Following the close of the highly successful Offshore Voluntary Disclosure Program in late 2018, the Internal Revenue Service updated its longstanding Voluntary Disclosure Program and, in April 2020, released a detailed form and instructions relating to participation in this new iteration of the program.
Then this past fall, the agency updated the voluntary disclosure section of the Internal Revenue Manual. It also launched a new website that describes the new program, identifies who may participate, and outlines the submission procedures.
Unlike some earlier compliance programs that generally were limited to individuals, this updated program is available to individuals, trustees, business entities and executors.
The program provides a means for voluntarily disclosing tax violations/deficiencies beyond those relating to income tax (domestic and foreign). Also, the program is open to individuals seeking to disclose potential issues related to employment, gift and estate tax.
As broad as the program may appear, however, it will not be a suitable option for many taxpayers, and anyone considering participation should be sure to consider its pros and cons, preferably with an experienced lawyer.
Why use a voluntary disclosure program?
For years, the IRS has had programs that have allowed individuals to self-disclose tax violations to substantially lower the risk of criminal prosecution for tax crimes.
The OVDP, in particular, offered a high degree of predictability given its “one size fits all” penalty framework. Under that program, a set penalty amount was applied based on the tax year with the highest aggregate noncompliant account balance. This was in lieu of the normal penalties that would have otherwise applied under the Foreign Bank Account Report and foreign information return rules.
Many taxpayers participated due to this standard penalty structure. The updated program similarly provides a framework for coming into compliance with the tax laws in exchange for a reduced risk of criminal prosecution.
Although a submission need not involve an offshore issue, the government remains focused on criminal tax enforcement in the offshore context, so the program may be of particular interest to taxpayers who have criminal tax exposure that stems from the ownership of non-U.S. business entities and accounts.
How to Apply
To enter the program, taxpayers make a submission on the IRS Form 14457. The submission can be made by an individual, a trustee on behalf of a trust, a partnership, a corporation and, in some cases, an executor.
The submission can cover domestic and foreign income tax, estate and gift tax and employment tax. Notably, it cannot be used to disclose illegal source income, which includes income that is derived through illegal activities for federal purposes even if those activities are legal under state law (e.g., income related to the cannabis industry).
The form is divided into two parts. The first part is a mandatory pre-clearance, which determines whether a taxpayer is eligible to participate and whether the IRS is already aware of the taxpayer’s noncompliance.
Acceptance in the program is not guaranteed, and a taxpayer should not submit prior year returns until the IRS has assigned an agent to the case and cleared the taxpayer to participate.
Once accepted, the taxpayer must provide a detailed narrative related to their history of tax noncompliance on the second part of the form. The narrative cannot be supplemented at a later stage, so it is critical to provide a complete story from the outset.
In general, there is a six-year lookback period for purposes of filing delinquent or amended returns, and the IRS will apply a civil fraud penalty to the year with the highest tax liability.
Specifics about the application of foreign information return penalties and penalties related to employment, gift, and estate tax issues are still unclear. Where Foreign Bank and Financial Accounts noncompliance is an issue, willful FBAR penalties likely will apply, which could represent a significant amount in monetary penalties.
Essential to program participation is that the taxpayer cooperates with the government in investigating others who may have assisted in the noncompliance. This is consistent with the Department of Justice and the IRS Criminal Investigations Unit’s focus on third party advisors, known as professional enablers.
Form 14457 instructions require cooperation with the IRS in determining the taxpayer’s own tax liability and reporting requirements, and also cooperation in the IRS’s investigation of professional enablers.
To that end, detailed information on professional advisors and facilitators who provided services to them over the period of noncompliance must be provided by the taxpayer.
Who Should Apply?
Only taxpayers who have engaged in willful or fraudulent tax noncompliance and who face a material risk of criminal prosecution should consider applying. Such taxpayers generally fall into one of three categories:
1) Anxious taxpayers.
This category includes taxpayers losing sleep because they are worried about criminal consequences related to tax noncompliance. For the anxious client, monetary penalty uncertainty is unlikely to be a deterrent to participation in the program because the threat of jail time looms large.
This type of client similarly is not deterred by the need to fully disclose his or her own activity or the identities of others, and cooperation with the government is not an issue. For such clients, the potential drawbacks and uncertainties of the program are outweighed by the clear path it offers to come into tax compliance.
2) Taxpayers who fear disclosure by others.
The program is likely to be attractive to taxpayers who fear or even anticipate, disclosure of their tax misbehavior by others. Third-party disclosure could take several forms:
- Details about an individual’s tax noncompliance may come to light in the course of a divorce proceeding.
- A state court litigation involving a taxpayer’s business could make public certain facts that could lead to an IRS criminal investigation.
- A taxpayer’s employee may initiate a whistleblower action.
- A financial institution or service provider could provide the government information in response to a John Doe summons, triggering a criminal tax investigation.
Those who anticipate third-party disclosure should engage counsel quickly to help evaluate the benefits of participation and to move quickly toward preclearance, if appropriate. A delay in applying may disqualify the taxpayer if the government has in the meantime already opened an investigation or otherwise become aware of the noncompliance.