You may have seen the recent announcement of the settlement of a New York tax whistleblower suit brought by the New York Attorney General against Fanatics Inc., the sports merchandise and memorabilia retailer. The suit was brought after a whistleblower-initiated investigation found that Fanatics undercollected sales and use tax on online sales between 2014 and 2017.

In 2012, Fanatics engaged a third-party tax software provider to have it calculate state and local sales tax rates and exemptions for its sales in New York. Fanatics also used a backup system to calculate the tax if the third-party software failed.  The backup system's rates were initially set at 4%, but in July 2013 the default rate was set to zero and remained unchanged until November 2015, when it went back to 4%. When the primary system went down, the backup system charged taxes that did not always reflect the applicable local rate or the state rate when exemptions were not applicable.  As a result, Fanatics failed to collect approximately $1.4 million in sales tax that it should have.  According to the settlement, Fanatics was aware of the issues with its backup system, but did not fully correct them until December 2017.

While, according to the settlement, Fanatics did not admit liability and agreed to settle the action to "avoid the time, expense, uncertainty, and distraction of litigation," the case is a reminder of the importance of maintaining systems for the collection of sales tax that comply with applicable state and local rules.  The case also is a reminder that detection of any such systemic failure is not necessarily the result of a governmental audit or examination.  In the Fanatics case, New York’s investigation was triggered by a qui tam complaint filed by whistleblowers under New York's False Claims Act.  Interestingly, the whistleblowers, who are attorneys, will collect $464,371 as part of the settlement.  The same attorneys brought a whistleblower action related to Fanatics’ sales tax practices in Illinois earlier this year, but an Illinois appellate court held that they were not entitled to a portion of Fanatics’ $2.1 million settlement payment because the Illinois Department of Revenue had already audited Fanatics' tax liability and sent it a notice of proposed liability by the time the attorneys filed their qui tam complaint.