IRS Quietly Changes its Voluntary Disclosure Practice For the Worse

The IRS’s Voluntary Disclosure Practice (VDP) allows noncompliant taxpayers who have failed to meet their tax obligations to come into compliance and avoid criminal prosecution. Financially, the VDP offers the benefit of reduced penalties compared to those imposed through audits or criminal investigations, helping taxpayers resolve liabilities more predictably and possibly with lower penalties. The VDP assesses a single one-year 75% fraud penalty instead of all years’ 20% accuracy-related penalties and 25% delinquency penalties.

Last month the IRS quietly implemented significant changes to Form 14457, which is integral to the Voluntary Disclosure Practice (VDP). These updates reflect a more stringent approach by the IRS towards taxpayers seeking to rectify past noncompliance. Key changes include stricter requirements for document preparation and submission, a mandatory admission of willfulness, and a reinforced expectation of full payment of taxes, interest, and penalties. These revisions emphasize the need for taxpayers to be fully prepared and transparent in their disclosures, signaling the IRS’s commitment to expediting compliance and closing the door on leniency in cases of tax noncompliance.

Below is an in-depth overview of the key changes and their implications:

1. Document Submission Requirements

Previous Requirement (Before June 2024):
Taxpayers granted preliminary acceptance into the VDP were instructed to wait for an IRS examiner to contact them, at which point the examiner would request additional documents. This allowed taxpayers some flexibility in preparing and gathering necessary documents after entering the program.

Updated Requirement (June 2024):
The updated Form 14457 now requires that taxpayers have all their documents prepared and ready to submit immediately upon initial contact from an IRS examiner. This includes, but is not limited to:

• Delinquent or amended tax returns for the last six years.
• Full payment of tax, interest, and penalties.
• Supporting documents such as bank statements, accountant work papers, and statute consents.

This change emphasizes the need for taxpayers to be fully prepared at an earlier stage of the process, effectively accelerating the timeline and reducing any potential delays in the compliance process. The IRS expects taxpayers to have their documentation in order before even seeking preliminary acceptance into the program.

2. Full Payment Requirement

Previous Requirement (Before June 2024):
Historically, the IRS allowed for some flexibility in closing cases, including accepting Offers in Compromise (OICs) or Partial Payment Installment Agreements (PPIAs) when full payment could not be made. This approach provided some leniency for taxpayers who might have faced financial difficulties in paying the full amount due.

Updated Requirement (June 2024):
The IRS now requires full payment of all taxes, interest, and penalties as a strict condition of the VDP. Taxpayers are either expected to pay in full or enter into a full-pay installment agreement. This requirement is reinforced by the new language in Form 14457, which makes it clear that partial payments or deferred payments (such as PPIAs) are no longer acceptable under the VDP.

The instructions accompanying the form also make it clear that the burden is on the taxpayer to establish an inability to fully pay, and such cases will be scrutinized closely. The IRS is taking a firmer stance on ensuring that all outstanding liabilities are settled promptly as part of the disclosure process.

3. Admission of Willfulness

Previous Requirement (Before June 2024):
There was no explicit requirement for taxpayers to formally admit willfulness in their noncompliance when entering the VDP. The process focused more on voluntary disclosure and cooperation without necessarily requiring a formal acknowledgment of intent.

Updated Requirement (June 2024):
The updated Form 14457 introduces a crucial new requirement where taxpayers must explicitly acknowledge their willfulness in the actions that led to their tax noncompliance. This is done by checking a box in Part II of the form. Failure to check this box results in an automatic denial of entry into the VDP, with no possibility of appeal or reinstatement.

This change is significant because it places a formal acknowledgment of willfulness at the center of the voluntary disclosure process, ensuring that taxpayers are fully aware of the gravity of their actions and are making a conscious admission as part of their disclosure.

4. Submission Deadlines

Updated Requirement (June 2024):
The IRS has imposed stricter deadlines for the submission of Part II of Form 14457. Taxpayers are granted only one 45-day extension to submit the required documents. This tightens the timeline and reduces the potential for prolonged submissions, pushing taxpayers to be more diligent and timely in their compliance efforts.

5. Expanded Reporting Requirements

Previous Requirement (Before June 2024):
The disclosure in Part II of the form required taxpayers to report unreported income but did not explicitly address overstated deductions or other forms of misreporting.

Updated Requirement (June 2024):
The form has been expanded to require the disclosure of overstated deductions in addition to unreported income. This broader scope ensures that taxpayers are fully transparent about all forms of noncompliance, not just the underreporting of income.

Additionally, the narrative required in Part II has been expanded significantly. Taxpayers must now provide detailed descriptions of:

• The roles of all parties involved in the noncompliance.
• The institutions (such as banks) involved.
• Interactions with professional advisors and the specific advice given.
• The specific acts of noncompliance and other pertinent facts.

This expanded narrative requirement forces taxpayers to provide a more comprehensive account of their noncompliance, offering the IRS greater insight into the full context of the disclosure.

6. Communication Methods

Previous Requirement (Before June 2024):
Communications from IRS Criminal Investigation (CI) to the taxpayer (or their representative) were typically sent by USPS first-class mail.

Updated Requirement (June 2024):
The IRS has now shifted to using email as the primary method of communication between CI and the taxpayer or their representative. This change is likely intended to expedite communications and reduce delays associated with traditional mail.

7. Digital Assets

Previous Requirement (Before June 2024):
The form included provisions related to virtual currency, reflecting the IRS’s increasing focus on the taxation of digital assets.

Updated Requirement (June 2024):
The provisions related to digital assets have been updated and expanded. The form now includes much more detailed requirements for reporting digital assets, reflecting the IRS’s evolving approach to ensuring compliance in this rapidly growing area. The updated language emphasizes the importance of transparency in reporting transactions involving digital assets.

8. Corporate Disclosures

Previous Requirement (Before June 2024):
When tax fraud involved a corporate officer and the corporation, the corporation was required to submit a separate Form 14457.

Updated Requirement (June 2024):
The updated form now requires corporations involved in tax fraud to complete Line 7c by checking a box indicating that the entity is making a disclosure. This change simplifies the process and ensures that corporate disclosures are acknowledged as part of the voluntary disclosure process.

9. Additional Changes

• Penalties and Compliance: The instructions have been modified to clarify that penalties related to excise taxes, estate and gift taxes, etc., will not be automatically asserted. These will be handled based on the specific facts and circumstances of each case, which may offer some flexibility depending on the taxpayer’s situation.
• Communication and Payment: Taxpayers seeking to make payments before the assignment of a revenue agent are now advised to contact the VDP Hotline rather than mailing payments to LB&I in Austin.

These updates to Form 14457 reflect the IRS’s broader efforts to tighten compliance, ensure full transparency, and expedite the voluntary disclosure process. The emphasis on full payment, admission of willfulness, and detailed disclosures suggests a shift towards a more stringent and unforgiving approach to taxpayers seeking to rectify past noncompliance.

For tax professionals working with clients on voluntary disclosures, these changes emphasize the importance of thorough preparation, timely submission, and clear communication with the IRS to avoid automatic denials or other negative outcomes.

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