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The New IRS Voluntary Disclosure Practice: Not a Good Deal for Noncompliant Taxpayers

For all voluntary disclosures received after September 28, 2018, the IRS has a new program called the Voluntary Disclosure Practice (VDP), which is for both domestic and international noncompliance. Unlike the old Offshore Voluntary Disclosure Program (OVDP), taxpayers do not receive automatic protection against criminal/civil penalties and the IRS has wide discretion to impose penalties based on the taxpayer’s level of cooperation. The VDP was announced via an IRS memorandum, not through the IRS website.

The new VDP does not offer the finality and certainty that many noncompliant taxpayers wish in a voluntary disclosure submission. However, presuming full cooperation and good faith disclosure by the taxpayer, there is a possibility for favorably reduced penalties. Based on our discussions with other tax attorneys, there have been very few VDP submissions to the IRS thus far because of the uncertainty of the penalty. However, for nervous taxpayers with possible willful exposure, the VDP program may be a good option that must be carefully explored.

Here are some highlights of the new procedure:

  • There is a 6 year disclosure period, but examiners may reduce that if the noncompliance involves fewer years, or expand it if the voluntary disclosure is disputed or if a cooperative taxpayer (for some reason) wants to expand the disclosure;
  • Taxpayers must submit all required returns and reports for the disclosure period and examiners will determine applicable taxes, interest, and penalties under existing law;
  • A 75% civil fraud penalty of the tax underpayment will apply to only the one tax year with the highest tax liability, but examiners may apply it to more than one year up to all six years if there is no agreement, or more than six years if the taxpayer is uncooperative. Interesting, a taxpayer may request the 20% accuracy-related penalty instead of the 75% civil fraud penalty, but the taxpayer must present convincing evidence to justify why the civil fraud penalty should not be imposed.  For this reason, I would recommend qualified legal counsel to persuasively argue for such reduced penalty;
  • Willful FBAR penalties (greater of $100,000 or 50% of the amount in the account at the time of the violation) will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17. Interesting, a taxpayer may request the non-willful FBAR penalties (generally $10,000) instead of willful penalties, but the taxpayer must again present convincing evidence to justify why the willful penalty should not be imposed;
  • Penalties for the failure to file other information returns (such as Form 5471) will not be automatically imposed, and examiner discretion will take into account the application of other penalties and resolve the examination by agreement;
  • Penalties relating to excise taxes, employment taxes, estate and gift tax, etc. will be handled based upon the facts and circumstances with examiners coordinating with appropriate subject matter experts; and Taxpayers retain the right to request an appeal with the Office of Appeals.
  • The VDP does not impact the existence of the IRS’ Streamlined filing compliance procedures.

The Advantages and Disadvantages of the IRS New Voluntary Disclosure Practice:

Advantages:

  • Avoidance of criminal prosecution if the taxpayer is willing to concede to all demands by civil examiner.
  • Some degree of predictability.
  • Some reduction in likely penalty exposure.
  • Most beneficial for clients with a high risk who are willing to pay penalties to mitigate risk.

Disadvantages:

  • Expensive because of high fraud penalty and/or willful FBAR penalty with limited exceptions.
  • Failure to reach an agreement or cooperate with examiner may trigger higher penalties.

I believe there has been little interest in the VDP program because the program does not offer the finality and certainty that many noncompliant taxpayers seek in a voluntary disclosure submission. However, presuming full cooperation and good faith disclosure by the taxpayer, there is a possibility for reduced penalties. Nonetheless, for sensitive taxpayers with high risk, the VDP program is an option that must be analyzed and fully explored.