Voluntary disclosure programs stand as important points of resolution for businesses navigating potential sales tax and state income tax non-compliance issues. Understanding the nuances of these programs is crucial for enterprises seeking to rectify their tax affairs. In this article we’ll focus on voluntary disclosure agreements (known as “VDAs” in the state tax arena) as they relate mostly to sales tax and state income tax. Note that each state has its own process for engaging in these remedies and there is no “one-size fits all” although there are similarities among the programs.
We’ll cover some of those nuances here:
1. Understanding Voluntary Disclosure Programs:
2. Risks of Non-Compliance:
- Overview:
Explore risks related to non-compliance, emphasizing proactive mitigation. - 1. Audits and Investigations:
Non-compliance increases the risk of time-consuming audits as happens when a state identifies a company as non-compliant before the company is able to come forward voluntarily - 2. Financial Penalties:
Non-compliance leads to financial penalties and interest. - 3. Legal Actions:
Non-compliance may escalate to legal actions. - 4. Reputational Damage:
Non-compliance can harm a business’s reputation. - 5. Loss of Business Opportunities:
Non-compliance limits opportunities. - 6. Unpredictable Financial Impact:
The financial impact of non-compliance is unpredictable.
3. Benefits of Participation:
- Benefits include potential penalty reductions, limited lookback period (i.e.; shorter windows in which to calculate retroactive taxes) avoidance of legal actions, and reputation preservation, as well as being on the offense (rather than defense) with a state taxing authority. Another huge benefit is the ability to remain anonymous for a period of time (in most states) while the company compiles its supporting documentation.
4. Steps for Effective Preparation:
- Initial Steps:
Recognizing potential tax liabilities and understanding non-compliance. - Risk Evaluation:
Assessing the likelihood of tax authorities detecting non-compliance and preparing internal estimates of the potential retroactive sales tax and income tax exposure. - Document Compilation:
Collecting relevant documents to support the disclosure process. - Organization:
Efficient organization of collected documents for streamlined disclosure. - Internal Audits:
Thorough internal audits to identify potential issues. - Gaps and Inconsistencies:
Identifying gaps or inconsistencies for proactive resolution. - Timeline Establishment:
Developing a realistic timeline for voluntary disclosure.
Still not what you need? No problem – let’s talk. Reach out to us at info@milesconsultinggroup.com.
1. Understanding Voluntary Disclosure Programs
Voluntary disclosure programs are initiatives offered by state taxing authorities to allow businesses to come forward voluntarily and rectify certain tax liabilities or non-compliance issues. The primary purpose is to encourage businesses to disclose errors or omissions willingly while receiving limited lookback periods and reduced penalties.
Fundamentally, engaging in a voluntary disclosure program means you are on the offense and not the defense – you as taxpayer are being proactive.
But how does a company even evaluate when to use a VDA program? As discussed more fully below, a company might realize after internal analysis or discussion with a consultant that it had the obligation to collect and remit sales tax. Likely this is a result of having created either physical presence or economic nexus in a state. Such exposure in prior years must be rectified with a state before the company can properly register and move forward with current sales tax collection and compliance. As such, companies often decide to come forward (often anonymously at first) and agree to reduced years of liability reporting and waiver of most penalties, among other things. We find that VDAs are a very good way for companies to come forward and handle retroactive exposure. It’s part of what we help clients with every day! (So, if this is something your company is considering, you’re in good company!) Contact us for more information and assistance now at info@milesconsultinggroup.com.
2. Risks Associated with Non-Compliance
Non-compliance with tax regulations exposes businesses to a spectrum of inherent risks, each with potential consequences that can adversely impact their financial stability and reputation. Recognizing and understanding these risks is crucial for businesses to appreciate the significance of proactive participation in voluntary disclosure programs. The key risks associated with non-compliance include:
- Audits and Investigations: Failure to comply with tax regulations increases the likelihood of audits and investigations by tax authorities. These processes can be time-consuming, disruptive, and resource-intensive for businesses. Audits may uncover discrepancies, leading to additional tax assessments, interest charges, and potential penalties. Proactively addressing non-compliance through voluntary disclosure programs can mitigate the risk of intensive audits.
- Financial Penalties: Non-compliance often results in the imposition of penalties and interest, which can significantly impact a business’s bottom line. These penalties may be calculated based on the severity and duration of non-compliance. Participating in voluntary disclosure programs offers businesses the opportunity to potentially reduce or eliminate these penalties, demonstrating a commitment to rectifying issues and fostering cooperation with tax authorities. How much are we talking about? We generally recommend that clients use a ballpark of between 25-30% to cover interest and penalties that might be due in a retroactive lookback situation. So, it can definitely be significant.
- Legal Actions: Non-compliance can escalate to legal actions, including litigation and prosecution. Tax authorities may pursue legal avenues to enforce compliance, leading to additional costs and potential damage to a business’s reputation. Voluntary disclosure programs provide an alternative route for businesses to address non-compliance without resorting to legal actions, fostering a cooperative approach and avoiding the associated risks.
- Reputational Damage: Non-compliance can have severe consequences for a business’s reputation. Negative publicity, damage to customer trust, and strained relationships with suppliers and partners can result from public knowledge of tax-related issues. Proactive participation in voluntary disclosure programs allows businesses to rectify non-compliance discreetly, minimizing reputational damage and preserving trust within the business community.
- Loss of Business Opportunities: Businesses that are non-compliant with tax regulations may face limitations in securing contracts, partnerships, or financing opportunities. Many stakeholders, including customers and investors, prioritize working with businesses that demonstrate a commitment to ethical practices and compliance. Voluntary disclosure programs offer a pathway for businesses to rectify non-compliance, enhancing their eligibility for various business opportunities.
- Unpredictable Financial Impact: The financial impact of non-compliance can be unpredictable, with potential consequences ranging from unexpected tax liabilities and related interest and penalties to unplanned expenses related to audits and legal proceedings. Voluntary disclosure programs provide businesses with the opportunity to gain control over their financial destiny by proactively addressing non-compliance, allowing for better financial planning and risk management.
For more on sales tax compliance, click here.
3. Benefits of Participating in Voluntary Disclosure Programs
Participating in voluntary disclosure programs provides businesses with a range of valuable benefits, creating a proactive and mutually beneficial approach to resolving tax-related issues. These programs, often offered by tax authorities, aim to encourage businesses to come forward voluntarily to address any potential non-compliance. The advantages of participating in such programs include:
- Potential Penalty Reductions: One of the primary benefits is the potential for significant reductions in penalties. Tax authorities recognize that businesses voluntarily disclosing errors or omissions are demonstrating a commitment to rectifying compliance issues. As a result, participating businesses may receive favorable treatment, including reduced or waived penalties compared to those imposed in cases of non-disclosure.
- Avoidance of Legal Actions: Voluntary disclosure programs provide businesses with an avenue to rectify compliance issues without facing severe legal consequences. By voluntarily coming forward and addressing potential tax liabilities, businesses can avoid or mitigate the risk of legal actions, audits, or investigations that may arise if non-compliance is discovered through other means. This approach fosters a cooperative relationship between businesses and tax authorities.
- Opportunity to Rectify Errors Proactively: Participating in these programs offers businesses the opportunity to rectify errors in a controlled manner. Rather than waiting for potential audits or investigations, businesses can voluntarily disclose inaccuracies, omissions, or past oversights. This proactive stance allows for the implementation of corrective measures, demonstrating the business’s commitment to compliance and ethical business practices.
- Preservation of Reputation: Maintaining a positive reputation is crucial for businesses, and voluntary disclosure programs provide a means to address compliance issues discreetly. By voluntarily addressing and rectifying potential tax liabilities, businesses can preserve their reputation in the business community and among customers, suppliers, and other stakeholders. This transparency and commitment to compliance contribute to building trust and credibility.
- Clarity on Tax Liabilities: Participating in voluntary disclosure programs provides businesses with clarity on their tax liabilities. Through open communication with tax authorities, businesses can gain a better understanding of their tax obligations and work collaboratively to resolve any uncertainties. This clarity enables businesses to plan and budget effectively, reducing the risk of future compliance issues.
- Potential for Extended Payment Plans: In some cases, voluntary disclosure programs may offer businesses the flexibility of extended payment plans for outstanding tax liabilities. This can be particularly beneficial for businesses facing financial constraints, allowing them to fulfill their obligations over a structured timeframe without compromising their operational viability. Note that each state varies in these types of payment plans, and many are not guaranteed.
4. Steps for Effective Preparation
Back to the crux of the matter – once you’ve initiated the voluntary disclosure program, these are the steps that need to be taken, for the process to be fast and beneficial:
- Recognizing Potential Tax Liabilities
Begin the preparation process by identifying potential tax liabilities, examining previous filings, and understanding any areas of non-compliance. This is often accomplished by performing a nexus and taxability review, which also includes exposure analysis. From this, a company can determine when its obligations to collect and remit sales tax starts, how much money is at stake and what the specific benefits of a VDA in each state would be. - Assessing the Risk of Detection
Evaluate the likelihood of tax authorities detecting non-compliance, considering factors such as industry norms, regulatory changes, and audit triggers. Clients often ask us “how likely am I to be audited?” or “what are the triggers?” There are many items to consider (and we can chat about those), but it’s important to note that states are fairly aggressive in determining non-compliance. And once a state reaches out with a notice or nexus questionnaire, then VDAs are almost always off the table and a company can no longer obtain the benefits mentioned above. Timing is very much of the essence in voluntary disclosure. - Types of Documents to Collect
Compile relevant documents, including financial records, transaction details, and tax filings, to support the disclosure process. This may include reaching out to customers to determine if they have self-assessed tax previously. Or if they have exemptions or resale certificates that the selling company did not timely collect but may now be able to. (Note that there are some nuanced processes here that we are happy to discuss in more detail.) This process is often referred to as an “XYZ letter” process. - Organizing and Categorizing the Documents
Efficiently organize and categorize the collected documents to streamline the disclosure process and enhance clarity. - Conducting Internal Audits
Conduct thorough internal audits to identify potential issues, ensuring a comprehensive understanding of the scope of non-compliance. - Identifying Gaps and Inconsistencies
Scrutinize the collected information to pinpoint any gaps or inconsistencies, addressing them proactively during the disclosure process. - Establishing a Timeline for Disclosure
Develop a realistic timeline for the voluntary disclosure, considering internal capabilities, regulatory deadlines, and the need for thorough preparation. Once companies decide to go down this route of disclosure, they often want to start right away. It’s important to note that the process can take 2-3 months to complete. And sometimes longer, depending on the backlog of a particular state.
When you choose to work with Miles Consulting Group, you choose a speedy, experienced and professional handling of all of the above steps. You’ll work closely with one of our knowledgeable consultants, and you’ll get anonymity as long as possible.
