Since the inception of the U.S. tax system, some taxpayers have willfully failed to comply with the tax laws. Because failures due to willful conduct may result in criminal prosecution, taxpayers sometimes seek methods to resolve prior year tax matters, often with the goal of avoiding criminal sanctions.
As a means to incentivize taxpayers to come forward and regain compliance with the tax laws, the IRS has historically offered a program known as the Voluntary Disclosure Practice (VDP). Under this program, taxpayers can disclose their willful conduct, submit accurate original or amended returns, and pay any outstanding taxes and interest. In exchange for all of this and a fraud penalty, the IRS usually agrees not to refer the matter for criminal prosecution. To enter the VDP, taxpayers must meet certain requirements, such as those related to timeliness, cooperation, and full and adequate disclosure. And because no statute specifically authorizes the VDP, taxpayers who want to participate in the VDP are wise to follow the administrative requirements set forth by the agency.
Significantly, in June 2024, the IRS quietly revised its VDP program. Although the modifications are subtle, they represent some significant departures from the prior version of the VDP. Therefore, taxpayers and tax professionals should take note of the new requirements, many of which are discussed more below.
Email Communications
Generally, a voluntary disclosure requires three steps. First, taxpayers must submit information on Part I of an IRS Form 14457, Voluntary Disclosure Practice Preclearance Request and Application. Part I requires the taxpayer to provide identification (i.e., name, social security number, and address), the type of disclosure (i.e., domestic or offshore, estate and gift taxes, or employment taxes), and identification of entities and financial accounts involved in the noncompliance.
Second, if IRS-CI grants preclearance, taxpayers must submit additional information on Part II of the Form 14457. Part II requires taxpayers to provide, among other items, an estimate of the amounts at issue and a noncompliance narrative (more on the narrative below). In most cases, IRS-CI denies preclearance when the disclosure is untimely—that is, the IRS already has the information related to the noncompliance through its own sources or other third-party sources.
Third, if IRS-CI grants preliminary acceptance, IRS-CI assigns the case to an IRS auditor. The auditor contacts the taxpayer and requests all original and amended returns. If the returns are accepted, the taxpayer enters into a closing agreement and pays the outstanding tax liabilities, interest, and a fraud penalty (up to 75%).
Prior to the June 2024 revisions, the IRS instructed taxpayers to submit Parts I and II of the completed Form 14457 to IRS-CI by fax or mail. With the modifications, taxpayers may now submit this information to IRS-CI by email. Accordingly, the new Form 14457 asks the taxpayer and the taxpayer's representative to provide email addresses if this communication option is preferred.
Noncompliance Narrative
Historically, the IRS has required taxpayers to disclose facts associated with the noncompliance in a narrative. Although the new Form 14457 similarly asks for this information, it also specifies that the taxpayer must address certain "subsections," including: (i) the parties involved; (ii) banks/financial institutions involved; (iii) advisor interactions and advice given; (iv) the specific acts of noncompliance; and (v) "other pertinent facts."
New "Willful" Box
In prior iterations of the VDP, taxpayers detailed their willful conduct through the narrative. In some cases, taxpayers tried to disclose facts while also hedging against a finding of willfulness. Or, alternatively, they were not willful at all—rather, due to their unique facts, they wanted to use the VDP for strategic purposes.
As a means to stop all of this, the revised Form 14457 now requires taxpayers in Part II to affirmatively check a box admitting that they were willful. In addition, the new Form 14457 cautions that a taxpayer's failure to check the box "will result in an automatic denial into the VDP" with "no appeals or reinstatements . . . granted."
Another New Box
Prior to the June 2024 revisions, taxpayers were not expected to have the original and/or amended returns prepared upon first contact by the IRS auditor (i.e., in Step 3). The revised Form 14457 changes this, requiring taxpayers to check a box in Part II affirmatively stating that they "have prepared and will hold all required documents to provide to the examiner upon initial contact, including, but not limited to, delinquent and/or amended returns, bank statements, and financial statements." Leaving nothing to doubt, the new Form 14457 instructions also hammer this point home, stating that "[t]axpayers should have their documents prepared, packaged and ready to provide to the examiner at initial contact."
New Emphasis On Full Payment
The new Form 14457 instructions also emphasize a full payment requirement. Before the June 2024 modifications, the IRS suggested that taxpayers who were unable to make full payment could request "other payment arrangements." The new Form 14457 instructions strongly suggest that taxpayers must make full payment of all tax liabilities, interest, and the fraud penalty to participate in the VDP.
Digital Assets
The old version of the Form 14457 asked questions pertaining to "virtual currency". The current version of the Form 14457 relabels virtual currency as "digital assets," and asks for more information related to these types of disclosures. For example, this portion of the form asks for identifying information related to any centralized digital asset exchanges and transactions recorded on a public blockchain. Because digital assets have been a hot issue with the IRS, the revisions to the Form 14457 requesting more details are not surprising.
Conclusion
The VDP continues to offer refuge to taxpayers with risk of criminal prosecution. Given the new revisions and Form 14457, however, taxpayers should ensure they fully understand the new terms of the VDP prior to making a voluntary disclosure. Taxpayers who fail to follow the new guidance run significant risks, including the IRS potentially rejecting the voluntary disclosure outright.
Originally published by Forbes
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