For most of us, tax season is over for another year, and while no one likes paying taxes, most people comply with the rules and regulations, filing returns in a timely and forthright fashion.
But for others, tax season – or any thought about taxes – can be a source of anxiety and sleepless nights due to tax problems that are not yet known to the regulatory agency, usually the IRS or state revenue department.
For CPAs especially, tax season is the time when potential problems – such as embezzlement, non-reporting or underreporting of income or assets – come to light. While these often are the result of willful non-compliance, many times a problematic situation occurs unintentionally, or due to circumstances beyond the control of the taxpayer. Some real life examples:
- Taxpayer was a partner in a successful business. As the company was going through a breakup because of a shareholder dispute, forensic accounting discovered irregularities in its books. Further investigation revealed that the shareholders had not properly reported their income and expenses.
- A start-up company began selling specialty clothing in Michigan. It quickly expanded across many states and used its salespeople to travel to other states to conduct training, set up displays, offer free samples and, in some cases, maintain inventory. The company continued to be very successful, and made sales in multiple states for ten years. In the 11th year, the company began due diligence for a refinancing and discovered that it had sales tax and business tax obligations in at least five states in which it had never filed a tax return or paid a tax.
One all too common reaction to the discovery of problems like these is to panic and do nothing, other than worry and lose sleep. Of course, that is not a good option. Fines and penalties can be significant and are all but assured if an incorrect filing is discovered by the IRS. Criminal as well as civil penalties are a common consequence. When a business is involved, tax inconsistencies – regardless if the IRS knows about them – can negatively impact financing, sale of the business and other opportunities.
Fortunately, there is a better course of action. Voluntary disclosure allows taxpayers to rectify non-compliance situations, whether they are the result of unintentional mistakes or willful non-compliance. Property executed, a voluntary disclosure can significantly reduce the penalty that would otherwise result if the violation were discovered through an IRS audit.
Voluntary disclosure is most effectively done using an experienced tax attorney, which provides a level of protection due to attorney/client privilege. For CPAs, working with an attorney will help protect both you and your client in areas where there is a clear violation.
The voluntary disclosure process was used in the real life examples above, with very favorable results. In the first case, by filing an immediate and complete voluntary disclosure, our client avoided a criminal investigation and was able to settle the entire matter quickly and efficiently without any public disclosures or negative business implications.
In the second matter, the company was able to complete voluntary disclosure filings in each of the five states at issue by filing back tax returns and paying taxes and interest for a period of three to four years. By very carefully making taxpayer-initiated filings under available state programs, the company was able to eliminate all penalties, along with at least six years of exposure for taxes and interest associated with business activities that occurred prior to the applicable look-back periods.
In today's world, it's likely just a matter of time before non-compliance issues come to light, often in unexpected ways. We have worked with a client who was threatened with extortion by an acquaintance for alleged improper business and tax filings. Offshore banks that formerly may have helped clients conceal assets are vulnerable to hackers, if not the IRS. Incidents like the recent Panama papers breach are becoming commonplace as electronic data becomes more susceptible.
If you are aware of a potential non-compliance problem:
- Get experienced legal counsel quickly. Almost without exception, the sooner the process is started, the greater the options and generally the more favorable the results. If the IRS finds you first, all deals, offers and workable arrangements are off the table.
- Choose an experienced tax attorney who has a good working relationship with the IRS or other taxing agencies involved. Your legal counsel should focus on resolving problems and should be familiar with both state and federal tax programs available.
- If you are a CPA, you may want to consider working with attorney who can help you approach areas of concern with clients whom you suspect of having a potential problem.
The government absolutely wants to get people back into compliance, and the voluntary disclosure policy provides an excellent opportunity to do so.