Voluntary Disclosures by Homelanders who were Non-Filers

Practitioners often struggle with the issue of whether a taxpayer can avoid a criminal tax investigation by making a disclosure to the IRS. A "voluntary disclosure" generally involves the process of contacting the IRS in some manner and voluntarily reporting previously undisclosed income (or false deductions) through an amended return or the filing of a delinquent return. A taxpayer's timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution. Properly resolving this issue can mean the difference between a taxpayer being criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.

Certainly, the IRS has a somewhat limited capacity to perform criminal investigations. However, a significant amount of time is not required to criminally investigate and prosecute a non-filer, particularly one who files delinquent or amended returns following an IRS inquiry. Without adequate representation, the perceived light at the other end of the voluntary disclosure tunnel . . . may be the IRS train coming straight at the taxpayer!

Why Consider a Voluntary Disclosure? Non-compliant taxpayers rarely do so as a result of some patriotic tendencies. Most often there is some type of triggering event that is causing sleepless nights such as a potential divorce or break-up of a business relationship that might uncover prior tax indiscretions.

IRS Voluntary Disclosure Practice.  Since 1952, the IRS has maintained an informal IRS voluntary disclosure practice[1] that creates no substantive or procedural rights for taxpayers, but rather is a matter of internal IRS practice, provided solely for internal guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution. A timely voluntary disclosure will not guarantee immunity from criminal prosecution, but a true voluntary disclosure will normally result in the IRS not even recommending a criminal prosecution to the Department of Justice.

A voluntary disclosure must be truthful, timely and complete, and the taxpayer must demonstrate a willingness to cooperate (and must in fact cooperate) with the IRS in determining the correct tax liability. The taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. Additionally, the policy only applies to income earned through a legal business - - so called "legal source" income. Al Capone could not take advantage of the policy.

To be timely, the disclosure must be received before: (i) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation; (ii) the IRS has received information from a third party (e.g., informant, other governmental agency, the media, or a soon to be ex- spouse or business partner) alerting the IRS to the specific taxpayer's noncompliance; (iii) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or (iv) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

Any taxpayer who contacts the IRS regarding voluntary disclosure will likely be directed to IRS-Criminal Investigation (CI) for an evaluation of the disclosure. To determine whether the disclosure is truly voluntary, the IRS will review the actual status of any prior interest in the taxpayer, the taxpayer's potential knowledge of such interest, and the taxpayer's fear of some potential trigger that could have alerted the IRS. A voluntary disclosure cannot be made anonymously. Any plan by a taxpayer, or their representative, to resolve a tax liability, file a correct return, or offer payment of taxes for an anonymous client is not to be considered a voluntary disclosure.

A voluntary disclosure does not occur until IRS has actually been contacted. As such, it is imperative that the disclosure occur as quickly as possible. IRS will rarely recommend prosecution if there has been a timely voluntary disclosure. Since returns filed pursuant to a timely voluntary disclosure have significant audit potential, they should be "bulletproof" in correctly reflecting the taxpayer's income and expense items.  Due to various federal-state information sharing agreements, any applicable state returns should be contemporaneously filed or amended with the federal returns. Returns for related entities should also be contemporaneously filed or amended. Questions or doubts should likely be resolved in favor of the government.  If a return filed pursuant to a voluntary disclosure is less than accurate, the taxpayer is compounding - - not helping the problem.

Disqualifying Factors. Counsel should inquire whether the taxpayer is currently the subject of a criminal investigation or civil examination; whether the IRS notified the taxpayer that it intends to commence an examination or investigation; whether the taxpayer is under investigation by any law enforcement agency; whether source of any income is from an illegal activity; whether the taxpayer has any reason to believe that the IRS has already obtained information concerning the tax liability to be reported pursuant to the voluntary disclosure.[2]

How many returns must be filed or amended? While there is certainly no well-established rule as to how many returns must be filed in making a voluntary disclosure, the general consensus is probably 6 tax years since the applicable statute of limitations for most tax related crimes is six years.  However, depending on the applicable facts and circumstances, a voluntary disclosure is sometimes limited to fewer than six tax years. The disclosure should eliminate any government concern that there might be any potential issues with respect to a particular tax year for which the applicable statute of limitations for criminal prosecutions has not already expired. In some situations, additional returns could be in order since the statute of limitations for a criminal prosecution is tolled for the period of time a taxpayer is outside of the United States or is a fugitive from justice.

Typically, in a civil context, it is also the IRS policy to enforce the filing of returns for the prior six tax years. In considering whether shorter or longer periods should be civilly enforced, the IRS will determine the prior history of non-compliance, the possible existence of income from illegal sources, the effect on voluntary compliance, the anticipated revenue in relation to the time and effort required to determine the tax due, and special circumstances existing in the case of a particular taxpayer, class of taxpayer, or industry, which may be particular to the class of tax involved.

Counsel must determine whether to contact the IRS before submitting a voluntary disclosure and actually filing the delinquent or amended tax returns. Some practitioners prefer to submit a Freedom of Information Act (FOIA) request or request IRS transcripts seeking income information already in the possession of the IRS before filing the returns.

No Specified Format Required. Information may be provided either verbally or in writing but must include a statement on behalf of the taxpayer indicating that they are willing to cooperate with the IRS in determining the correct tax liability and make good faith arrangements to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable in full. Some practitioners simply choose to file the delinquent or amended returns, with payment, with the appropriate IRS service center (now referred to as a "campus") by certified mail, return receipt requested as set forth in Example 6.A of IRM 9.5.11.9  accompanied by a cover letter from a lawyer which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), and which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full. If pursuing a voluntary disclosure – specifically reference Example 6.A of IRM 9.5.11.9 in the lawyers cover letter accompanying the amended returns.

Finally, some practitioners prefer making the voluntary disclosure in a meeting with the Special Agent in Charge of the local IRS-CI where the investigation would be conducted. At this meeting, the potential voluntary disclosure would initially be discussed in a hypothetical format. Counsel would generally outline the facts in hypothetical form (probably in writing) and would request whether IRS-CI would consider the return filing to be a voluntary disclosure in order to avoid recommendation of a criminal prosecution. Counsel may also attempt to secure an IRS waiver of all applicable penalties before revealing the taxpayers identity.  In the event that IRS-CI responds affirmatively, counsel would then disclose the client's identity and taxpayer identification number. However, IRS will assert that there has not been the requisite “disclosure” until the taxpayers information has been provided to the IRS.

Department of Justice – Onboard? The IRS investigates tax crimes and, when they deem it appropriate, makes a referral to the Tax Division of the Department of Justice for prosecution. The Criminal Tax Manual for the Department of Justice provides that whenever a person voluntarily discloses that he or she committed a crime before any investigation of the person’s conduct begins, that factor is considered by the Tax Division along with all other factors in the case in determining whether to pursue criminal prosecution. If a putative criminal defendant has complied in all respects with all of the requirements of the Internal Revenue Service’s voluntary disclosure practice, the Tax Division may consider that factor in its exercise of prosecutorial discretion. It will consider, inter alia, the timeliness of the voluntary disclosure, what prompted the person to make the disclosure, and whether the person fully and truthfully cooperated with the government by paying past tax liabilities, complying with subsequent tax obligations, and assisting in the prosecution of other persons involved in the crime.[3]

Further, the Policy and Procedures Memoranda for the Department of Justice acknowledges that the IRS's voluntary disclosure policy remains, as it has “since 1952, an exercise of prosecutorial discretion that does not, and legally could not, confer any legal rights on taxpayers. If the IRS has referred a case to the Tax Division, it is reasonable and appropriate to assume that the IRS has considered any voluntary disclosure claims made by the taxpayer and has referred the case to the Division in a manner consistent with its public statements and internal policies. As a result, our review is normally confined to the merits of the case and the application of the Department's voluntary disclosure policy set forth in Section 4.01 of the Criminal Tax Manual.”[4]

What to do? A taxpayer's timely, voluntary disclosure of a significant unreported tax liability is an important factor to the IRS in considering whether the matter should be referred to the U.S. Department of Justice for criminal prosecution. Properly resolving this issue can mean the difference between a taxpayer being criminally excused of a tax crime or being convicted on the basis of admissions derived from the voluntary disclosure itself.

Counsel should likely determine whether to contact the IRS before submission of a voluntary disclosure and should be consulted before actually filing the delinquent or amended tax returns. If not properly coordinated (or not timely), submission of amended or delinquent returns might be deemed an important admission in a later criminal proceeding. If timely and submitted in accordance with the IRM, a timely voluntary disclosure can avoid a criminal referral and may significantly reduce or possibly eliminate the imposition of civil penalties on any resulting tax deficiency.

Generally, people who come forward and file returns prior to being contacted by IRS are not pursued through a criminal investigation, might be able to reduce or eliminate potential civil penalties, and may be able to coordinate an effective installment payment arrangement (or Offer in Compromise) for any resulting deficiencies. Regardless, a non-filer should not wait since the "first knock on the door" may be that of a special agent from IRS-CI.

[1] Internal Revenue Manual (IRM) 9.5.11.9

[2] IRM 9.5.11.9.5

[3] Section 4.01, Criminal Tax Manual, U.S. Department of Justice (2008)

[4] Policy Directives Memoranda, Section 3, Policy Directives and Memoranda, Tax Division, U.S. Department of Justice (02/17/1993)
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