This May Be a Very Good Time to Consider a Voluntary Disclosure By SANDRA R. BROWN
Posted by Hochman Salkin Toscher Perez P.C. 
Posted on Sunday, May 03, 2020
For decades, the Internal Revenue Service (“IRS”) has maintained a voluntary disclosure policy which provides an opportunity for taxpayers to come forward and disclose their noncompliance with the tax laws with the primary incentive being that, in almost all cases, the taxpayer will avoid criminal prosecution. The IRS made some significant announcements recently that could benefit those who wish to consider a voluntary disclosure to come into compliance with the tax laws.
IRS Announcement for Non-Filers
On March 25, 2020, the IRS announced the new IRS People First Initiative to provide immediate relief to help people facing uncertainty over taxes.[i] A highlight of the key actions in the IRS People First Initiative focused on Non-Filers with the IRS reminding people who have not filed their returns for tax years before 2019 that they should file their delinquent returns and consider taking the opportunity to resolve any outstanding liabilities with the IRS to obtain a “Fresh Start.”
IRS Memorandum Limiting New LB&I Examinations
On April 14, 2020, a Memorandum was issued to all IRS Employees assigned to the Large Business and International Division (“LB&I”) regarding compliance priorities during COVID-19 Pandemic.[ii] The Memorandum directed that through July 15, 2020, with some limited exceptions[iii], LB&I will not open new examinations unless it falls within a continuing activity as defined therein.
IRS’s Voluntary Disclosure Program
The IRS’s Voluntary Disclosure Program is designed to give taxpayers with exposure to potential criminal liability or substantial civil penalties due to a willful failure to report legal source income and/or foreign assets an opportunity, with potential protection from criminal liability, to pay all tax due associated with respect to unreported income and foreign assets. The current procedures, applicable for voluntary disclosures made after September 28, 2018, apply to both domestic and offshore voluntary disclosures. That said, the current policy bears many of the earmarks found under the prior offshore voluntary disclosure programs.
Current IRS Voluntary Disclosure Program
On November 20, 2018, the IRS announced its newest voluntary disclosure procedures as set forth in a five-page guidance memorandum.[iv] The guidance makes several points very clear: (1) taxpayers who did not commit any tax or tax related crimes and do not need the voluntary disclosure practice to seek protection from potential criminal prosecution can continue to correct past mistakes using the Streamlined Filing Compliance Procedures or by filing an amended or past due tax return; (2) for those taxpayers who do need protection, the filing of corrected tax returns for the most recent six-year period will be required, with IRS agents having the discretion to expand the disclosure period to cover additional years and cooperative taxpayers also being allowed to expand the disclosure period; (3) for taxpayers participating in a voluntary disclosure, cooperation with the IRS means more than just making full disclosure of unreported income and offshore assets, extending the time to assess, and arranging for payment: the IRS expects taxpayers to assent to all adjustments that result from the audit; and, (4) while the current voluntary program, unlike the preceding offshore voluntary programs, does permit the right to seek review by IRS Appeals, the IRS expects that taxpayers will not to exercise their legal rights to contest audit adjustments and seek review by IRS Appeals in return for the IRS’s agreement, in general, not to assess more stringent penalties.
Voluntary Disclosure Preclearance by IRS-Criminal Investigation
IRS-Criminal Investigation (“CI”) will continue to screen all voluntary disclosure requests to determine if a taxpayer is eligible to make a voluntary disclosure. For all cases where CI grants preclearance, taxpayers must then promptly submit all required voluntary disclosure documents using Form 14457.
Form 14457 requires information related to taxpayer noncompliance, including a narrative providing the facts and circumstances, assets, entities, related parties, and equally important, identification of any professional advisors involved in the taxpayer’s noncompliance.
After CI has preliminarily accepted the taxpayer’s voluntary disclosure, it will notify the taxpayer of preliminary acceptance by letter and simultaneously forward the voluntary disclosure letter and attachments to the LB&I unit in Austin, Texas. This LB&I unit will select the most recent tax year covered by the voluntary disclosure for examination and forward cases to the appropriate Business Operating Division and Exam function for civil audit. All voluntary disclosures will follow standard audit procedures.
Voluntary Disclosure Penalty Framework
The nature and extent of penalties assessed under the voluntary disclosure program will, in large part, be a function of the taxpayer’s cooperation during the process. A taxpayer who provides prompt and full cooperation during the examination of a voluntary disclosure is entitled to civil penalty mitigation, whereas a taxpayer whose case is not resolved by agreement can expect to face maximum civil penalties under the law.
A summary of the penalties applied to taxpayers who fully cooperate with the IRS during the process are as follows:
Civil Fraud Penalty
The civil penalty under IRC § 6663 for fraud or the civil penalty under IRC §6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. In limited circumstances, the IRS may apply the civil fraud penalty to more than one year – up to all six years – based on the facts and circumstances of the case. Typically, the IRS’s assertion of the civil fraud penalty beyond six years will only occur if the taxpayer fails to cooperate and resolve the examination by agreement. Note, while the taxpayer may request imposition of accuracy-related penalties under IRC §6662 instead of civil fraud penalties, the IRS expects that such requests will involve exceptional circumstances.
FBAR Penalty
If the voluntary disclosure also involves a non-disclosed foreign bank account, then willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines contained in the Internal Revenue Manual, which include mitigation guidelines that permit the IRS to reduce FBAR penalties if certain criteria are met. A taxpayer must present convincing evidence to justify why such penalty should not be imposed. Additionally, while a taxpayer may request that the IRS impose non-willful FBAR penalties, the granting of such request is again expected to only happen in exceptional circumstances.
Information Return Penalties
The penalties for failure to file information returns will not be automatically imposed. This is a positive development for taxpayers, as the penalties for not filing information returns such as Forms 5471 (requiring disclosure of ownership of foreign corporations), Forms 8938 (requiring disclosure of foreign financial assets), and Forms 3520 (requiring disclosure of information regarding foreign trusts), can be significant, especially if the taxpayer’s noncompliance spans multiple years. The procedures provide that agents will exercise discretion as to these types of penalties and will take into account the application of other penalties (such as the civil fraud penalty and the willful FBAR penalty) and the extent of the taxpayer’s cooperation.
Other Penalties
Other penalties, such as those relating to excise taxes, employment taxes, and estate and gift taxes, will be based upon the facts and circumstances of each case and taxpayers should anticipate that when such facts exist, the examining agent may seek assistance from the appropriate subject matter experts within the IRS.
Options for Taxpayers with Unfiled Returns or Unreported Income Who Do Not Need Protection from Potential Criminal Prosecution
There are other programs for taxpayers with unfiled returns or unreported income who may not have exposure to criminal liability or substantial civil penalties due to willful noncompliance. As noted above, those options include the Streamlined Filing Compliance Procedures, the delinquent FBAR submission procedures, or the delinquent international information return submission procedures. Most taxpayers would prefer to settle things through these later programs, as the options call for significantly smaller penalties, if not penalty-free, resolutions with the IRS. So, while the adage no “one size fits all” may always be applicable when it comes to noncompliant taxpayers coming in from the cold, with the IRS currently standing down on the opening of new examination cases, the adage that “timing is everything” in the context of getting to the IRS before the IRS gets to you, is especially true right now.
Sandra R. Brown is a Principal at Hochman Salkin Toscher Perez P.C. Prior to joining the firm, Ms. Brown served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal). Ms. Brown specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court.
[i] IR-2020-59, March 25, 2020.
[ii] Revision to Internal Revenue Manual 4.46.3; LB&I-04-0420-009.
[iii] Id.(e.g., LB&I managers have discretion with respect to examinations of prior, subsequent, and related returns associated with an existing examination.)
[iv] https://www.irs.gov/pub/foia/ig/spder/lbi-09-1118-014.pdf
For decades, the Internal Revenue Service (“IRS”) has maintained a voluntary disclosure policy which provides an opportunity for taxpayers to come forward and disclose their noncompliance with the tax laws with the primary incentive being that, in almost all cases, the taxpayer will avoid criminal prosecution. The IRS made some significant announcements recently that could benefit those who wish to consider a voluntary disclosure to come into compliance with the tax laws.
IRS Announcement for Non-Filers
On March 25, 2020, the IRS announced the new IRS People First Initiative to provide immediate relief to help people facing uncertainty over taxes.[i] A highlight of the key actions in the IRS People First Initiative focused on Non-Filers with the IRS reminding people who have not filed their returns for tax years before 2019 that they should file their delinquent returns and consider taking the opportunity to resolve any outstanding liabilities with the IRS to obtain a “Fresh Start.”
IRS Memorandum Limiting New LB&I Examinations
On April 14, 2020, a Memorandum was issued to all IRS Employees assigned to the Large Business and International Division (“LB&I”) regarding compliance priorities during COVID-19 Pandemic.[ii] The Memorandum directed that through July 15, 2020, with some limited exceptions[iii], LB&I will not open new examinations unless it falls within a continuing activity as defined therein.
IRS’s Voluntary Disclosure Program
The IRS’s Voluntary Disclosure Program is designed to give taxpayers with exposure to potential criminal liability or substantial civil penalties due to a willful failure to report legal source income and/or foreign assets an opportunity, with potential protection from criminal liability, to pay all tax due associated with respect to unreported income and foreign assets. The current procedures, applicable for voluntary disclosures made after September 28, 2018, apply to both domestic and offshore voluntary disclosures. That said, the current policy bears many of the earmarks found under the prior offshore voluntary disclosure programs.
Current IRS Voluntary Disclosure Program
On November 20, 2018, the IRS announced its newest voluntary disclosure procedures as set forth in a five-page guidance memorandum.[iv] The guidance makes several points very clear: (1) taxpayers who did not commit any tax or tax related crimes and do not need the voluntary disclosure practice to seek protection from potential criminal prosecution can continue to correct past mistakes using the Streamlined Filing Compliance Procedures or by filing an amended or past due tax return; (2) for those taxpayers who do need protection, the filing of corrected tax returns for the most recent six-year period will be required, with IRS agents having the discretion to expand the disclosure period to cover additional years and cooperative taxpayers also being allowed to expand the disclosure period; (3) for taxpayers participating in a voluntary disclosure, cooperation with the IRS means more than just making full disclosure of unreported income and offshore assets, extending the time to assess, and arranging for payment: the IRS expects taxpayers to assent to all adjustments that result from the audit; and, (4) while the current voluntary program, unlike the preceding offshore voluntary programs, does permit the right to seek review by IRS Appeals, the IRS expects that taxpayers will not to exercise their legal rights to contest audit adjustments and seek review by IRS Appeals in return for the IRS’s agreement, in general, not to assess more stringent penalties.
Voluntary Disclosure Preclearance by IRS-Criminal Investigation
IRS-Criminal Investigation (“CI”) will continue to screen all voluntary disclosure requests to determine if a taxpayer is eligible to make a voluntary disclosure. For all cases where CI grants preclearance, taxpayers must then promptly submit all required voluntary disclosure documents using Form 14457.
Form 14457 requires information related to taxpayer noncompliance, including a narrative providing the facts and circumstances, assets, entities, related parties, and equally important, identification of any professional advisors involved in the taxpayer’s noncompliance.
After CI has preliminarily accepted the taxpayer’s voluntary disclosure, it will notify the taxpayer of preliminary acceptance by letter and simultaneously forward the voluntary disclosure letter and attachments to the LB&I unit in Austin, Texas. This LB&I unit will select the most recent tax year covered by the voluntary disclosure for examination and forward cases to the appropriate Business Operating Division and Exam function for civil audit. All voluntary disclosures will follow standard audit procedures.
Voluntary Disclosure Penalty Framework
The nature and extent of penalties assessed under the voluntary disclosure program will, in large part, be a function of the taxpayer’s cooperation during the process. A taxpayer who provides prompt and full cooperation during the examination of a voluntary disclosure is entitled to civil penalty mitigation, whereas a taxpayer whose case is not resolved by agreement can expect to face maximum civil penalties under the law.
A summary of the penalties applied to taxpayers who fully cooperate with the IRS during the process are as follows:
Civil Fraud Penalty
The civil penalty under IRC § 6663 for fraud or the civil penalty under IRC §6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. In limited circumstances, the IRS may apply the civil fraud penalty to more than one year – up to all six years – based on the facts and circumstances of the case. Typically, the IRS’s assertion of the civil fraud penalty beyond six years will only occur if the taxpayer fails to cooperate and resolve the examination by agreement. Note, while the taxpayer may request imposition of accuracy-related penalties under IRC §6662 instead of civil fraud penalties, the IRS expects that such requests will involve exceptional circumstances.
FBAR Penalty
If the voluntary disclosure also involves a non-disclosed foreign bank account, then willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines contained in the Internal Revenue Manual, which include mitigation guidelines that permit the IRS to reduce FBAR penalties if certain criteria are met. A taxpayer must present convincing evidence to justify why such penalty should not be imposed. Additionally, while a taxpayer may request that the IRS impose non-willful FBAR penalties, the granting of such request is again expected to only happen in exceptional circumstances.
Information Return Penalties
The penalties for failure to file information returns will not be automatically imposed. This is a positive development for taxpayers, as the penalties for not filing information returns such as Forms 5471 (requiring disclosure of ownership of foreign corporations), Forms 8938 (requiring disclosure of foreign financial assets), and Forms 3520 (requiring disclosure of information regarding foreign trusts), can be significant, especially if the taxpayer’s noncompliance spans multiple years. The procedures provide that agents will exercise discretion as to these types of penalties and will take into account the application of other penalties (such as the civil fraud penalty and the willful FBAR penalty) and the extent of the taxpayer’s cooperation.
Other Penalties
Other penalties, such as those relating to excise taxes, employment taxes, and estate and gift taxes, will be based upon the facts and circumstances of each case and taxpayers should anticipate that when such facts exist, the examining agent may seek assistance from the appropriate subject matter experts within the IRS.
Options for Taxpayers with Unfiled Returns or Unreported Income Who Do Not Need Protection from Potential Criminal Prosecution
There are other programs for taxpayers with unfiled returns or unreported income who may not have exposure to criminal liability or substantial civil penalties due to willful noncompliance. As noted above, those options include the Streamlined Filing Compliance Procedures, the delinquent FBAR submission procedures, or the delinquent international information return submission procedures. Most taxpayers would prefer to settle things through these later programs, as the options call for significantly smaller penalties, if not penalty-free, resolutions with the IRS. So, while the adage no “one size fits all” may always be applicable when it comes to noncompliant taxpayers coming in from the cold, with the IRS currently standing down on the opening of new examination cases, the adage that “timing is everything” in the context of getting to the IRS before the IRS gets to you, is especially true right now.
Sandra R. Brown is a Principal at Hochman Salkin Toscher Perez P.C. Prior to joining the firm, Ms. Brown served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal). Ms. Brown specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court.
[i] IR-2020-59, March 25, 2020.
[ii] Revision to Internal Revenue Manual 4.46.3; LB&I-04-0420-009.
[iii] Id.(e.g., LB&I managers have discretion with respect to examinations of prior, subsequent, and related returns associated with an existing examination.)
[iv] https://www.irs.gov/pub/foia/ig/spder/lbi-09-1118-014.pdf
