An Excerpt from an article by José I. Marrero
May 2008

Benjamin Franklin once said, “In this world nothing is certain but death and taxes.”  While one may still not be able to avoid death or paying their proper share of taxes, the Internal Revenue Service (“IRS”) does have a program that allows individuals to voluntarily disclose situations that may be considered attempts to evade taxes and thus avoid criminal prosecution.  Since the 1960’s the IRS has attempted to more formalize their policy regarding voluntary compliance.

The voluntary disclosure program has been successfully utilized to avoid prosecution and reduce taxes, penalties and interest in various engagements such as:

Employment Taxes. Why is this important to you?  The definition of who is a responsible person is the determinative factor for assessing taxes and penalties as well as potentially subjecting a person to criminal prosecution.

The courts have made it clear that any person, regardless of corporate title, may be held liable for unpaid employment taxes if the person knew or should have known that the employment taxes were unpaid, and had some connection with the corporation to affect a decision on the payment of the taxes.  Below is an example of how taking advantage of the voluntary disclosure program can help resolve a significant employment tax problem:

Unpaid employment taxes from year-end bonuses. The review and analysis of the information resulted in eliminating periods due to statute expiration issues, negotiating withholding amounts due and eliminating criminal investigation potential regarding unreported income for all employees receiving bonuses.  Additionally, the client saved in excess of $400,000 in taxes, penalties and interest as compared to the original potential deficiency computed.

Income Taxes. During a divorce proceeding while preparing financial statements to the courts, one or both spouses may be aware of unreported income or false deductions related to previously filed Federal income tax returns that must be reflected on the financial statements.  This situation, if not handled properly, could expose the client to criminal prosecution and severe civil or criminal fraud penalties.  Below are examples of the potential impact of a voluntary disclosure in resolving a significant income tax problem:

In a divorce where diversion of corporate income to purchase assets in a foreign country through the use of nominees resulted in no prosecution recommendation and hundreds of thousands of dollars in reduced penalties and interest.

Repatriation of millions of dollars in previously untaxed income secreted off shore over many years.  The client wished to return to the United States and have use of funds.  An agreement not to recommend prosecution and limiting the reporting and paying tax on the untaxed monies to the immediately preceding six years was obtained.

The IRS continuously strives to balance the need to promote deterrence through prosecution of tax cases with the desire to bring the non complaint taxpayers back into the fold.  The current policy, revised December 11, 2002 strives to gain that delicate balance of voluntary compliance with the need to prosecute truly egregious violations.  The revised practice continues to be a matter of internal IRS use and creates no substantive or procedural rights. As in the past, it is provided solely for the guidance of IRS personnel.  A voluntary disclosure will not automatically guarantee immunity from prosecution.

This situation can arise regarding any form of tax, including income, employment, excise, gift or estate.  This practice does not apply to illegal source income.

Clearly, the penalties and potential criminal exposure can be quite severe.  While a voluntary disclosure will not automatically guarantee immunity from prosecution, it may often be the only opportunity many clients have to avoid a prosecution recommendation. To qualify for consideration the client/taxpayer’s communication must be truthful, timely and complete; there must be a demonstrated willingness to cooperate to determine the correct tax liability and good faith arrangements must be made with the IRS to pay in full all taxes, interest and penalties determined to be applicable.

Frequently the “timeliness and full disclosure issues” become major stumbling blocks.  We see too often when the client does not move to resolve their potential tax issues before proceeding with other legal actions.  Once the “cat is out of the bag”, the IRS has the ability, and often does, receive and analyze legal filings in matters regarding divorces, bankruptcies, civil suits regarding damage claims and disputes among parties, sales of assets and business enterprises, in short, any situation where financial information becomes public knowledge.  An early review and analysis of any financial and related tax issues in these situations could save your client from an expensive criminal investigation, potential prosecution and additional taxes, penalties and interest. The amount of tax due and owing is not the determinative factor, but rather the timeliness and truthfulness of the information disclosed.

Understanding the policies and procedures that the IRS will and can follow is key.  For example, making sure that potential tax issues are timely and adequately addressed before, during and after the filing of required financial statements in divorce proceeding will ensure the ability to avail oneself of the voluntary disclosure program.  The tax professional can possibly assist your client in avoiding situations that could even unwittingly give rise to potential criminal tax prosecution and reduce the ability to negotiate any abatement of penalties or interest.