Given the growing number of states seeking to increase revenues by taxing out-of-state businesses, a company located in one state may find it has had a taxable presence in another for several years, but has neither filed a return in nor paid tax to that state. This can present a problem as the company, theoretically, is liable for unpaid taxes, interest, penalties and possibly even criminal sanctions.
Voluntary disclosure. The solution to the dilemma may be an administrative procedure known as voluntary disclosure. In this process a taxpayer, which is clearly subject to a state’s taxing jurisdiction but has not filed or paid tax, can, if eligible, voluntarily approach the state to negotiate an agreement that will cover all the company’s obligations.
Under a voluntary disclosure agreement, a company typically agrees to register and pay its current and future taxes. Most states, in addition, insist that the company pay tax and interest for a minimum number of open back years (the lookback period). The majority of them forgive all civil tax penalties during the lookback period and may forgive a portion of the interest. Most important, states usually agree never to audit tax years preceding the lookback period. And although few expressly waive criminal sanctions, most states do not want to risk the success of the voluntary disclosure programs by investigating a company that has come forward on its own to pay its taxes.
Beginning the process. The taxpayer (or its tax adviser) first should become familiar with a state’s voluntary disclosure regulations, administrative notices and announcements. The taxpayer or adviser then should contact the official who administers the program governing the particular tax issue.
Note. Preserving the anonymity of the taxpayer until an agreement is reached is crucial. Therefore, the tax adviser should not let the tax official know the taxpayer’s identity at any point until an acceptable agreement has been fully negotiated and accepted by the taxpayer.
Voluntary disclosure agreement details. A typical agreement requires disclosure of certain information:
- A general description of the items the taxpayer manufactures or sells or the services it provides and the typical nature of the transactions into which the taxpayer enters in the normal course of its business.
- How the taxpayer markets its products or services within the state, including a description of any other nexus-creating activities.
- The date on which nexus first occurred.
- For sales and use taxes, whether the taxpayer collected tax from customers and did not remit those funds. (The tax adviser should know whether a taxpayer in this situation is subject to criminal sanctions and how the state handles such disclosure in the context of a voluntary disclosure proceeding before he or she identifies the taxpayer.)
- For use taxes, a general description of purchases the taxpayer made but for which it paid no use tax.
- A description of all prior contacts between the taxpayer and the state department of revenue. This can be critical in determining whether a taxpayer may take advantage of a state’s voluntary disclosure program. For example, in some states, receiving a “nexus questionnaire” will preclude voluntary disclosure.
Generally, it is the taxpayer’s responsibility to submit the first draft of a proposed voluntary disclosure agreement, which the state then reviews. The state may suggest changes (some of which may be material to the taxpayer’s financial position). To avoid surprises, taxpayers not only should work out agreements in principle but also include as much detail as possible before submitting the first draft of the agreement to the state.
For a discussion of this process, see the State & Local Taxes column, edited by Karen Boucher and Bill Lundeen, in the September 2000 issue of The Tax Adviser .
—Nicholas Fiore, editor
The Tax Adviser