Whether due to oversight or intentional conduct, there are number of individuals and businesses with unfiled federal tax returns. Under the Internal Revenue Code (IRC) the failure to file a tax return is a misdemeanor (IRC Section 7203) punishable by imprisonment of not more than one year and a fine of up to $25,000. Failure to file can become a felony, punishable by imprisonment of up to five years and a fine of up to $100,000, if the IRS can show that the failure to file was an attempt to evade or defeat tax in violation of IRC Section 7201. To reduce the potential for a criminal investigation or prosecution, taxpayers with unfiled tax returns can make a voluntary disclosure or quiet disclosure to the IRS to resolve any delinquency. Determining what option is best depends on the facts and circumstances of each taxpayer’s situation.
The Internal Revenue Manual has a voluntary disclosure practice that allows taxpayers with unfiled tax returns to voluntarily come forward to reduce the chance of a criminal investigation and prosecution. Although an IRS voluntary disclosure does not automatically guarantee immunity from prosecution, as a matter of practice, the IRS does not pursue criminal charges against a taxpayer who meets the requirements of the voluntary disclosure practice. A voluntary disclosure occurs when a taxpayer timely, truthfully, completely and voluntarily notifies the IRS about one or more unfiled tax returns. Generally, a delinquent taxpayer who makes a voluntary disclosure will file six years of back tax returns, unless there are indications that more returns should be filed.
Above all else, timeliness is the most important factor for a voluntary disclosure. 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 these situations, establishing the day, and even the time, a disclosure is made to the IRS can be critical.
Importantly, a voluntary disclosure can be made by an individual who has not filed tax returns after the individual has received a notice stating that the IRS has no record of receiving a return for a particular year and inquiring into whether the individual filed a return for that year. The individual must file complete and accurate returns and makes arrangements with the IRS to pay the tax, interest, and any penalties determined by the IRS to be applicable. This is a voluntary disclosure because the IRS has not yet commenced an examination or investigation of the taxpayer or notified the taxpayer of its intent to do so.
A voluntary disclosure occurs when the taxpayer or his attorney contacts the IRS and provides the taxpayer’s name, social security number, and date of birth. If the IRS determines that the disclosure is timely, i.e., before the IRS has started a civil examination or criminal investigation or received information from a third party, the taxpayer is notified that he or she is preliminarily accepted into the voluntary disclosure program. If the taxpayer then files complete and accurate tax returns, cooperates with the IRS in determining the correct tax liability and makes good faith arrangements with the IRS to pay any tax, interest and applicable penalties, the disclosure is complete and the taxpayer will not face criminal prosecution.
A “quiet disclosure” occurs when the taxpayer quietly files delinquent tax returns, without first contacting the IRS. The IRS has publicly announced that it does not consider a “quiet disclosure” to be a voluntary disclosure as defined by the Internal Revenue Manual. Because the IRS is not contacted, the taxpayer does not know if a civil or criminal investigation has already started or if the IRS has received information from a third party. As a result, a taxpayer making a quiet disclosure has continuing exposure to a criminal investigation and possible prosecution.
Another example of what is not considered a voluntary disclosure is a letter from an attorney stating his or her client, who wishes to remain anonymous, wants to resolve his tax liability. This is not a voluntary disclosure until the client’s identity is revealed. Likewise, a disclosure made after the start of an IRS examination or investigation or after a third party provides information to the IRS is not a voluntary disclosure.
Any disclosure to the government must be handled carefully, and this is especially true for a disclosure to the IRS. All risks must be analyzed before deciding whether to make a voluntary disclosure or a quiet disclosure to the IRS regarding delinquent tax returns.