Page 3 - Penalties:To Amend or Not to Amend: Correcting Non-Compliance on Past Returns

can be extremely important for a taxpayer to correct a proceeds with a voluntary disclosure. The IRS will run the
fraudulent return because the consequences of a fraudulent taxpayer’s name against lists of taxpayers that the IRS or
return can be so severe. The civil fraud penalty is 75% of the Department of Justice has already identified for audit
the underpayment on the return and, more significantly, or investigation, and will respond to the taxpayer inform-
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a taxpayer who filed a fraudulent return risks criminal ing him or her that he or she is either pre-cleared to make
prosecution. a disclosure or is ineligible to proceed.
Fortunately, for decades, the IRS has used a “voluntary A practitioner must also explore the source of the income
disclosure” practice pursuant to which taxpayers can or assets that are the subject of a potential disclosure. A
voluntarily disclose the fraud on an original return in the voluntary disclosure, properly done, gives the taxpayer a
hope of avoiding criminal prosecution and limiting civil significant benefit by essentially eliminating the risk of a
penalties. The voluntary disclosure practice is described in criminal prosecution. The IRS does not intend to extend
the Internal Revenue Manual. On November 20, 2018, these benefits to taxpayer who committed non-tax crimi-
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the IRS issued a memorandum updating and explaining nal acts or to those who acquired previously unreported
its voluntary disclosure practice. The IRS’s voluntary income or assets through illegal means (other than simple
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disclosure practice does not guarantee non-prosecution tax evasion). Taxpayers with illegal-source income or assets
for a taxpayer’s prior non-compliance; however, the IRM cannot participate in the voluntary disclosure program
does provide that the IRS will consider the voluntary and must resolve their tax issues without the protections
disclosure in determining whether to refer the case for of the voluntary disclosure program.
criminal prosecution. While this promise to “consider” It is important to know that, while making a voluntary
the voluntary disclosure does not provide much com- disclosure provides significant protection against criminal
fort to a taxpayer thinking of disclosing his or her prior prosecution, a voluntary disclosure does not insulate a
non-compliance, the reality is that the IRS places a very taxpayer from civil penalties. In fact, the recent IRS memo-
high value on the voluntary disclosure practice as a tool randum regarding voluntary disclosures provides that,
for bringing taxpayers into compliance and, in practice, generally, a taxpayer who makes a voluntary disclosure
the IRS does not prosecute taxpayers who fulfill all the will be charged a fraud penalty for at least one of the years
requirements for a voluntary disclosure. for which he or she is correcting prior non-compliance.
There are essentially four requirements for a voluntary In certain cases, the IRS has discretion to apply the fraud
disclosure: (1) it must be timely; (2) the income or assets penalty to more than one year or to apply other types of
being disclosed must come from legal sources; (3) the penalties.
taxpayer must be completely truthful and cooperate with The main difference between a QAR and the voluntary
any requests for information; and (4) the taxpayer must disclosure practice is the type of protection that the two
pay, or make good faith arrangements to pay, any taxes, alternatives provide. The QAR rules only provide ben-
penalties and interest determined to be due. Accordingly, efits to those taxpayers who submitted a non-fraudulent
before advising a voluntary disclosure, practitioners must original return. In such cases, the QAR rules will provide
make threshold determinations concerning whether the protection against civil accuracy related penalties. In con-
potential voluntary disclosure is timely and whether the trast, when the prior non-compliance involves fraud, the
source of the assets and income to be disclosed is legal. taxpayer will need protection against civil fraud penalties
Timeliness means that the taxpayer, or a related entity, and even criminal fraud prosecution. While the voluntary
is not already under audit or investigation, or that the disclosure practice provides only limited benefits against
IRS has not already received information about the tax- civil fraud penalties, it does provide substantial protection
payer’s specific non-compliance from another source. In against criminal fraud prosecutions. Thus, in any case
most cases, taxpayers will know if they are under audit or where there is a potential for criminal prosecution, it is
investigation because the IRS will have, in some fashion, very important that the taxpayer strongly consider making
communicated with the taxpayer, a representative or a a voluntary disclosure.
witness. However, it is possible that a taxpayer has been
selected for audit or investigation without the taxpayer Advising Clients to Amend Tax
knowing because the IRS has not yet initiated contacts.
The recently issued voluntary disclosure memorandum Returns
requires a taxpayer to request “pre-clearance” by submit-
ting a Form 14457 to the IRS to determine whether As is the case with taxpayers, there is no legal require-
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there is an open audit or investigation before the taxpayer ment that tax practitioners alert the IRS of a client’s

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