The IRS Voluntary Disclosure Program
The federal tax system is a voluntary system that relies on taxpayers to file complete and accurate tax returns. However, the IRS released a study reporting that individuals and businesses underpay their taxes by an estimated 17% each year, resulting in almost $450 billion of lost tax revenues each year. Taxpayers who intentionally file inaccurate or incomplete tax returns risk exposure to significant criminal penalties. For taxpayers who have a guilty conscience or second thoughts, the IRS has a voluntary disclosure program that allows taxpayers to reduce the chance of a criminal investigation or prosecution by voluntarily confessing their sins to the IRS and filing amended tax returns. Taxpayers who have not filed tax returns when they are required to do so are also eligible to participate in the IRS voluntary disclosure program. The IRS will require a delinquent taxpayer who makes a voluntary disclosure to file six years of back tax returns, unless there are indications that more returns should be filed.
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 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.
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.
A voluntary disclosure is often referred to as a “noisy disclosure”. A “noisy 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 is preliminarily accepted into the voluntary disclosure program. If the taxpayer then files complete and accurate amended tax returns, cooperates with the IRS in determining the correct tax liability and makes good faith arrangements with the IRS to pay in full 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 an amended return, without first contacting the IRS. 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. Furthermore, the IRS has stated that it does not consider a “quiet disclosure” to be a voluntary disclosure as defined by the Internal Revenue Manual.
Other IRS examples of what is not considered a voluntary disclosure include 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 are not voluntary disclosures.
In deciding whether a client should make a quiet or noisy disclosure, an advisor must consider the client’s risk tolerance and the seriousness of the misstatement on the original return. A noisy disclosure is the safest and most conservative approach and should be used if there is any concern that the client has exposure to criminal tax penalties. Any voluntary disclosure to the government must be handled carefully, but especially a voluntary disclosure to the IRS. It is critical to analyze all the risks before deciding whether to make a voluntary disclosure.