The Internal Revenue Service (IRS) Voluntary Disclosure Practice (VDP) is alive and well. Its parameters are set out in Internal Revenue Manual (IRM) provisions dedicated strictly to the VDP. IRM 184.108.40.206.1 Voluntary Disclosure Practice, is available here. Under the VDP, the nature and extent of penalties to be assessed against a taxpayer will, to a great extent, be a function of the taxpayer’s cooperation with the IRS during the process. Taxpayers who provide “prompt and full cooperation during the civil examination of a voluntary disclosure” are entitled to civil penalty mitigation; however, taxpayers whose cases that are not resolved by agreement can face “maximum penalties under the law.”
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, regardless if the activity involves offshore issues or strictly domestic ones. (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 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 have been incorporated into the instructions to Form 14457. Generally, the VDP involves a 6 year time frame even if the tax issues extend for a much longer time period. This is a boon to taxpayers. Here is some general information regarding penalties in VDP, but bear in mind the IRS agent has a great deal of discretion, so anything is possible:
Civil Fraud Penalty
The 75% civil fraud penalty will apply to the one tax year with the highest tax liability. Caveat – The IRS may apply the civil fraud penalty to more than one year in the six-year scope or assert the penalty beyond the six year frame based on the facts and circumstances (e.g., taxpayer is not cooperating or if there is no agreement between the parties as to the tax liability).
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. Generally, taxpayers can expect a one-year willful FBAR penalty of 50% of the highest aggregate balance in all foreign bank accounts.
Information Return Penalties
Penalties for failure to file information returns will not be automatically imposed (e.g., Form 5471, 8938, 3520). The IRS agent will exercise discretion on 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 taxpayer’s cooperation (or lack thereof).
Done and Dusted
The final conclusion of a taxpayer’s entry into the Voluntary Disclosure program is memorialized in the Form 906, Closing Agreement on Final Determination Covering Specific Matters. This is the Closing Agreement signed by the taxpayer and the IRS Commissioner and signifies the completion of the voluntary disclosure. The Closing Agreement decides only those items specifically listed on the Form 906. Other items remain open and can be adjusted by the IRS in subsequent actions. The Form 906 includes language making this clear so that taxpayers understand the Closing Agreement does not prevent the IRS from auditing a taxpayer for unrelated issues and years. Clearly the Closing Agreement is a very important document when it is involved in any tax dispute, and it is especially critical in the Voluntary Disclosure process.
Next week’s post will examine the Closing Agreement in greater detail.
Posted November 3, 2022
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