Comparing State Tax Amnesty to Voluntary Disclosure, Which Program is Best for Resolving State Tax Delinquencies

Practical SALT Guidance:  A while back (a long while back), I wrote a post on State Tax Amnesty programs (August 2010) and a second post on State Tax Voluntary Disclosure programs (February 2011) – two options available for individual and business taxpayers who wish to resolve state tax delinquencies.

The first post, “State Tax Amnesty: An Opportunity for Taxpayers to Pay Delinquent State Taxes, What Taxpayers Need to Know”, was an overview of state tax amnesty programs – how they come about, what they are and what taxpayers needs to consider before deciding to the participate in a tax amnesty program.  Back in 2010, when I wrote this post, the amnesty train was charging full steam ahead as many states had offered or were planning on offering tax amnesty.  As a matter of fact, between 2009 and 2010, more than half the states (at least 27 of them), plus the District of Columbia and the City of Philadelphia held an amnesty program. For some of these taxing authorities, it had been many, many years since their previous amnesty.  For instance, both Illinois’ and Florida’s 2010 amnesties came seven years after their previous ones.  And, Philadelphia’s 2010 tax amnesty occurred 25 years after the City’s first amnesty!  Not surprisingly many of my initial State and Local Tax “Buzz” posts covered some of these amnesty programs in detail. (See my prior “Buzz” posts on: Massachusetts’2010 amnesty, Florida’s 2010 amnesty, New Mexico and Nevada’s 2010 amnesties, and Washington’s 2011 amnesty)

 

State tax amnesty programs, which for states have offered a way to quickly bring in much needed revenue as well as add new taxpayers to their rolls, are once again becoming popular.  For instance, Texas just wrapped up its “Fresh Start” amnesty and Rhode Island’s amnesty, which begins on September 2^nd, will run until November 15^th.

And so, I thought it would be a good time to write a fresh post revisiting state tax amnesty programs, but more importantly comparing and contrasting state tax amnesty programs to state voluntary disclosure programs. 

A state tax amnesty is a limited-time program approved by a state’s legislature and administered by the state agency responsible for administering and enforcing the state’s tax laws, (e.g., the Department of Revenue, Department of Taxation, etc.)  These programs give taxpayers an opportunity to can come forward voluntarily and satisfy their delinquent tax obligations in exchange for certain benefits, such as an abatement of penalties and some or all of the interest owed.  These abatements can be substantial since the amount of penalty and interest that can accrue when a tax liability remains unpaid for many years can be significant, and could very possibly exceed the tax liability itself.  Therefore, penalty and interest abatements also help taxpayers retain cash they might otherwise have had to pay.

Filing delinquent taxes during an amnesty period also allows taxpayers to come forward with minimal scrutiny as “eligible” taxpayers need only follow the amnesty “process”, which generally means simply filing all required forms and returns and paying all taxes by the amnesty’s deadline. (However, filings made during an amnesty period could still be chosen for audit at a later date.) Of course, filing under amnesty also alleviates the potential negative consequences (notices, assessments, penalties, interest, liens on property, civil or even criminal investigation) that could result if a taxpayer’s delinquencies are discovered by the state first.

But while state tax amnesty may offers many benefits, there are issues that taxpayers need to consider before disclosing and filing under amnesty. For instance, a taxpayer coming forward during an amnesty period may be required to file and pay delinquent taxes for as far back as the taxpayer’s liability extends.  You’ve likely heard the term “statute of limitations”, which, for tax law purposes, refers to the maximum amount of time after the filing of a return or the payment of a tax that the federal or a state government can assess or collect an additional tax, or a taxpayer can file an amended return or a claim for refund. When a taxpayer has never filed in a state, the statute of limitations never begins to “run”.  Therefore, in order to be fully compliant a taxpayer may be required to file (and pay the associated tax) for as many years as the taxpayer is delinquent unless the amnesty program specifies that a taxpayer only needs to report a set number of prior years. 

Additionally, taxpayers filing under amnesty shouldn’t expect that they can “negotiate” for better terms. As I’ll discuss in bit, this is one major difference between an amnesty program and a voluntary disclosure program (which may permit some level of negotiation). Another possible drawback applies to taxpayers who have received tax assessments. These taxpayers may be required, as a condition of participation, to pay the full amount of the tax owed to the state even if they do not agree with the assessment. Some amnesty programs may also require taxpayers to expressly waive their right to claim a refund or protest an amount paid under amnesty, thus creating a further dilemma for a taxpayer whose participation requires payment of the disputed assessment.  Additionally, some state amnesty programs require taxpayers who are already in the process of protesting an assessment through the state’s administrative process or in state court, to formally withdraw their protest, or dismiss any administrative or judicial proceedings.  

Here’s another consideration.  Sometimes an amnesty program will include a negative incentive in the form of an “amnesty penalty” which is imposed on taxpayers with outstanding assessments who choose not to participate in the current amnesty program. Thus, a taxpayer who disagrees with a tax assessment and chooses not to participate in the current amnesty, but is unsuccessful in protesting the assessment may find himself owing the original assessment, interest, re-instated penalties, and the additional amnesty penalty. (And yes, this outcome is very possible! See the Additional Notes and Comments section below for an update of a recent Illinois decision which upheld a 200% interest amnesty penalty against a taxpayer who did not participate in a 2003 amnesty program. Ouch!)

Also, since amnesties only run for a specified, limited time period, taxpayers may find they don’t have sufficient time to fully evaluate the pros and cons of participation, or to generate the funds needed to fully cover the taxes due. (For instance, as noted above, Rhode Island’s upcoming tax amnesty will only run for 75 days.)

Although the state legislature approves an amnesty, the specifics of the program, such as, the eligibility requirements for participation and the specific procedures that must be followed, are generally left to the State taxing agency to determine and administer and thus, amnesty programs can vary widely from state to state. For instance, a state may offer a general amnesty program, which means that it covers many types of taxes (personal income, corporate income, sales and use, etc.), or a state may offer a specific amnesty program, one which is targeted at a specific type of tax or specific category of taxpayers. (See Comments and Additional Resources below for a note on the sales tax amnesty requirement imposed by the Streamlined Sales Tax Agreement on states moving towards SST membership.)

One common requirement found in most amnesty programs is that taxpayers under criminal investigation for tax law violations are not allowed to participate (though some amnesty programs will allow taxpayers under civil investigation to participate). Some amnesty programs may prohibit taxpayers who have been chosen for audit from participating, but others may include special provisions that allow these taxpayers to participate. As noted above, some amnesty programs require taxpayers to waive their appeal or refund rights, while others allow taxpayers to retain these significant rights.    

Unless a state legislature has introduced or passed a bill approving a future amnesty, it’s nearly impossible to predict when a state will offer an amnesty period as amnesties do not generally occur according to any specific schedule. And waiting for the next amnesty to come along isn’t the best idea, as the longer a state tax delinquency remains unresolved, the worse the possible consequences become. As I noted above, because the requirements to participate in a state amnesty vary from state to state, even if an amnesty program does occur it’s possible that a delinquent taxpayer may not meet the requirements to participate.

But delinquent taxpayers need not wait for an amnesty to occur as there’s another avenue available to taxpayers to assist them in resolving their state tax delinquencies. A state’s Voluntary Disclosure Program (“VDP”).  

These programs, generally administered by a voluntary disclosure unit or designated group within a State Taxing Agency (e.g., Department of Revenue, etc.) exist in almost every state and are generally on-going.  (Note, sometimes a state will suspend its VDP during an amnesty period.) Like state tax amnesty, state voluntary disclosure encourages delinquent taxpayers to come forward and file and pay their delinquent state taxes.  Participating in a VDP generally requires a that a taxpayer meet certain eligibility requirements and enter into a Voluntary Disclosure Agreement (“VDA”) with the state. In exchange for the taxpayer’s voluntary disclosure, the state agrees to grant the taxpayer certain benefits and protections. Note that the level of formality of the programs varies from state to state. For instance, while many states may issue a formal binding agreement (an actual legal contract) signed by a state official and the taxpayer, other states simply send out a letter communicating to the taxpayer they have been accepted into the program and listing what the taxpayer must provide.

For taxpayers, the primary overall benefit to entering into a VDA is that it allows a taxpayer to resolve outstanding tax delinquencies fully and completely under beneficial terms. And although the exact benefits offered under the various VDPs vary from state to state (and can vary from taxpayer to taxpayer even in the same state), in general, the primary benefits include a limited “look-back” period and a waiver of all applicable penalties. The “look-back” period refers to the number of prior years or periods a taxpayer will be required to report and pay tax on. For example, a three or four year look-back period is common under most VDPs. (Note, Massachusetts is an exception in that some taxpayers may be subject to a seven year look-back period.  Also note that sales & use tax look-back periods are generally expressed in months, with 36 or 48 months being common.) This means that a taxpayer’s tax delinquencies for years prior to the beginning of the state’s voluntary disclosure look-back period would not need to be disclosed or paid. This could translate to significant cash savings in particular if the taxpayer owed back taxes for many years.

Another significant benefit offered through most VDPs is a full abatement of penalties. As noted above, an abatement of penalties can also add up to significant cash savings, as accrued penalties can be substantial when tax liabilities remain unpaid for many years.  Interest, however, is almost always required by the various state statutes and generally isn’t abated. (Texas is an example of one state that offers a waiver of interest provided the voluntary disclosure does not involve a trustee type tax, e.g., sales tax.)

However, one of the most significant benefits to resolving tax delinquencies through a state’s VDP is the ability to request participation in the program on an anonymous basis through a taxpayer representative – a CPA, attorney, or tax consultant.  There is also often an opportunity to negotiate preferred terms before the taxpayer’s identity is disclosed to the state. 

How is this possible? Well, often the first step in the process involves a phone call or a letter to the voluntary disclosure unit or designated contact. Because most states do not require the actual name of the taxpayer during the initial communication with the state, a taxpayer’s representative can ferret out whether the taxpayer will meets the program’s eligibility requirements and might even be able to obtain a general idea of the benefits the taxpayer might receive.

Just as there potential issues to consider with state tax amnesty programs, there are issues to consider when deciding whether to resolve state tax delinquencies through voluntary disclosure.  States offer voluntary disclosure a means of collecting undisclosed taxes that might have never been recovered by the state or that might have only been recovered through extensive collection efforts.  However, another reason states offer voluntary disclosure is because it brings new taxpayers onto the state’s tax rolls. This is because a typical eligibility requirement of many VDPs is that the taxpayer not already be registered for the type of tax for which they are requesting a VDA. (There are always exceptions to the general rule. Minnesota, for instance, offers voluntary disclosure even for registered taxpayers through its Track B program.)  Once a taxpayer is on the state rolls, the taxpayer is then subject to future filings and audits.

Another issue is that a state may require that the taxpayer either come forward for every type of state tax the taxpayer owes (income/franchise, sales, use, payroll withholding) and/or that the taxpayer make an affirmative statement that no other type of state tax is owed. (Alabama, for instance, requires that all tax types to be addressed in the initial written request to enter the VDP or that the taxpayer make an affirmative statement that no other Alabama taxes are due.)  But a taxpayer may not realize that other types of state taxes are owed.  This is because the various state “nexus” rules are complicated and a taxpayer may not be aware that his activities in a state have created a filing obligation and tax liability for other types of taxes. Additionally, once a state has accepted the taxpayer’s request to participate in the voluntary disclosure program and has prepared the VDA for signature, the state may require completion of additional documents such as a nexus questionnaire, registration forms, or other documents. (Texas is an example of a state that will not process a voluntary disclosure request without the completion of a nexus questionnaire.) The responses on these “other forms” may be scrutinized by the state, and could inadvertently subject the taxpayer to other taxes or filing requirements. A taxpayer could end up owing other state taxes which would need to be resolved outside of the protection offered through a VDA.

Finally, some states, in particular those with structured programs, require that the various steps in the voluntary disclosure process be completed within short time-frames. For instance, once a taxpayer has come forward, been accepted into the program, and disclosed their identity, may only have 30 or 60 days to prepare and file all delinquent returns and pay all monies owed to the state. Because the taxpayer has entered into a legal contract with the state, failing to comply with all the requirements of a VDA within the state’s timeframe could cause the VDA to become null and void, thereby extinguishing all the benefits and protections to the taxpayer. 

Well, there you have it!  State tax amnesty and voluntary disclosure programs – two avenues for taxpayers to come forward voluntarily and resolve tax delinquencies. Which avenue is best?  As we like to say in the state tax world, “it depends”.  While there are many benefits to resolving delinquencies under both of these options, there are significant issues to consider too.  Whichever avenue is chosen, it’s particularly important to understand the eligibility requirements, including how quickly returns and tax payments must be remitted to the state and what the implications of failing to follow-through on these requirements could be.  Using a taxpayer representative, in particular when coming forward under voluntary disclosure, can be extremely beneficial.  And using a representative with experience in the voluntary disclosure process (such as your author here, wink!) is extremely important as this individual not only negotiates on the taxpayer’s behalf, but is also the primary communicator with the state voluntary disclosure contact. 

• The above discussion on state tax amnesties was intended to address general state amnesties. It does not address the Streamlined Sales and Use Tax Agreement’s (SSUTA) requirement for new member and associate member states to provide amnesty for uncollected or unpaid sales or use taxes to a seller who registers to pay or collect and remit applicable sales or use taxes on sales made to purchasers in the state.  For more on the SST’s sales & use tax amnesty and seller eligibility requirements visit the Streamlined Sales Tax website.  Also see the SSUTA(specifically, section 402 of the Agreement) and the SST’s State Registration FAQs (FAQ #11).

• Also see, the Multistate Tax Commission’s (MTC) Multi-state Voluntary Disclosure Program: Taxpayers (or their representatives) can utilize the services of the MTC to complete the voluntary disclosure process. This can be helpful when a taxpayer discovers that he owes state taxes in a many states.

• Want to find out more about your particular state’s VDP? See my State Tax Department Links web page here at The State and Local Tax “Buzz”. On this page you’ll find a web-link (and the URL address) to the State Tax Agency for all fifty states and the District of Columbia. Once you’re at the state tax agency site, enter “voluntary disclosure” into the search box (assuming one is available). This search will generally direct you to the agency’s webpage or document on the state’s VDP. 

• August 28th Update:  See this recent SALT Alert at the Sutherland SALTOnline blog (one of my favorite tax blogs – listed on my blog roll).  This Alert discusses a recent Illinois Appellate Court decision which upheld the imposition of a 200% double interest amnesty penalty. This case is, however, controversial because the taxpayer wasn’t even aware at the time of the 2003 amnesty, that additional Illinois taxes were owed.  Still, this outcome highlights that states can, and will, impose amnesty penalties on taxpayers who do not disclose and report taxes liabilities during a specified amnesty period.