future award for his investigative work, both constitute an 

interest in future payment for services. And compensation 

for services qualifies as ordinary income, not a capital gain. 

See Canal-Randolph Corp., 568 F.2d at 32; Bouchard, 229 

F.2d at 704. Because the Patricks have not demonstrated that 

Patrick possessed a capital asset, his relator’s share from the 

qui tam suit cannot constitute a “capital gain.” See 26 U.S.C. 

§ 1222(1), (3) (defining “capital gain” as a “gain from the sale 

or exchange of a capital asset”). 

III. CONCLUSION

For all the foregoing reasons, the decision of the Tax 

Court is AFFIRMED. 

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