What is IRS Voluntary Disclosure?
The IRS Voluntary Disclosure Practice Preclearance Request and Application (VDP) is designed for taxpayers who have failed to report their full tax liability but wish to come into compliance. This program allows individuals, businesses, and other entities to voluntarily disclose their tax noncompliance, thereby mitigating the risk of criminal prosecution and reducing certain penalties. However, strict requirements must be met to qualify.
Eligibility for IRS Voluntary Disclosure
To be eligible for voluntary disclosure, a taxpayer must:
- Be truthful, timely, and complete in their disclosure.
- Cooperate with the IRS in determining tax liability and compliance requirements.
- Assist the IRS in investigating enablers who may have facilitated the noncompliance.
- Submit all required returns, information returns, and reports for the disclosure period.
- Make arrangements to pay all owed taxes, interest, and penalties in full.
Timeliness is Critical: A voluntary disclosure must be made before the IRS obtains information about the noncompliance. A disclosure is not considered timely if:
- The IRS has already started a civil or criminal investigation.
- The IRS has received information from a third party regarding the taxpayer’s noncompliance.
- The IRS has obtained information through a criminal enforcement action.
What Happens If Your Voluntary Disclosure Is Accepted?
Upon preliminary acceptance of a disclosure (via Form 14457, Part I), the IRS Criminal Investigation (IRS-CI) will forward the case for civil examination. Taxpayers should be prepared to provide the following documents:
- Delinquent/amended tax returns and information returns.
- Accounting records, including books, accountant workpapers, and other supporting documents.
- Bank statements and account opening documents.
- Professional advice documentation related to tax decisions.
- Documentation related to promoters or enablers of tax noncompliance.
- Full payment of tax, interest, and penalties.
A civil examiner may conduct interviews to verify the disclosure’s accuracy and completeness. Taxpayers must comply with all U.S. tax laws for periods following the disclosure period, or risk having their voluntary disclosure revoked and facing possible criminal prosecution.
Understanding Civil Penalties in Voluntary Disclosure
Under the IRS-CI Voluntary Disclosure Program (VDP), civil penalties will generally include:
- A single fraud penalty (IRC §6663 or §6651(f)) for one tax year with the highest tax liability.
- No accuracy-related penalties for other years included in the disclosure.
- In cases of fraudulent failure to file, a penalty is assessed only on the year with the highest tax liability.
- FBAR penalties may apply for noncompliance related to foreign accounts.
Scope of the Disclosure Period
Typically, voluntary disclosures cover the six most recent tax years. However, exceptions apply:
- If a taxpayer does not fully cooperate, the IRS may extend the review period beyond six years.
- If noncompliance involves fewer than six years, the taxpayer must correct all affected years.
- With IRS consent, cooperative taxpayers may expand the disclosure period to address issues such as foreign tax obligations, entity transactions, or unreported gifts.
Making Payments Under Voluntary Disclosure
Taxpayers must arrange to pay all taxes, interest, and penalties in full. If full payment is not possible, they must:
- Disclose their financial status via Form 433-A (individuals) or 433-B (businesses).
- Propose an installment payment plan for IRS review.
- Submit to interviews with revenue officers to determine financial ability to pay.
Final Considerations for Taxpayers Seeking Voluntary Disclosure
- Voluntary disclosure is not a guarantee of penalty relief but significantly reduces the risk of criminal prosecution.
- IRS scrutiny is rigorous, and taxpayers should be prepared for interviews, financial reviews, and document requests.
- Failure to remain compliant post-disclosure could lead to revocation of voluntary disclosure status and legal action.
- Taxpayers must act swiftly—voluntary disclosure is only an option before the IRS uncovers the noncompliance.
If you are considering a voluntary disclosure, consult with a tax professional for proper compliance and submission under IRS guidelines.
