Practical SALT Guidance, State Tax Controversy Options: In the past, I’ve written about and explained State Tax Amnesty programs. (See my August 23, 2010 "Buzz" post, "State Tax Amnesty: An Opportunity for Taxpayers to Pay Delinquent Taxes, What Taxpayers Need to Know") State tax amnesties have been very popular in the last few years as a means to quickly raise badly needed state revenues within a short period. Not surprisingly, state tax amnesties have historically occurred in response to recessionary periods. As in explained in my State Tax Amnesty post, a state tax amnesty is a limited-time program approved by a state’s legislature and administered by a state’s Department of Revenue. During an amnesty period, taxpayers can come forward voluntarily and satisfy their delinquent tax obligations in exchange for certain benefits, such as an abatement of penalties and possibly interest.
But what if you determine that you or your business owes state taxes and your state’s amnesty program has already passed?
Unless your state legislature has introduced or passed a bill approving a future amnesty, it’s nearly impossible to predict when your state will institute another amnesty. State tax amnesty programs generally do not occur according to any specific schedule and it could be several years before another amnesty is available. In 2010, the City of Philadelphia announced its first tax amnesty in nearly 25 years! Both Illinois’ and Florida’s 2010 amnesties came seven years after their previous ones. And waiting for the next amnesty to come along isn’t the best idea, as the longer you sit on an unresolved state tax delinquency, the worse the consequences of not resolving it may become. As I also explained in my State Tax Amnesty post, the requirements to participate in a state amnesty vary from state to state. Therefore, even if an amnesty program will be available in your state in the near future, it’s possible that you or your business might not be eligible to participate.
However, there is another avenue available to taxpayers to assist them in resolving their state tax delinquencies. A state’s Voluntary Disclosure Program.
These programs, which are generally administered by a voluntary disclosure unit or designated group within a state's Department of Revenue, exist in virtually every state and are generally on-going (available all the time). The main objective of a voluntary disclosure program is very similar to that of an amnesty program; these programs encourages delinquent taxpayers to come forward and file and pay their delinquent state taxes. Participating in a voluntary disclosure program generally requires a taxpayer who meets the eligibility requirements to enter into a Voluntary Disclosure Agreement (“VDA”) with the state. In exchange for the taxpayer’s voluntary disclosure, the state agrees to grant the taxpayer certain benefits and protections. Note that the level of formality of the programs varies from state to state. For instance, while many states do issue a formal binding agreement (an actual legal contract) which is signed by a state official and the taxpayer, other states simply send out a letter communicating to the taxpayer they have been accepted into the program and listing what the taxpayer must provide and by when.
For taxpayers, the overall primary benefit to entering into a VDA is that it provides an opportunity to resolve outstanding tax delinquencies fully and completely under beneficial terms. Although the exact benefits offered under the various voluntary disclosure programs vary from state to state and taxpayer to taxpayer, in general, the most significant benefits include a limited “look-back” period and a waiver of all applicable penalties. The “look-back” period refers to the number of prior years or periods a taxpayer will be required to report and pay tax on. For example, a three or four year look-back period is common for income tax and sales & use tax voluntary disclosures (although sales & use tax look-back periods are often expressed in months, e.g., 36 or 48 months instead of 3 or 4 years). A taxpayer who has tax delinquencies which relate to years prior to the a state's VD lookback period would be relieved from filing (and paying the associated tax) for all those prior years. This could represent a significant cash savings to a taxpayer who owes back taxes for many years.
Another significant benefit offered through most voluntary disclosure programs is a full abatement of penalties. Receiving an abatement of penalties can also add up to significant cash savings, as accrued penalties can be substantial when tax liabilities remain unpaid for many years. Interest on unpaid taxes, however, is almost always required by the various state statutes and generally isn't abated. (Texas is an example of one state that offers a waiver of interest, as long as the voluntary disclosure does not involve a trustee type tax, e.g., sales tax.)
In addition to the limited look-back period and the abatement of penalties (and possibly interest), one of the most significant benefits of resolving tax delinquencies through the state’s voluntary disclosure program is the ability to request participation in the program on an anonymous basis through a taxpayer representative (a CPA, Attorney, or Tax Advisor) and to negotiate preferred terms before the taxpayer’s identity is disclosed to the state.
The first step in the voluntary disclosure process in most states involves a phone call or a letter to the voluntary disclosure unit or designated contact. Because most states do not require the actual name of the taxpayer during the initial communication with the state, a taxpayer’s representative can ferret out whether the taxpayer will meets the program’s eligibility requirements and might even be able to obtain a general idea of the benefits the taxpayer might receive.
Despite the many benefits of voluntary disclosure, here are a few potential disadvantages or pitfalls to keep in mind. One of the main reasons a state offers voluntary disclosure, in addition to collecting undisclosed taxes that might have never been recovered by the state or that might have only been recovered through extensive collection efforts, is that the program brings new taxpayers onto the state’s tax rolls. This is because a typical eligibility requirement of many voluntary disclosure programs is that the taxpayer is voluntarily disclosing taxes that the taxpayer is not already registered for. (Here again, there are always exceptions to the general rule. Minnesota is one example of a state that allows voluntary disclosure even for registered taxpayers through its Track B program.) To complicate matters, a state may require that the taxpayer either come forward for every type of state tax (income, sale & use, etc.) that the taxpayer owes or that the taxpayer make an affirmative statement that they do not owe other types of tax. However, a taxpayer might not even realize that he owes other state taxes. This is because the various state “nexus” rules are complicated and a taxpayer may not realize that his activities in a state may have created a filing obligation and tax liability. Additionally, once a state has accepted the taxpayer’s request to participate in the voluntary disclosure program and has prepared the VDA for signature, the state may require completion of additional documents such as a nexus questionnaire, registration forms, or other documents. The responses on these other forms may be scrutinized by the state, and could, inadvertently subject the taxpayer to other taxes. Unfortunately, a taxpayer could end up owing other state taxes which they would need to file and pay outside of the protection offered through a VDA. Finally, some states, in particular those with structured programs, require that the various steps in the voluntary disclosure process be completed within short time-frames. For instance, once a taxpayer has come forward, been accepted into the program, and disclosed their identity, they may only have 30 or 60 days to prepare and file all delinquent returns and pay all monies owed to the state. Because the taxpayer has entered into a legal contract with the state, failing to comply with all the requirements of a VDA within the state’s timeframe could cause the VDA to become null and void, thereby extinguishing all the benefits and protections to the taxpayer.
Similar to a state tax amnesty program, a state voluntary disclosure program allows delinquent taxpayers an avenue to come forward voluntarily and pay delinquent taxes. These programs are available in practically every state, but many of the specifics, such as the requirements to participate, the benefits of participating, the process to fulfill, and the time line for completing the process vary from state to state. Even within the same state, the benefits could vary from taxpayer to taxpayer as the voluntary disclosure process allows negotiation to occur. Finally, unlike tax amnesty programs, which only occur periodically, voluntary disclosure are on-going and allow taxpayers an opportunity to resolve their delinquencies on an anonymous basis through a taxpayer representative. If you or your business are concerned about unresolved state tax delinquencies, a discussion with your CPA, attorney or tax advisor regarding your state’s voluntary disclosure program could prove to be very beneficial. I also have extensive experience in assisting companies in resolving their state tax delinquencies through the voluntary disclosure process.
The Multistate Tax Commission’s (MTC) Multi-state Voluntary Disclosure Program: Taxpayers (or their representatives) can utilize the services of the MTC to complete the voluntary disclosure process. This can be particularly helpful when a taxpayer discovers that he owes state taxes in a numerous state. Visit the MTC website for more information.
“Navigating Nexus”, Journal of Accountancy, November 2010 issue: In this article, my co-author and I provide an extensive overview of state nexus, including what activities may create nexus in a state, and what businesses need to consider.
The State Tax Department Links page. On this page you'll find a weblink to the Department of Revenue (Taxation) for all fifty states and the District of Columbia. Find out more about your particular state’s voluntary disclosure program by visiting your state’s Department of Revenue website.