IRS Proposed Changes to Voluntary Disclosure Program

The IRS VDP provides a way for taxpayers with previously undisclosed income and potential criminal tax exposure to contact the IRS and resolve their tax matters. To participate, taxpayers must make a truthful, timely, and complete voluntary disclosure regarding their willful noncompliance, and pay outstanding tax liabilities with interest and penalties. In return, participating taxpayers receive a commitment from the IRS not to recommend criminal prosecution. 

The National Taxpayer Advocate has stated in a report to Congress that “the VDP in its current form is not working as effectively as intended” and “discourages taxpayers from participating” due in part to its “strict penalty structure and burdensome filing requirements.” 

The IRS states that the proposed revisions to the VDP are intended to “improve its processes” and “further incentivize non-compliant taxpayers to come into compliance.” 

Revised Penalty Framework

The proposed revisions include a revised penalty framework. Under this framework, the IRS would: 

• Apply failure-to-file penalties on delinquent returns for each year in the six-year disclosure period (but would not apply failure-to-pay penalties).

• Apply a 20% accuracy-related penalty on amended returns for each year in the disclosure period, replacing the prior 75% civil fraud penalty that was assessed on the year with the highest tax understatement.

• Apply penalties for delinquent or amended Reports of Foreign Bank and Financial Accounts (FBARs) on a per-year basis, subject to annual inflation adjustments.

• Apply penalties of up to $10,000 per return, per year, for delinquent or amended international information returns (IIRs). 

The transition from a 75% civil fraud penalty to a 20% accuracy-related penalty for amended returns represents a significant change that may encourage increased participation in the VDP program. Still, it remains unclear under the proposed framework whether the FBAR penalty would be imposed at the non-willful FBAR penalty level (currently $10,000 per year, subject to annual inflation adjustments), or the willful level (50% of the maximum account balance during the year).

Disclosure and Compliance Requirements

The proposed program retains the six-year disclosure period for delinquent and amended returns. Taxpayers conditionally approved to participate must, within three months after being conditionally approved to participate:

• File amended or delinquent income tax returns, international information returns, and FBARs, as applicable;

• Pay all applicable taxes, penalties, and interest in full; and 

• Execute required agreements to finalize participation.

Taxpayers must also submit a signed closing agreement waiving statutes of limitations, agree to accuracy-related penalties and, where applicable, sign an FBAR agreement. Under the proposed updates, taxpayers will electronically submit Form 14457, Voluntary Disclosure Practice Preclearance Request and Application. The disclosure must identify all years of noncompliance and provide a full and accurate description of the taxpayer’s willful noncompliance.

Full Payment Requirement

The proposed framework requires taxpayers to pay all outstanding taxes, penalties, and interest within three months of conditional approval.

Practitioner Comments on Proposed Changes

On March 22, the American Bar Association (ABA) Section of Taxation submitted a detailed 53-page comment letter responding to the IRS’ proposed changes. The letter commended the IRS for taking steps to improve the VDP, explaining that “[i]t is important for tax administration that Taxpayers with criminal exposure have a path to correct their past noncompliance in a manner that minimizes their risk of criminal prosecution” and noting that “VDP provides that path.” However, to be more widely utilized, the letter explained that the VDP “must be clear and predictable.” The letter offered 30 substantive recommendations to assist the IRS in clarifying and further improving the VDP program. Some of these recommendations include:

• Adopting flexibility with respect to the proposal’s full payment requirement, so that taxpayers may be allowed to come into compliance by participating in the VDP regardless of their ability to immediately pay in full.

• Limiting both failure-to-file penalties on delinquent returns and 20% accuracy-related penalties on amended returns to no more than three years within the disclosure period — preferably the three most recent years, or alternatively the three highest-liability years.

• Confirming that VDP FBAR penalties will be assessed as non-willful at the unadjusted statutory maximum of $10,000 per year, and limiting FBAR penalties to the three most recent years within the disclosure period (or alternatively, the three highest-liability years).

• Specifying that the proposed “up to $10,000” per-return penalty for international information returns applies as a cap to all IIRs carrying a statutory penalty, including forms whose statutory penalties exceed $10,000.

• Implementing a “certification” process for VDP cases rather than conducting traditional examinations.

• Establishing and publishing a timeline for the closure of VDP cases.

Takeaways

The IRS’ proposed revisions to its Criminal Investigation VDP represent a significant step toward a framework that incentivizes noncompliant taxpayers to come into compliance and promotes future tax compliance.

Noncompliant taxpayers considering participating in the VDP should consult experienced tax counsel to assess their options.

ArentFox Schiff attorneys will continue to monitor VDP developments.