Voluntary Disclosure – Benefits of Timely Filing Amended and Delinquent Tax Returns
Voluntary Disclosure. Practitioners often struggle with the issue of whether a taxpayer can avoid a criminal tax investigation by making a disclosure to the IRS. A “voluntary disclosure” is generally the process of voluntarily reporting previously undisclosed income (or false deductions) through an amended return or the filing of a delinquent return. A taxpayer’s timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution.
A voluntary disclosure must be truthful, timely and complete, and the taxpayer must demonstrate a willingness to cooperate (and must in fact cooperate) with the IRS in determining the correct tax liability. Further, the taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. Additionally, the policy only applies to income earned through a legal business – so called “legal source” income.
IRS and JOJ Voluntary Disclosure Practice. Importantly, the IRS Voluntary Disclosure Practice describes a voluntary disclosure to include: (6) Examples of voluntary disclosures include: a. a letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above. This is a voluntary disclosure because all elements . . . above are met.” See Internal Revenue Manual (IRM) 18.104.22.168. If this process is pursued, it is important that all the appropriate “bells and whistles” set forth in the IRM are followed, exactly.
The Department of Justice maintains a voluntary disclosure policy that provides: “Whenever a person voluntarily discloses that he or she committed a crime before any investigation of the person’s conduct begins, that factor is considered by the Tax Division along with all other factors in the case in determining whether to pursue criminal prosecution. If a putative criminal defendant has complied in all respects with all of the requirements of the Internal Revenue Service’s voluntary disclosure practice, the Tax Division may consider that factor in its exercise of prosecutorial discretion. It will consider, inter alia, the timeliness of the voluntary disclosure, what prompted the person to make the disclosure, and whether the person fully and truthfully cooperated with the government by paying past tax liabilities, complying with subsequent tax obligations, and assisting in the prosecution of other persons involved in the crime.” Section 4.01, Criminal Tax Manual, U.S. Department of Justice (2008).
Further, the Department’s Policy Directives and Memoranda provides: “. . . the Service’s voluntary disclosure policy remains, as it has since 1952, an exercise of prosecutorial discretion that does not, and legally could not, confer any legal rights on taxpayers. If the Service has referred a case to the Division, it is reasonable and appropriate to assume that the Service has considered any voluntary disclosure claims made by the taxpayer and has referred the case to the Division in a manner consistent with its public statements and internal policies. As a result, our review is normally confined to the merits of the case and the application of the Department’s voluntary disclosure policy set forth in Section 4.01 of the Criminal Tax Manual.” Section 3, Policy Directives and Memoranda, Tax Division, U.S. Department of Justice (02/17/1993).
A practitioner should always advise a client seeking advice about a potential voluntary disclosure that the client must comply with the next set of filing requirements. Any suggestion to the contrary by the practitioner could subject him or her to potential criminal liability for aiding or assisting in the failure to file a return or the filing of a false return. This precept becomes important because many clients express a fear that a current filing may trigger scrutiny of their prior conduct, and some change their minds about making a voluntary disclosure prior to actually filing. Thus, the practitioner should always advise the client of the legal requirements for the current filing season and memorialize in the file that such advice was given.
Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution. A timely voluntary disclosure will not guarantee immunity from criminal prosecution, but a true voluntary disclosure will normally result in the IRS not even recommending a criminal prosecution to the Department of Justice.
Timely? To be timely, the disclosure must generally be received before: (i) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; (ii) the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance; (iii) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or (iv) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
Any taxpayer who contacts the IRS regarding voluntary disclosure may be directed to IRS-CI for an evaluation of the disclosure. To determine whether the disclosure is truly voluntary, IRS will review the actual status of any prior interest in the taxpayer, the taxpayer’s potential knowledge of such interest, and the taxpayer’s fear of some potential trigger that could have alerted the IRS. A voluntary disclosure cannot be made anonymously. Any plan by a taxpayer, or their representative, to resolve a tax liability, file a correct return, or offer payment of taxes for an anonymous client is not likely to be considered a voluntary disclosure.
A voluntary disclosure does not occur until IRS has actually been contacted. As such, it is imperative that the disclosure occur as quickly as possible. Since returns filed pursuant to a timely voluntary disclosure have significant audit potential, they should be “bulletproof” in correctly reflecting the taxpayer’s income and expense items.
Fed-State Information Sharing. Due to various federal-state information sharing agreements, any applicable state returns should be contemporaneously filed or amended with the federal returns. Returns for related entities should also be contemporaneously filed or amended. Questions or doubts should likely be resolved in favor of the government. If a return filed pursuant to a voluntary disclosure is less than accurate, the taxpayer is compounding – not helping the problem.
Qualified Amended Return (QAR). Under certain situations, a timely filed amended return may reduce or eliminate accuracy-related penalties. The “amount shown as the tax by the taxpayer on his return” not subject to penalties includes an amount shown as additional tax on a QAR, except that such amount is not included if it relates to a fraudulent position on the original return. See Treas. Reg. § 6664-2(c). A QAR effectively eliminates accuracy-related penalties by removing amounts shown on the amended return from the penalty calculation. Significantly, even if timely, an amended return does not qualify as a QAR if the tax deficiencies that are corrected in the amended return relate to a fraudulent position on the original filed return.
How many returns must be filed or amended? While there is certainly no well-established rule as to how many returns must be filed in making a voluntary disclosure, the general consensus is probably six tax years since the applicable statute of limitations for most tax related crimes is six years. The disclosure should eliminate any government concern that there might be any potential issues with respect to a particular tax year for which the applicable statute of limitations for criminal prosecutions has not already expired. Additional returns could be in order since the statute of limitations for a criminal prosecution is tolled for the period of time a taxpayer is outside of the United States or is a fugitive from justice.
Typically, in a civil context, it is also the IRS policy to enforce the filing of returns for the prior 6 tax years. In considering whether shorter or longer periods should be civilly enforced, the IRS will determine the prior history of non-compliance, the possible existence of income from illegal sources, the effect on voluntary compliance, the anticipated revenue in relation to the time and effort required to determine the tax due, and special circumstances existing in the case of a particular taxpayer, class of taxpayer, or industry, which may be particular to the class of tax involved.
Should IRS be Contacted Directly? Counsel must determine whether to contact the IRS before submitting a voluntary disclosure and actually filing the delinquent or amended tax returns. Some practitioners prefer to submit a Freedom of Information Act (FOIA) request seeking income information already in the possession of the IRS before filing the returns. Some simply choose to file the delinquent or amended returns, with payment of tax and interest, with the appropriate IRS service center (now referred to as a “campus”) by certified mail, return receipt requested. Such filings occur during the typical tax return filing season (around April 15 and October 15 for individual returns).
Some prefer making the voluntary disclosure in a meeting with the Special Agent in Charge of the local IRS-CI where the investigation would be conducted. At this meeting, the potential voluntary disclosure would initially be discussed in a hypothetical format. Counsel would generally outline the facts in hypothetical form (probably in writing) and would request whether IRS-CI would consider the return filing to be a voluntary disclosure in order to avoid recommendation of a criminal prosecution.
Counsel may also attempt to secure an IRS waiver of all applicable penalties before revealing the taxpayers identity. In the event that IRS-CI responds affirmatively, counsel would then disclose the client’s identity and taxpayer identification number. However, IRS will assert that there has not been the requisite “disclosure” until the taxpayers information has been provided to the IRS.Properly resolving these issues can mean the difference between a taxpayer being subjected solely to civil tax adjustments (and possibly civil penalties), criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.
Certainly, the IRS has a somewhat limited capacity to perform criminal investigations. However, a significant amount of time is not required to criminally investigate and seek to prosecute a non-filer, particularly one who files delinquent or amended returns following an IRS inquiry. Without adequate representation, the perceived light at the other end of the voluntary disclosure tunnel . . . may be the IRS train coming straight at the taxpayer!