The federal tax system is a voluntary system that relies on taxpayers to file complete and accurate tax returns and other information with the IRS. However, sometimes after a tax return or other information in filed with the IRS, a taxpayer discovers it was incomplete or inaccurate. In order to avoid potential civil or criminal penalties, a taxpayer may want to act. This blog post discusses some of the options taxpayers have for addressing incomplete or inaccurate tax filings.
A taxpayer can simply file an amended tax return that corrects any omission or inaccuracy and in most cases the amended return will be a Qualified Amended Return (QAR). A QAR is defined in Treas. Reg. Section 6664-2(c)(3) as an amended return filed after the due of the original return (determined with regard to extensions) and before:
- The date the taxpayer is first contacted by the IRS regarding an examination or criminal investigation with respect to the return;
- In the case of a promoted transaction, the date the tax shelter promoter is first contacted concerning an IRS examination;
- In the case of a pass-through item, the date the pass-through entity is first contacted by the IRS in connection with an examination of the return to which the pass-through item relates;
- The date a John Doe summons is served on a third party with respect to an activity of the taxpayer for which the taxpayer directly or indirectly claimed a tax benefit; and
- The date on which the IRS announces, by revenue ruling, revenue procedure, notice or announcement, to be published in the Internal Revenue Bulletin, a settlement initiative to waive or compromise penalties with respect to a listed transaction.
If the amended return is a QAR, the amount of tax reported on the QAR is treated as if it were reported on the original tax return. Thus, there is no underpayment of tax for purposes of the 20% accuracy-related penalty. However, a taxpayer could be subject to a 75% civil fraud penalty if the tax deficiency corrected on the amended return relates to a fraudulent position on the original return, including unreported income.
Where there was a fraudulent position on a tax return and a taxpayer is concerned with potential criminal exposure, the taxpayer can make a voluntary disclosure to the IRS. Although an IRS voluntary disclosure does not automatically guarantee immunity from prosecution, as a matter of practice, the IRS will not pursue criminal charges against a taxpayer who meets the requirements of the voluntary disclosure program. A voluntary disclosure occurs when a taxpayer timely, truthfully, completely and voluntarily notifies the IRS about an inaccurate tax return or other document filed with the IRS. A disclosure is timely only if it is made before the IRS has initiated a civil examination or criminal investigation of the taxpayer, or before the IRS has notified the taxpayer that it intends to commence a civil examination or criminal investigation. In addition, a disclosure must be made before a third party alerts the IRS to the taxpayer’s noncompliance. A taxpayer who is concerned that a former spouse, disgruntled employee or former business partner, may provide information to the IRS should consider making a voluntary disclosure before the third party contacts the IRS.
In September 2018, the IRS closed its Offshore Voluntary Disclosure Program and shortly thereafter issued IRS Memo LB&I-09-1118-014, which addresses the process for all voluntary disclosures (domestic and offshore) filed after September 2018. An IRS voluntary disclosure is initiated by completing and filing IRS Form 14457, Part I. If the IRS accepts the taxpayer’s voluntary disclosure, the taxpayer must file all required returns and reports, and pay tax and interest on all previously unreported income for the six most recent tax years. The returns will be assigned to an IRS examiner for review and the taxpayer must cooperate with the IRS examination. A taxpayer who fails to cooperate will be kicked out of the Voluntary Disclosure program and be subject to all civil and criminal penalties. For taxpayers in the program, in most cases the IRS will assess one 75 percent civil fraud penalty under Section 6663 [or in the case of unfiled tax returns, under Section 6651(f)] for the year with the highest tax liability. The IRS examiner will have the discretion to either expand the use of the civil fraud penalty or downgrade it to a 20 percent negligence penalty. In cases involving undisclosed foreign bank accounts, the IRS will follow its willful penalty guidance which typically caps the penalty at 50 percent of the highest year’s balance. The IRS examiner will have the discretion to apply the non-willful FBAR penalty instead of the 50 percent willful penalty. Taxpayers have the right to appeal any determination made by the IRS examiner to the IRS Office of Appeals.
Taxpayers who failed to report foreign financial assets and pay all tax due in respect of those assets have the alternative of using the Streamlined Filing Compliance Procedures. The streamlined procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. The Streamlined Filing Compliance Procedures are designed only for individual taxpayers, including estates of individual taxpayers. The streamlined procedures are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States. In addition to paying the tax due, a miscellaneous offshore penalty equal to five (5) percent of the highest aggregate balance/value of the taxpayer’s unreported foreign financial assets may be applicable.
Taxpayers who have paid all their tax due, but who have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114), can use the Delinquent FBAR Submission Procedures. The IRS will not impose a penalty for the failure to file the delinquent FBARs if the taxpayer properly reported on a U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
Finally, taxpayers who have paid all their tax due, but who have not filed one or more required international information returns, can use the Delinquent International Information Return Submission Procedures. The IRS will not impose a penalty for the failure to file the delinquent international information returns if the taxpayer has reasonable cause for not timely filing the information returns, is not under a civil examination or a criminal investigation by the IRS and has not previously been contacted by the IRS about the delinquent information returns. The delinquent information returns must include a statement of all facts establishing reasonable cause for the failure to file.
A taxpayer’s best option will depend on his or her particular facts and circumstances. Before deciding how to proceed, a taxpayer should consult with a tax professional with experience in making disclosures to the IRS.
For questions related to this or any other civil tax or criminal tax related matter, please feel free to contact Joel Crouch at (214) 749-2456 or firstname.lastname@example.org.