Tax Amnesty Programs and Voluntary Compliance Initiatives: A Way to Mitigate Declining State Revenues

Since 2000, more than half of the states have offered tax amnesty programs one or more times (see Federation of Tax Administrators, “State Tax Amnesty Programs” (July 2007)). The programs allow taxpayers to “come clean” and report and pay delinquent tax liabilities. They are popular with taxpayers because they provide a waiver of most penalties and, in some cases, some or all of the interest that otherwise would be assessed. States like the programs because they add taxpayers to the rolls and inject much-needed revenue into state coffers without the need for costly audits that may run for an extended period of time. Despite these benefits, there can be serious ramifications for taxpayers, not the least of which is the need to pay significant sums in short order. In addition, failure to pay qualified delinquencies during the amnesty period can lead to significant post-amnesty penalties in certain jurisdictions. States also face challenges by offering tax amnesty given the need to provide balance for taxpayers currently complying with tax laws while adding new taxpayers to the rolls.

The rise in amnesty programs appears to be tied to the country’s economic health, as evidenced by the frequency of amnesty programs over the past decade. Most of those programs were offered in 2001–2003, just as the country was coming out of a recession. Only a handful of states, including New York, Ohio, Rhode Island and Texas, offered tax amnesty programs from 2004 through the end of 2008, most likely because state budgets generally were improving during those years. However, as the recent economic downturn strains tax revenues, amnesty programs have resurfaced as an immediate fix to the problem. By way of example, Alabama, Arizona, Connecticut, Massachusetts, New Jersey and Virginia will offer tax amnesty in 2009; other states, including Louisiana, Maryland, New Mexico and Vermont, have proposed (as of this writing) tax amnesty, and it is expected that other states will follow.

A look at the projected fiscal outlook for many states and the potential for tax amnesty programs to raise significant revenues is key to understanding why more states may enact tax amnesty in the near future. According to a November 2008 study by the Center on Budget and Policy Priorities, at least 45 states face budget shortfalls for this and/or next year, and severe fiscal problems are likely to continue after that (see McNichol and Lav, Center on Budget and Policy Priorities, “State Budget Troubles Worsen” (updated March 13, 2009)). The combined budget deficits for the remainder of fiscal year 2009 and fiscal years 2010 and 2011 are estimated to total more than $350 billion.

As reported by the Federation of Tax Administrators, tax amnesties have generated significant revenues in some states. For example, New Jersey raised more than $275 million in 2002, and Illinois and New York state raised more than $530 million and $580 million, respectively, in 2003 via their tax amnesty programs. Although these programs were among the leading revenue raisers nationwide, in the aggregate the programs raised millions in tax revenues for the states. Even Connecticut, which, according to a press release by Gov. Jodi Rell, expects to raise only $40 million during its 2009 amnesty program, sees tax amnesty as an opportunity to bring much-needed revenue into the state (“Governor Rell Announces Deficit Mitigation Plan” (10/21/08)).

However, not everyone is enamored with amnesty. As reported by Tax Analysts in State Tax Today, Tennessee revenue Commissioner Reagan Farr called amnesty programs “gimmicks” and implied that amnesty could “reduce public respect for the tax laws” (see Setze, “States Offering Amnesties in Wake of Fiscal Crisis, but at What Price?” 2009 STT 50-1 (March 18, 2009)). The article quoted a study by Luna, Brown, Mantzke, Tower, and Wright (“State Tax Amnesties: Forgiveness Is Divine—and Possibly Profitable,” State Tax Notes 497 (Aug. 21, 2006)), which said that “there was widespread criticism from law-abiding taxpayers that frequent amnesty programs unfairly reward tax evaders,” and a fiscal note attached to an amnesty proposal in New Mexico, which said that “[f]requent amnesty periods may indirectly communicate a message to taxpayers that they do not need to comply with the Tax Administration Act because, potentially, another amnesty period may be approved. It is not known how frequent is too frequent.”

In addition to more general tax amnesty programs, a growing number of states occasionally offer voluntary compliance initiatives (VCIs). Unlike general tax amnesty programs, which apply to a broad category of taxpayers and a wide range of taxes, VCIs target taxpayers involved in tax shelter transactions, such as reportable and listed transactions at the federal and state levels. As a result, VCIs are limited in their application and may not provide the same types of benefits available under the more general amnesty programs. Notably, VCIs enacted to date have provided taxpayers limited appeal rights in exchange for a waiver of penalties, something to consider given the significant sums at issue.

HOW TAX AMNESTY WORKS

Most amnesty programs have a number of similar key features:

• Most require legislative action as a prerequisite before being offered. Such legislation, while granting the administrator authority as to timing and administration, generally specifies the amnesty program’s parameters, such as duration, timing, penalty and interest waivers, applicable taxes, payment provisions, and qualifying taxpayers.

• Some taxing agencies have the ability to offer amnesty programs under the general grant of administrative authority in the taxing statute, eliminating the need to get the legislature on board.

• States offer the programs for a limited time period, which may run from one to six months, with a two-month period the most common.

• Amnesty generally is limited to nonfiling taxpayers or to those not otherwise identified by the tax administrator as owing liabilities for a specific tax or a specific tax period—for example, taxpayers identified from a nexus questionnaire and taxpayers currently under audit are prohibited from participating in an amnesty program.

• The programs often do not extend amnesty to taxpayers that, at the time of payment, are under criminal investigation or charge for any state tax matter.

• The programs generally apply to all taxes administered by a taxing agency, but some programs target limited taxes (for example, individual income taxes).

• Some programs may exclude certain transactions (for example, tax shelter transactions, intangible holding company structures).

• Most programs generally require taxpayers to resolve problems of all tax types (for example, income/franchise, sales/use, withholding), not just a single type or category of tax.

• Programs generally require a taxpayer to pay all outstanding liabilities for all open years, either at the time the taxpayer submits an amnesty application or within a stated period thereafter; however, some programs allow taxpayers to enter into installment agreements.

• Most programs provide a waiver of penalties that otherwise would be assessed.

• Some programs provide a limited waiver of interest.

• Some programs may require a taxpayer to file returns for each and every open period to which amnesty applies; however, some jurisdictions will accept a schedule summarizing overall outstanding liabilities.

• A number of programs impose significant post-amnesty penalties when a taxpayer with exposures eligible for amnesty fails to participate in an amnesty program, regardless of exposure knowledge.

• Amnesty programs may result in a temporary stay of voluntary disclosure programs or a permanent end to such programs.

As noted above, most amnesty programs require legislative action; however, certain state statutes grant the taxing authorities fairly broad administrative authority that encompasses the ability to adopt a tax amnesty program to settle outstanding liabilities. For instance, Alabama in 2009 announced the start of Operation Clean Slate, an amnesty program offered without the need for legislative action. Similarly, the Texas Comptroller of Public Accounts in 2004 offered a tax amnesty program under the authority granted under Texas Tax Code § 111.103, which authorizes the comptroller to settle a claim for tax penalty or interest on a tax.

One of the features of all tax amnesty programs is a period of limited duration. Based on a survey of the past 10 years of programs, periods can range from as long as six months, as in the case of the 2004 Arkansas tax amnesty program, to less than one month, as in the case of the 2004 Texas tax amnesty program. The dates are not always part of the enacting legislation. Often the legislation requires that the state tax authority set the dates for the amnesty, subject to specific guidelines. For example, Massachusetts legislation (HB 5143, enacted Jan. 7, 2009) authorizing tax amnesty in 2009 requires that the Department of Revenue offer a two-month tax amnesty program and that the program end no later than June 30, 2009.

In contrast, Connecticut legislation (HB 7601, Nov. 25, 2008) authorizing tax amnesty specifies that the program be offered from May 1 through June 25, 2009. A comparable provision (SB 1200, enacted Nov. 25, 2008), which authorizes tax amnesty at the municipal level, generally leaves the decision in the hands of the individual municipalities, merely stating that they may offer tax amnesty for up to a 90-day period through Dec. 31, 2009.

AMNESTY LIMITATIONS AND INCLUSIONS

States generally limit amnesty to taxpayers not currently reporting or those with outstanding liabilities that have not been identified by the taxing agency. For example, Florida’s 2003 tax amnesty program barred taxpayers that were currently under audit, inquiry, examination or civil investigation, regardless of whether an assessment had been issued or the amount due was subject to a pending administrative or judicial proceeding, from participating in the amnesty program.

On a similar note, the 2009 Connecticut amnesty program is not available to taxpayers that have received a notice of audit examination for the amnesty years or that are a party to any criminal investigation or any pending civil or criminal investigation in any U.S. jurisdiction for failure to file or failure to pay taxes, or for tax fraud. Alabama’s 2009 program excludes taxpayers with an outstanding debt shown on the department’s records in the form of a bill, assessment or civil collection action; taxpayers scheduled for audit or currently under investigation; taxpayers that entered into a voluntary disclosure agreement with the department before Feb. 1, 2009; or taxpayers with existing sales, withholding or motor fuel tax accounts.

Arguably, the most important feature of an amnesty, and the very reason taxpayers participate, is the waiver of penalties and possibly some percentage of interest otherwise due. In general, amnesty programs provide a waiver of most civil penalties; however, criminal penalties may not be waived. A waiver of interest is fairly uncommon; that is, of the more than 30 tax amnesty programs offered in the past 10 years, fewer than six states waived some percentage of interest. Connecticut’s 2009 program is one of the more unusual amnesty programs in that it provides a partial waiver of interest. Payments during the Connecticut amnesty period are subject to an interest rate of 9% rather than 12%. New Jersey is offering taxpayers a waiver of half the interest that the state would otherwise impose on payments made during its 2009 amnesty program.

Another important feature of any amnesty program is applicability: What taxes are eligible for amnesty and for what periods? A growing number of state tax amnesty programs apply to all taxes administered by the taxing agency, which generally include personal and business income taxes, sales and use taxes, and certain miscellaneous taxes. Taxes not covered in an amnesty program may include property taxes or other taxes assessed at the local level.

For example, California limited its 2005 tax amnesty to corporation franchise and personal income tax liabilities attributable to tax years beginning before Jan. 1, 2003, and sales and use tax liabilities due and payable for tax reporting periods beginning before Jan. 1, 2003. In contrast, the more recently adopted Connecticut amnesty program applies to all outstanding taxes (except motor carrier license fees) imposed by the state and collected by the Department of Revenue Services for any tax period ending before Nov. 30, 2008.

The Massachusetts 2009 amnesty enactment left the scope of the program to the commissioner of revenue, who decided to limit the program to individuals who have (1) unpaid and previously self-assessed liabilities or (2) unpaid delinquent or properly disputed liabilities assessed by the department for personal income tax, use tax or cigarette excise tax. In addition, taxpayers must receive a tax amnesty notice from the department to be eligible for the program. Massachusetts amnesty applies only to those liabilities for periods that began before Jan. 1, 2007.

Closely tied to the issue of the amnesty period is the timing of payment. As noted, taxpayers participating in a tax amnesty must make payments during the designated period. However, some programs allow taxpayers to enter into installment agreements if the taxpayer is unable to meet its full obligation under the program. In general, such agreements specify the timing and amount of payment due, applicable interest provisions, and penalties, should a taxpayer default on its obligation. The 2005 Indiana and California amnesty programs allowed taxpayers to make amnesty payments under installments.

NONPARTICIPATION

What happens to taxpayers with liabilities eligible for amnesty that do not participate in the program? If the tax delinquencies are still open under the state’s statute of limitation for assessments, taxpayers run the risk of assessment, as well as responsibility for the associated interest and penalties that the state would have waived if they came forward during the amnesty period. More troubling, however, is the growing number of states that impose additional penalties on taxpayers that could have, but did not, participate in the amnesty program.

A disturbing amnesty trend involves the imposition of significant post-amnesty penalties on underpayments that qualified for amnesty but the taxpayer did not remit during the amnesty period. The California 2005 amnesty program offers one of the more dramatic examples of how states use post-amnesty penalties to “encourage” participation. Taxpayers with outstanding liabilities that did not participate and those that participated but understated their income/franchise tax exposure were subject to:

• An increase in the accuracy-related penalty from 20% to 40% on new tax assessments;
• An amnesty penalty at the rate of 50% of the existing unpaid interest for years for which the taxpayer could have applied for amnesty; and
• An additional amnesty penalty at the rate of 50% of accrued interest on tax assessments that became final after March 31, 2005.

On a similar note, taxpayers with outstanding sales and use tax liabilities that failed to participate in the amnesty program as well as those that participated but understated their exposure were subject to penalties at “double the normal rate,” per legislation that authorized the State Board of Equalization to impose penalties at twice the statutory rate upon deficiency determinations issued after the amnesty period for any liability that could have been reported and paid during the amnesty period, plus an added charge equal to 50% of the interest due.

There was also a problematic provision that prohibited taxpayers from seeking a refund of overpayments made during the amnesty program. This bar against claiming refunds via an appeals process for amounts paid under the amnesty program led to remedial legislation (AB 911, enacted Sept. 29, 2005). The legislation allows taxpayers to file a refund claim on the grounds that the amnesty penalties were not properly computed and permits, for purposes of computing the penalty, taxpayers to offset tax underpayments for years covered in the amnesty program by overpayments from other tax years. The legislation also repealed provisions that bar taxpayers from claiming a refund for the 50% unpaid interest penalties imposed for failing to participate in the sales and use tax amnesty program and on assessments that became final after the sales and use tax amnesty period.

Other states have taken similar action with eligible taxpayers that did not participate in tax amnesty. Taxpayers with outstanding tax liabilities that were eligible for the 2003 Illinois amnesty program but did not participate were subject to (following the amnesty period’s close) an additional penalty of 200% of the interest and penalties that otherwise would be imposed. Indiana doubled any applicable penalties for taxpayers with liabilities qualifying for amnesty that were not settled under its 2004 program. Eligible taxpayers that failed to make total payment of taxes owed during the 2004 Mississippi amnesty program were guilty of a felony.

It should be noted that even in states where the legislation provides detailed information regarding the mechanics of a tax amnesty program, state revenue departments are charged with administering the program and usually provide detailed guidance after the enactment as the amnesty period approaches or as taxpayer questions and concerns are brought to the tax agency’s attention.

VOLUNTARY COMPLIANCE INITIATIVES

As noted above, voluntary compliance initiatives are limited in scope compared with tax amnesty programs. Generally, under a VCI, taxpayers receive a waiver of penalties resulting from their participation in tax shelters, reportable transactions, listed transactions, or other defined (federally or at the state level) “tax avoidance transactions” in exchange for filing returns that report and, as appropriate, reverse the tax impact of these transactions.

States that enacted reportable or listed transaction disclosure requirements generally provided taxpayers a window of opportunity to participate in some form of VCI. Only a handful of states offered VCIs at the end of 2008; however, as states continue to grapple with deficits, they may look again to VCIs to generate revenue. In doing so, states may look at recent state VCIs for guidance. In the past few years, VCIs were available in Arizona, California, Connecticut, Illinois, Minnesota, New Jersey, New York, North Carolina, Oklahoma, South Carolina, West Virginia and Wisconsin, by either legislative action or administrative authority.

California was one of the first states to offer a limited VCI as part of its tax shelter legislation in 2003. The VCI, available Jan. 1–April 15, 2004, was available to all taxpayers, other than those that participated in the IRS Offshore Voluntary Compliance Initiative (an exclusion featured in several other state VCI programs). Benefits for participants were the waiver of certain tax penalties and immunity from criminal prosecution. During the VCI period, taxpayers were required to:

• File an amended return for each year for which the taxpayer previously filed a tax return and entered into an abusive tax avoidance transaction to underreport liability for the tax year; and
• Pay in full all taxes and interest due, unless the taxpayer and the California Franchise Tax Board had entered into an installment payment agreement.

While the program provided a waiver of penalties, taxpayers had to waive their rights to appeal, even when the validity of the transactions was open to debate.

Not all states followed the California program by enacting VCIs in conjunction with legislation. For instance, in 2005, without legislation, the Arizona Department of Revenue announced a VCI under which taxpayers that participated in potentially abusive tax shelters, generally defined as federal listed transactions and substantially similar transactions, could avoid penalties by timely submitting the required forms and paying any additional tax and interest owed. Penalties for participation in abusive tax shelters and failure to participate in the VCI were imposed at rates up to 75% of the additional tax due.

New Jersey’s administrative VCI was aimed at taxpayers that participated in federally listed abusive tax avoidance transactions, including, but not limited to, the bond and option sales strategy (BOSS) and its variant (son of BOSS). New Jersey taxpayers that timely notified the state of their participation in such transactions and conceded to pay the entire tax due, plus interest, received a waiver of all penalties, including a potential 50% civil fraud penalty.

The Multistate Tax Commission in 2007 conducted a voluntary compliance program during which taxpayers that entered into abusive tax shelters could file amended returns to disclose their participation in exchange for a waiver of penalties. Taxpayers whose participation in an abusive tax shelter resulted in the failure to file were permitted to file an initial return under the program. The program applied to tax periods commencing before Jan. 1, 2006. Twenty states participated in this program.

CONCLUSION

As the states continue to grapple with the fiscal crisis, it can be expected that they will use all possible measures to increase tax revenue. Taxpayers need to carefully review state legislative Web sites for new amnesty proposals and enactments as well as the guidance provided by state departments of revenue charged with administering these programs.

Even before a state enacts amnesty legislation, taxpayers should review amnesty proposals to see if they have outstanding liabilities for the tax and years at issue. Amnesty is often an excellent opportunity to clean up delinquencies without having to pay penalties, which may be substantial, and interest, in some cases. Taxpayers should pay particular attention to provisions that penalize taxpayers with eligible liabilities that do not participate in tax amnesty programs. These penalties can be substantial, which in these economic times is cause for great concern. Taxpayers also need to monitor any moves by states to enact, implement, or, in some cases, resurrect VCI programs.

Adam Stuart Weinreb, J.D., is a director in the Tax Knowledge Management Group at PricewaterhouseCoopers LLP in New York.

This article appears in the June 2009 issue of The Tax Adviser, the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price. Call 800-513-3037 or e-mail taxsection@aicpa.org for a subscription to the magazine or to become a member of the Tax Section.