The recent economic downturn has impacted government coffers very hard. It has forced difficult decisions regarding program cuts, tax increases and identifying other sources of revenue to assist with shortfalls.
Earlier this month, Illinois announced that the amnesty program in place last fall raised more than $700 million of revenue for governmental units, $450 million higher than the original estimate of $260 million. This was welcome news for the taxpayers facing a large budget shortfall and a fair amount of media coverage regarding the tax increases enacted to help reduce the budget shortfall.
Many other states enacted amnesty programs in 2010 and others are considering or will be imitating such programs in 2011.
States have many taxes that are often covered under an amnesty program. The taxes covered may include business income or franchise taxes, individual income taxes, state sales and use taxes, state wage withholding taxes, excise taxes, etc.
The intent of the amnesty programs is multi-faceted. It generates revenue from prior tax years that may not otherwise have been collected or would have used enforcement and collection resources that in many governmental units are overburdened with current efforts and initiatives. It also brings taxpayers back into the system and therefore increases future tax revenues for the governmental units since the hope is these will be back in compliance in filing tax returns and remitting tax liabilities on a current and recurring basis.
Each amnesty program has its own unique characteristics in terms of the time period, the process and any incentives (such as reduced interest or penalties) that may be allowed. Michigan had an amnesty program in effect for businesses and individuals from May 15 to July 1, 2002. The report on the results of that amnesty program are available at www.michigan.gov/documents/AmnestyReport_59671_7.pdf. Michigan also had an amnesty program in 1986.
Taxpayers don’t always need to wait for an amnesty program to come forward. Many governmental units offer taxpayers the ability to enter into voluntary disclosure agreements if they haven’t been identified or approached by a governmental taxing unit. Typically a VDA covers multiple years and includes terms on the amount of penalties and interest levied on any outstanding tax liability. Many VDAs originate on a no-name basis with a legal or accounting professional being the liaison between taxpayer and governmental unit.
At the federal level, a large-scale amnesty program similar to those many states offer has not been undertaken. There have been targeted initiatives to encourage compliance by taxpayers. A recent example is the program for voluntary disclosure relating to foreign bank or financial accounts and any resulting income omissions related to such accounts. A program was in place during 2009 and another was announced earlier this month for 2011.
The 2009 voluntary disclosure program was announced after the reports and prosecution of certain offshore financial institutions assisting U.S. taxpayers in hiding assets and the income on such assets from U.S. income tax. The IRS increased its resources and obtained cooperation from foreign governments in accessing information of foreign accounts that may be owned by U.S. citizens or residents subject to U.S. income tax and other reporting requirements. More than 14,000 taxpayers participated in the 2009 voluntary disclosure program. Taxpayers who were accepted into the 2009 program were subject to reduced penalties.
Legislation passed in 2010 will require specific disclosure by individuals of foreign assets to the IRS for tax years beginning after March 18, 2010. For calendar year taxpayers, the first reporting periods will be the 2011 calendar year. New code section 6038D requires any individual with more than $50,000 of foreign assets to annually report such assets to the IRS. In November 2010, the IRS released a draft Form 8938 (Statement of Foreign Financial Assets) for taxpayers to use to report foreign assets. The 2010 legislation also provides for penalties for non-disclosure of the assets as well as penalties on any income not reported on such assets. In addition, the legislation extends the statute of limitations on a return for the non-disclosure of income and /or assets that should have otherwise been reported under the new rules.
Additional resources have been committed to enforcing the various tax filing and information reporting requirements under U.S. law. The IRS has undergone reorganization over the past year to assist in its international tax administration and compliance efforts.
Based on the experiences from the 2009 program and the recent reorganization, the IRS announced on Feb. 8 a new voluntary disclosure initiative to encourage individuals with undisclosed income from hidden offshore accounts to get current with their taxes. Taxpayers who otherwise qualify for the voluntary disclosure initiative can avoid uncertain criminal or severe civil penalties by taking advantage of the IRS’s new initiative.
The 2011 initiative, referred to as the 2011 Offshore Voluntary Disclosure Initiative, includes several changes. The overall penalty structure for the 2011 initiative is generally higher than the 2009 program. The 2011 initiative provides a new penalty framework that requires participants to pay a 25 percent penalty on the amount in the foreign bank accounts in the same year with the highest total balance covering the 2003-2010 time period. This penalty is in addition to any unpaid taxes, interest and accuracy-related penalties. The 2011 voluntary disclosure requires that the disclosure be made by Aug. 31, 2011. For certain taxpayers, there are some reduced penalties for smaller account balances and income omissions.
The IRS also released on Feb. 8 a frequently asked question document to assist taxpayers in understanding the rules and other information under which the program will operate. The FAQ can be accessed at www.irs.gov/businesses/international/article/0,,id=235699,00.html. Also, the IRS posted documents needed to participate in the initiative: www.irs.gov/newsroom/article/0,,id=235584,00.html
No estimates of what additional revenue is expected to be generated by the IRS under the 2011 initiative have been provided so far. The resulting additional revenue likely won’t make a large impact on the deficit. However, it may provide for more taxpayers participating in the tax system and filing returns and paying taxes on a go-forward basis.
Some may think that the cost to come clean and catch up on filings and disclosures is expensive when considering the penalties and other costs associated with coming clean. However, the potential penalties for not coming forward may be significantly larger. There are criminal penalties that can be pursued in addition to civil penalties for undisclosed foreign financial accounts and income omissions related to the undisclosed assets.
Participation in any voluntary disclosure or amnesty program is a decision that should be discussed with legal and tax advisers as there are issues that need to be considered. When governmental units offer the opportunity to come clean, taxpayers should consider the benefits of making things right. There may not be second chance to take advantage of such opportunities.
William F. Roth III is a tax partner with BDO USA LLP. The views expressed are those of the author and not necessarily those of BDO. The comments are general in nature and not to be considered as specific tax or accounting advice and cannot be relied upon for the purpose of avoiding penalties. Readers are urged to consult with their professional advisers before acting on any items discussed herein.