On May 13 and 14, 2020, Caroline Ciraolo sat down with Tax Notes to discuss the revised Form 14457 and new guidance on the IRS voluntary disclosure practice in a two-part series.
Excerpts from the article entitled “IRS Gives New Answers on Eligibility for Voluntary Disclosure” are below:
Noting that the IRS received considerable taxpayer and practitioner feedback after the November 2018 guidelines were issued, Caroline Ciraolo of Kostelanetz & Fink LLP labeled the new instructions “very detailed and helpful.” She also pointed out that the process will continue, and that the form and instructions could be revised again.
The IRS had previously said using the practice to resolve estate tax liabilities would be inappropriate because it is designed for those with criminal exposure rather than as an outlet for resolving civil matters. But Ciraolo predicted at the time that many executors and personal representatives would use it to settle estate liabilities if allowed. While not encouraging use of the disclosure practice for decedents, the instructions now make clear that “extraordinary circumstances may merit” its use.
Ciraolo said she was pleased to see the allowance of decedents’ and estates’ disclosures in the practice as executors and personal representatives seek to administer estates and avoid personal liability under 31 U.S.C. section 3713, the federal priority statute. That statute imposes liability on fiduciaries if they distribute assets before satisfying claims by the government. “This is a substantial and much-needed development that will benefit the IRS and facilitate the administration of estates,” Ciraolo said.
While the form makes clear that in the case of joint returns in which only one spouse is at risk for criminal prosecution, the nonculpable spouse need not participate, Ciraolo said that approach could cause administrative burdens and delays. The instructions also state that the IRS could examine a spouse who does not make a voluntary disclosure.
“Because a non-willful spouse can participate without conceding culpability, joint letters should consider the benefits of joint disclosures and the potential costs of pursuing separate paths of compliance,” Ciraolo said.
“The IRS recognizes that not all noncompliant taxpayers have engaged in intentional or willful, much less criminal, conduct. In light of the aggressive assertion of international tax and FBAR penalties over the past several years, this is a welcome recognition,” Ciraolo said.
By specifically indicating activities that are legal under state law but illegal under federal law, the IRS decided to exclude noncompliant taxpayers involved in the production or sale of cannabis, Ciraolo said. “Such taxpayers are left, once again, outside the tax system at a time when [the Treasury Inspector General for Tax Administration] is recommending increased compliance efforts,” she said.
“Based on decades of prior domestic disclosures, many of these taxpayers and their advisers did not anticipate detailed audits, the extent of required cooperation, or the assessment of civil fraud penalties. Of course, these taxpayers can challenge the fraud penalty, but in doing so may find that the IRS seeks to impose greater penalties
based on the facts and circumstances,” Ciraolo said. “On the other hand, a high-income nonfiler may find the new framework favorable, in that it imposes a single civil fraud penalty and estimated tax penalties in lieu of multiple years of delinquency penalties — failure to file and failure to pay penalties — that can total 47.5 percent of the
tax due for each year.”
“This leaves taxpayers who submitted false or incomplete information under the OVDP with limited choices: comply going forward and hope that the noncompliance is not discovered; file amended returns and again hope that they are not selected for audit; or wait until six years after the most recent year of noncompliance within the OVDP,” Ciraolo said.
Ciraolo said she had diculty understanding why a possibly non-willful noncompliant OVDP taxpayer subject to an unrelated correspondence exam would be ineligible for the practice while the targets of criminal tax investigations could be allowed in.
Ciraolo also said that while the instructions clearly state that disclosure won’t guarantee immunity from prosecution, they may lead to confusion, as they also state multiple times that the practice provides a way to “avoid potential criminal prosecution.”
“It would be helpful if the IRS were to issue a clear statement that a timely, accurate, and complete voluntary disclosure will — not may — prevent a referral for criminal investigation or prosecution on the matters disclosed,” Ciraolo said.
Excerpts from the article entitled “IRS Updates What Voluntary Disclosure Entails” are below:
“The IRS has provided numerous helpful examples, many of which are based on questions raised following the November 2018 memorandum,” Caroline Ciraolo of Kostelanetz & Fink LLP said. “Advisers should carefully read through each of the examples before advising clients on what information and records are needed.”
“Taxpayers may want to advise related parties of their pending disclosures so those parties have an opportunity to make their own disclosure before a related audit or investigation is initiated and those parties become ineligible,” Ciraolo said. “Advisers should consider conflicts of interest, applicable privileges, and separate representation before attempting to advise related parties.”
Although the IRS has not expressly required taxpayers to waive privilege, Ciraolo argued that to fully cooperate, taxpayers may have to disclose enough information to assert privilege and prove that the communications are subject to such privilege. Information gathered by the IRS could be used in civil promoter investigations, John Doe summonses, Office of Professional Responsibility referrals, or criminal investigations, she added.
Advisers should keep in mind when managing client expectations regarding timing and compliance costs that taxpayers “must provide the source of funds in all foreign financial assets, not just those that are noncompliant, and must also disclose all transactions in these accounts,” Ciraolo said.
According to Ciraolo, the scope of cooperation envisioned under the new guidance is much broader than what is usually required under standard exams.
“This information is certain to lead to related audits and criminal investigations and should prompt discussions with clients regarding related disclosures,” Ciraolo said. Because of potential conflicts of interest, separate counsel may be needed for related third parties, she warned.
Ciraolo advised practitioners to “brush up on the basics,” in light of the new instructions.
“The disclosure audits will require more time and attention than the summary reviews of amended or delinquent returns that some taxpayers experienced in the OVDP,” Ciraolo said, adding that because the IRS is presuming noncompliance with tax reporting and payment, taxpayers for whom that doesn’t apply should note that at the beginning to avoid unnecessary document requests.
Ciraolo said that taxpayers claiming an inability to pay should expect “an extremely detailed and document-intensive” process with any false statements potentially counted as continuing acts of evasion.
Ciraolo added that given the IRS position that payments shouldn’t be made until preliminary approval is given, which could take several months after an initial request for pre-clearance, it would help taxpayers to be able to make payments online via Direct Pay or the Electronic Federal Tax Payment System. That could negate the need to send checks to offices closed during a federal emergency, she said.
According to the instructions, the scope of the examination can be expanded to all tax years involving willful noncompliance, with managerial approval, if a taxpayer fails to cooperate fully. Failure to cooperate can also result in revocation of preliminary acceptance into the practice, but, as Ciraolo noted, it’s unclear if this also requires managerial approval.
“Moreover, it is unclear whether the taxpayer has a right to independent review of these decisions,” Ciraolo said. “To avoid the inevitable claims for taxpayer advocate assistance that we saw with threats to expel taxpayers from the OVDP, it would benefit both taxpayers and the IRS to establish a procedure for independent review of expansion and revocation decisions.”
To Ciraolo, the 50-hour estimate means the IRS is sending “a clear message that taxpayers should take their time and proceed with caution.”
Part 1 of the article series can be found in its entirety here.
Part 2 of the article series can be found in its entirety here.
