An Egyptian al-Qaida operative will reportedly receive a $27 million reward for revealing the whereabouts of Khalid Sheikh Mohammed, the accused terrorist leader captured March 1. Where is that money coming from, and is it taxable?
The $27 million will be paid out by the Bureau of Diplomatic Security, a division of the U.S. Department of State. The bureau oversees the "Rewards for Justice" program, established by Congress as part of the 1984 Act To Combat International Terrorism. Formerly known as "Heroes," the program has so far paid over $9.5 million to 23 tipsters, not including the Egyptian who betrayed Mohammed. The identities of these informants are usually kept confidential, and the State Department refuses to answer most questions about the program's details.
What is known, however, is that the process for claiming such a reward is mighty convoluted. An informer must first be nominated by a law enforcement agency. A committee consisting of representatives from the State Department, the FBI, the CIA, the National Security Council, and the Justice Department then meets to consider whether an award is appropriate and to fix the amount. A recommendation is then made to the secretary of state, who must consult with the attorney general before signing off on the expenditure. If the reward is greater than $250,000, the president must also give his personal approval.
Prior to 2001, the maximum amount that could be awarded to an informant was $5 million. However, the Patriot Act, passed in the aftermath of 9/11, authorized the secretary of state to offer higher amounts if he deems it necessary to fighting al-Qaida. Colin Powell set the bounty on Mohammed at $25 million; he later sweetened the pot with an additional $2 million, a sum the Egyptian demanded to assist with the cost of relocating his family to Great Britain.
Though the money currently comes out of Uncle Sam's pocket, via the State Department, a group of private citizens is hoping to contribute to future rewards. The Rewards for Justice Fund, founded by Priceline.com founder Scott Case, has vowed to raise $100 million over the next five years, through donations and the sale of "United We Stand" license plates. It's unclear, however, whether the nonprofit fund has yet contributed to the government's program. (Calls to fund officers were not returned.)
Also somewhat uncertain is whether the suddenly flush Egyptian will have to fork over 38.6 percent of his windfall—the top tax rate—to the Internal Revenue Service. If the State Department adheres strictly to the letter of the law, the answer is yes. Since 1913, reward money has been subject to taxation, barring an act of Congress to exempt a specific reward. When David Kaczynski, brother of convicted Unabomber Ted Kaczynski, collected his $1 million reward in 1998, he was disappointed to learn that the sum would be taxed at the highest possible rate—despite the fact that he intended to distribute the money to the families of his brother's victims. A congressional bill to exempt the reward never made it past the House; Kaczynski ended up minimizing the levies by putting the money (less legal fees) into a tax-exempt fund administered by a charity.
Neither the 1984 Act To Combat International Terrorism nor the 2001 Patriot Act specifically exempt the State Department's rewards from taxation. A quickie bill could change that, of course, and might be in the program's best interest—a massive IRS levy might stir up more distrust in the Muslim world. The State Department is mum as to how it might get around that sticky situation, however; calls to the Bureau of Diplomatic Security were not returned.
Bonus Explainer: Aware that Afghan farmers have little concept of a dollar's worth, last March the Pentagon proposed developing its own rewards system in lieu of the State Department's. In exchange for information on the location of al-Qaida soldiers, peasants would receive such inducements as new livestock and water wells. The $5 million program has yet to be formally established.
Explainer thanks Bruce Friedland of the Internal Revenue Service.