As many will remember, the Offshore Voluntary Disclosure Program (OVDP) closed on September 28 2018 with the promise that the Internal Revenue Service (IRS) would issue new guidance on voluntary disclosures made after that date. The guidance arrived on November 20 2018 in the form of a 5-page Memorandum (IRS Memorandum LB&I-09-1118-014) (“Memorandum”) by the Deputy Commissioner for Services and Enforcement. I summarized the more salient points of the Memorandum in a prior tax blog posting. That Memorandum had an expiry date of November 20, 2020. The Memorandum is no longer available on the IRS website, but a copy is available here.
Newly Revised: IRM 220.127.116.11.1 Voluntary Disclosure Practice
In late September 2020, shortly before the expiry of the Memorandum, the IRS quietly and completely revised the Internal Revenue Manual (IRM) provisions dealing with its Voluntary Disclosure Practice (VDP). IRM 18.104.22.168.1 Voluntary Disclosure Practice is available here.
The near total rewrite conforms the IRM to the voluntary disclosure practices announced in the Memorandum. The IRM provisions also conform to revised instructions provided for IRS Form 14457 which is the initial portal for any taxpayer attempting a voluntary disclosure. There are no exceptions – the IRM VDP is now the one and only method for voluntary disclosures that apply to criminal tax activity. (Re Form 14457, some browsers do not support opening this PDF on the IRS website. I tried to upload the actual PDF to my blog, but unfortunately this would not work!).
Taken together, the Instructions to the Form 14457 and the new IRM provisions formulate a framework for voluntary disclosures for the taxpayer who wishes to avoid criminal prosecution. In addition to the guidance and processes to be followed, they provide some of the likely consequences of using the process. The civil penalty consequences of initiating a voluntary disclosure, described previously in the Memorandum, have been incorporated into the instructions to Form 14457.
Criminals Only Need Apply
The revised IRM makes clear that it is intended to provide a “compliance option” only for taxpayers who have engaged in criminal activity (IRM 22.214.171.124(2)) regardless if domestic or offshore. The IRM notes that “[i]f the violation of the law was not willful, taxpayers should consider other options including correcting past mistakes by filing amended or past due returns.” This is clearly emphasized in the Instructions to the Form 14457.
I will say here, that many times taxpayers are not sure if their tax noncompliance tips over to the “criminal side” of the continuum. The issue of “willfulness” is a very slippery concept. Without question, experienced tax counsel should be sought, and second opinions considered.
When I blogged about the Memorandum, I pointed out many of the uncertainties taxpayers would face. Remember, the IRM conforms the VDP to the Memorandum so the points set out in my earlier blog should still be noted.
I was interviewed by attorney John Richardson about the Memorandum voluntary disclosure practice and this interview can be accessed here. The issues have not changed and in fact, certain areas are more dangerous than before including the grayness over what “disqualifying factors” may otherwise impact a “timely” disclosure and what civil penalties might be imposed as a result of the apparent unfettered discretion left to the examining IRS agent.
Is the Taxpayer’s Voluntary Disclosure “Timely”? Any “Disqualifying Factors?”
On the issue of timeliness, it has always been part of any voluntary disclosure that the taxpayer must come forward to the IRS before the IRS comes to the taxpayer. The IRS has always used an objective approach to this inquiry – for example, a voluntary disclosure is not timely if the IRS has already initiated an audit or investigation of the taxpayer or if it received information from a whistleblower.
As to “timeliness”, the IRM provides:
A disclosure is timely if it is received before:
- The IRS has commenced a civil examination or criminal investigation of the taxpayer or has notified the taxpayer that it intends to commence such an examination or investigation.
- The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the taxpayer’s noncompliance.
- The IRS has acquired information directly related to the noncompliance of the taxpayer from an enforcement action (e.g., search warrant, summons, grand jury subpoena).
Under the IRM as revised, things are now murkier than ever because of potentially “disqualifying factors”. For example, the impact of an audit or investigation of an entity “related to the taxpayer”, even if that inquiry is not known to the taxpayer, is not clear. It is possible that such a “related” IRS audit/inquiry may result in the rendering the taxpayer ineligible for the procedure.
Below is the relevant section from the IRM concerning “disqualifying factors”:
- If a taxpayer answers “yes” to any of the following questions on the Form 14457 – Part I, the taxpayer may be ineligible from participating in the Voluntary Disclosure Practice.
- Has the IRS notified you, your spouse, or any related entities that it intends to commence an examination or criminal investigation?
- Are you, your spouse or any related entities currently the subject of a criminal investigation or civil examination?
- Are you, your spouse, or any related entities under investigation by any law enforcement authority?
- Do you, your spouse, or any related entities have income sourced from an illegal activity? (The IRS voluntary disclosure practice does not apply to taxpayers with illegal source income.)
Issues of Self-Incrimination
Of even greater concern is that the IRM formalizes the changes to the “pre-clearance” process initially adopted in 2014 and implemented and expanded in the recent revisions to Form 14457 and its instructions. Overall, these changes mean that taxpayers wishing to enter the procedure must make potentially significant and incriminating admissions simply in order to apply for pre-clearance without knowing if they will be allowed to use the procedure. If not so permitted, that incriminating information has already been revealed leaving the taxpayer open to criminal prosecution! In other words, a taxpayer must be prepared to give up the farm before he can even get the promise of a deposit on the deal.
It is best to illustrate the potential for self-incrimination by explaining what the taxpayer must reveal simply to submit a so-called “pre-clearance request” (again, this is required of anyone wishing to attempt entry into VDP). Pre-clearance requires that the taxpayer must complete Part I of the Form 14457. This part requires, among other things, a list of all domestic and foreign noncompliant financial accounts owned or controlled by the taxpayer, or in which he was a beneficial owner (whether directly or indirectly). It must also include a list of all accounts held through entities owned or controlled by the taxpayer or in which he was a beneficial owner, whether directly or indirectly. The listing must include opened and closed accounts which held any unreported funds and must cover the entire disclosure period which is generally 6 years. The Form requires the names and addresses of the relevant financial institutions or entities as well as full account numbers for financial accounts.
In a nutshell, revision of the IRM and Form 14457 underscores that a taxpayer who would like to make a formal voluntary disclosure enters the mouth of the dragon and faces many unknowns including the real risk of self-incrimination. The IRM warns that it creates no “substantive or procedural rights for taxpayers,” and that the IRS Criminal Investigation’s decisions as to whether any taxpayer qualifies or should remain in the program “are not subject to any administrative or judicial review or appeal process.” IRM 126.96.36.199.1(3), (4).
I suggest reading my earlier tax blog that detailed the IRS Memorandum. It provides a succinct overview of what taxpayers may face by entry into the VDP. For the latest information about developments related to Form 14457, and its instructions, as well as additional guidance related to the IRS Criminal Investigation’s VDP, IRS has a special VDP website.
Posted February 18, 2021