Disclosing False or Unfiled Tax Returns to the IRS.

One of the thorniest problems a tax practitioner can encounter is when a new client admits he or she has not filed a tax return for a period of years. Even worse is when a current client admits that tax returns prepared in the past were false. What do you do when both want to correct their indiscretions? You will need to be familiar with the concepts of voluntary disclosure to the IRS and FTB.

DISCLOSE AND SELF-INCRIMINATE

Taxpayers undertake voluntary disclosures prior to an IRS investigation that might reveal either a falsely filed tax return or before filing a series of delinquent tax returns. The object of a voluntary disclosure is, of course, to avoid criminal tax prosecution. However, making the disclosure is not without peril. Indeed, the act of disclosing either the fraudulent or delinquent return is an admission of all definitions of criminal elements except willfulness and thus constitutes a waiver of the Fifth Amendment privilege against self-incrimination.

Furthermore, although a successful voluntary disclosure might dissuade the government from prosecution of the tax crime, it may still subject the taxpayer to the fraud or accuracy-related civil penalty and statutory interest.

TIMING AND COOPERATION

Both the voluntary disclosure policy's history and provisions under the IRS Internal Revenue Manual's Special Agents Handbook provide guidance on successful voluntary disclosure, the basic elements of which are timeliness and cooperation.

Your client must disclose a false or delinquent return before the IRS begins its criminal investigation. This objective test cannot be satisfied even when the taxpayer makes a disclosure in good faith, erroneously believing that there is no ongoing criminal investigation at the time. Equally significant is the subjective test of whether the disclosure is motivated by an event that the taxpayer believes may trigger an IRS investigation, such as the belief that a disgruntled ex-partner of a business venture or an ex-spouse is about to inform on the taxpayer.

The second and equally important element in a successful voluntary disclosure is the taxpayer's full and complete release of all facts to assist the IRS in determining the proper tax liability. The taxpayer must give almost blind cooperation to the IRS, including waiver of advantageous return positions. This also includes payment with the disclosure, or within a reasonable time thereafter, of the additional tax, penalties and interest. If the taxpayer cannot make the full payment, then he or she must make good-faith arrangements to pay within a reasonable time after the disclosure.

Recent court decisions have given some solace to taxpayers in this area by recognizing that the IRS has a policy of voluntary disclosure and is required to apply it in a fair manner when the taxpayer relies upon it in good faith--notwithstanding protestations by the IRS to the contrary.

DIFFERENT WAYS TO DISCLOSE

Taxpayers use a variety of methods for making voluntary disclosures, each to a varying degree of usefulness. Some of the more common methods include:

* An anonymous payment to the U.S. Treasury. This is ineffective and results in a waste of money.

* An anonymous disclosure. Only attorneys acting on behalf of the taxpayer may use this method. The attorney must negotiate with an IRS representative without disclosing the identity of the taxpayer until and unless an agreement is reached in which the IRS promises not to criminally prosecute the taxpayer.

* A letter to the IRS advising it that the taxpayer is in the process of preparing amended returns or unfiled returns. This approach is hazardous for several reasons. For instance, the IRS might decide not to accept the disclosure after having been given the taxpayer's identity, or the taxpayer might change his or her mind about disclosure after the IRS has been contacted.

* Filing an amended return. This is the most common form of voluntary disclosure. It is also the simplest. At the same time, however, it is also a trap for the unwary inasmuch as filing the amended return is an admission that the original return contained a false position. Accordingly, the act of filing is a waiver of the taxpayer's rights under the Fifth Amendment.

RISKY BUSINESS

With appropriate guidance by a knowledgeable practitioner, errant taxpayers at least can make an attempt to remedy past tax malfeasance.

ELLIOTT H. KAJAN, ESQ. is a principal with Kajan Mat her & Barish, a Beverly Hills law firm. He is a certified tax specialist who represents clients in federal and state tax controversy matters, including audits, administrative appeals, tax litigation, collection and criminal tax matters.