What exactly is the California Franchise Tax voluntary disclosure program? For an individual’s federal income taxes, the IRS is charged with administering and enforcing the U.S. Tax Code. For state tax obligations in California, the Franchise Tax Board (FTB) is charged with administering the personal income and corporate tax. When taxpayers fail to file taxes, make and certify incomplete filings, make errors, fail to pay a tax obligation that is due and owing, or attempt to evade the assessment of tax they are likely to face a civil audit and potentially criminal enforcement action by the federal or state tax agency.
However, not every tax compliance issue is the product of voluntary or intentional behavior. In fact, the vast majority of tax problems likely come down to a lack of familiarity and understanding regarding one’s obligations and the process. However, taxpayers who make errors or otherwise accidentally fail to satisfy their obligation can avail themselves of voluntary disclosure programs that allow taxpayers to reduce or eliminate the fines and penalties they would otherwise face for a tax compliance failure and possibly avoid criminal sanctions even where they willfully avoided taxes (committed income tax evasion – a felony under federal and state law).
While the programs provided by the FTB and the IRS can have a similar effect in the end the way one qualifies for the program, the exact benefits provided, how one enters into the program, disqualifying characteristics, and other factors can differ significantly. Read further to understand the voluntary disclosure programs at the state and federal levels, how they are similar, and how the programs are different.
What Is a Voluntary Disclosure and what is Its Purpose?
IRS resources define a voluntary disclosure as a communication from a taxpayer that makes an accurate, timely, and comprehensive disclosure of past tax problems. Furthermore the taxpayer must cooperate with the IRS, the taxpayer makes arrangements to pay the unpaid tax and any other associated costs as determined by the IRS, and prior to the IRS receiving information from a third-party about the failure or initiating an investigation or opening an audit. The California version of the program is similar in the sense that it also requires a timely disclosure before unilateral action is taken by the FTB. Under the program for qualified applicants the FTB may decide to waive some or all penalties and waive its authority to take action on taxes prior to the 6-year period submitted as part of a voluntary disclosure in California.
Voluntary disclosure programs exist for a number of reasons while also satisfying the principles of equity and fairness in tax enforcement. When a taxpayer makes a tax filing error or some other mistake, he or she may incorrectly assume that the best option is to simply wait it out and see if the IRS or FTB notices. Unfortunately, such a strategy is risky and allows that risk and uncertainty to affect one’s finances and decisions for a significant number of years. While the IRS can typically audit up to three years back, there are situations where it may look back six years or more. Where tax fraud is discovered in an open tax year, both the IRS and the state of California can audit back to the dawn of time.
Making a voluntary disclosure can allow a business or individual taxpayer to address a known tax deficiency in a timely manner. As an incentive for coming forward voluntarily, the taxpayer is ensured reduced fines and penalties and the potential to avoid criminal liability. The tax authority benefits because it saves the time, expense, and other resources required to pursue a tax enforcement action while receiving income. A voluntary disclosure can allow you or your business to move forward from fear and anxiety over taxes.
Who can Qualify for the FTB and IRS Voluntary Disclosure Programs?
For both programs to make sense, you must generally have some tax compliance problem. Under California’s program qualified entities, qualified shareholders, and qualified beneficiaries can qualify for the voluntary disclosure program. Qualified entities can include corporations, S Corps, LLCs, and trusts. Qualified shareholders are nonresidents on the date of execution of the agreement who are a shareholder in an S corporation. Qualified beneficiaries are nonresidents at the time of signing and for the six previous years and is a beneficiary of a qualifying trust that has applied for relief under this program. However, if any of the following is true, the applicant is subject to disqualification from the program:
- The applicant organized and existed under the laws of the state of California.
- The applicant maintained a permanent facility and staff in the state.
- The applicant has previously been the subject of a FTB inquiry or enforcement action.
- The applicant is registered with the California Secretary of State.
- The applicant has filed a previous return with the FTB
- The applicant is a California resident.
Unlike the California program that mainly addresses out-of-state taxpayers, the IRS Voluntary Disclosure program is open to all U.S. taxpayers expect those who have income derived from an illegal source. The IRS voluntary disclosure program can apply to errors ranging from offshore accounts reporting failures to the failure to file or pay taxes. However, like the California program certain factors can disqualify a taxpayer from entering into the disclosure program and deriving benefits. If any of the following are true the taxpayer will be ineligible to utilize this option:
- The IRS has notified the individual regarding its intent to open an investigation.
- The IRS has already opened an investigation or civil examination.
- The taxpayer is under investigation by another law enforcement agency.
- The taxpayer has reason to believe that the IRS has already obtained information regarding the tax liability due to a FATCA disclosure or through other means.
While these factors provide a general overview of the qualifying and disqualifying characteristics a voluntary disclosure applicant may have, there are numerous other factors to consider. An experienced tax attorney can help you determine whether you can qualify, if the program is a good fit for your situation, and help you with the application process.
How Does One File to Enter into the Disclosure Program?
While there are significant similarities in the foregoing sections, in this area the process and practices of the IRS and FTB differ more significantly.
Individuals and businesses that choose to participate in the Voluntary Disclosure Program in California are required to apply via FTB Form 4925 — Application for Voluntary Disclosure. In California, all voluntary disclosure must be made in writing. However, applicants have the option to remain anonymous under the California program. In fact, representatives should refrain from revealing the company name or other information that could readily identify the entity until the execution of the disclosure agreement is complete.
However, while being careful to not identify the company or entity, any qualified parties must make an accurate and comprehensive disclosure. The disclosure must address all material facts relating to the unsatisfied income or franchise tax, a description of the applicant’s business activities in the state, the amount of tax in question for each year, the calculations and computations behind the tax in question, and other information. From the date of application’s executed disclosure agreement the individual is allowed 30 days to file tax returns and satisfy the agree-upon taxes and penalties now due and owing. Aside from these actions, the taxpayer must also agree to comply with filing taxes and paying any taxes due and owing going forward.
The IRS process is less constrained by formality in comparison to the California FTB process. The disclosure may be in writing in a form decided by the filer provided that the disclosure meets the requirements set forth in IRS manuals. The following information is required when an applicant requests relief through the IRS program:
- The taxpayer’s name
- The taxpayer’s Social Security number
- Addresses used by the taxpayer
- In the case of a business, the employer identification number
- The types of returns at issues (941, 1040, 1099, 1120)
- The type of taxes at issue
- A description of the tax scheme or error used by the taxpayer, the income that was omitted, and the tax that remains due and owing
- A verbal or written statement expressing the taxpayer’s commitment to cooperating with the IRS and their good-faith attempts to satisfy any outstanding obligations
- Amended tax returns
Information provided must be accurate, complete, and truthful. A valid power of attorney (POS) must be executed prior the filing of any of the above on the taxpayer’s behalf.
What Benefits can a Taxpayer Making a Disclosure Derive under Each Program?
While the exact benefits a taxpayer may derive from the programs is a fact-specific determination, we can discuss, in general, how the program can help. The California program can permit a qualified applicant to avoid some or all of the penalties associated with failures regarding obligations including:
- Unfiled returns under Section 19131
- Failure to pay tax due and owing under Section 19132
- Underpayment of an estimated tax or tax under Section 19136 or Section 19142, respectively
- Penalties imposed under Section 19141 by the Secretary of State
- Failure to maintain records under Section 19141.5
- Failure to file information returns under Section 19183
- Failure to file timely partnership returns under Section 19172
- Contract voidability penalties imposed under Section 23301.5
The IRS program will generally result in the waiving of most fines and penalties, however depending on the circumstances you may have to pay a reduced penalty. For instance, those who engage in the offshore version of the voluntary disclosure penalty must pay an offshore penalty. However, the program does offer significantly mitigated penalties in comparison to what the taxpayer would face in an enforcement action. Furthermore while a voluntary disclosure is one of the factors considered when the IRS determines whether referral for criminal tax prosecution is appropriate, engaging in the process does not provide a guarantee that criminal charges will not be advanced. An experienced tax attorney can provide guidance regarding whether a voluntary disclosure under either program is likely to be appropriate and beneficial.
Rely on Our Experience With California FTB & IRS Voluntary Disclosures
Taxpayers who suspect that they made errors or have other problems with their California state or federal taxes don’t have to face unending anxiety over their possible mistakes. The experienced tax professionals of the Tax Law Offices of David W. Klasing are dedicated to providing on-point guidance for an array of tax problems. To schedule a reduced-rate consultation, call us at 800-681-1295 or contact us online today.
