Voluntary disclosure: minimizing preexisting state tax liabilities.

Businesses having sufficient contact with a state to require filing a return, but not filing, may benefit from participating in a voluntary disclosure program. These programs limit prior-year filing requirements and eliminate potential penalties for nonfiling years. A business can negotiate a voluntary disclosure agreement to limit prior income, franchise, sales, use and other tax exposure and penalties. To do this, it would typically approach a state anonymously, through a tax representative. Voluntary disclosure" materially differs from tax amnesty, because the lookback period is typically three to four years; it is generally available only after amnesty expires.

Voluntary Disclosure Applications

In applying for voluntary disclosure, applicants usually have to include the following information:

1. A reason they are subject to a tax they have not paid in the past;

2. A description of the nature and extent of their activities in the state;

3. When they commenced doing business in the state;

4. Their tax year-end;

5. Whether the state has already contacted them about the taxes that are part of the voluntary disclosure;

6. The taxes for which they are currently registered, filing returns and remitting;

7. Whether they are registered with the secretary of state to transact business in the state; and

8. A good faith request to participate in the state's voluntary disclosure program.

Although not inclusive, these core points are typically required during the application process.

Lookback Periods

Pursuant to a voluntary disclosure agreement, states typically require applicants to file three to four prior-year returns. For example, Michigan's single business tax lookback period is generally 48 months; under certain circumstances, Michigan will limit the lookback period to 36 months. Pennsylvania will generally require a taxpayer to file a current year return plus four prior-year returns, for a total of five years, for corporate income or franchise tax purposes; however, it only requires three years of sales or use tax return filings.

Abatement of Penalties/Interest

Generally, pursuant to voluntary disclosure, states will abate penalties for not filing returns and not paying taxes. They usually do not abate interest on past-due taxes, because the statutes that assess interest on delinquent taxes typically do not grant the discretion to waive interest. However, one exception is Texas, which can waive interest on late tax payments under certain circumstances.

Income/Franchise Tax

In West Virginia, Pennsylvania and North Carolina, taxpayers have to report both income and franchise taxes on the same form. Depending on the facts and the state's nexus standard, applicants may not be subject to income tax, but subject to franchise tax. Similarly, Tennessee and New York have the same nexus standard for income or franchise tax purposes; if the applicant's activities are insufficient to create income tax nexus with a particular state, the applicant does not have a franchise tax filing requirement, either. However, even if the applicant does not have sufficient contact with a state to require an income tax return, it may have to file franchise tax returns, and should attempt to limit franchise tax liability and penalties pursuant to a voluntary disclosure agreement.

Sales Tax 

If an applicant's employees regularly enter a state to solicit sales, the applicant will typically have to file sales tax returns. Even though its sales may be all for resale and exempt from sales tax, the applicant's tax representative should definitely negotiate a voluntary disclosure agreement that limits the sales tax lookback period and permits the applicant to register prospectively and file sales tax returns annually, even though it owes no tax.

Some states do not include sales tax initially in a voluntary disclosure agreement, if applicants indicate that all sales are exempt. However, the applicant would be trapped if it could not register or file prospectively, because once its identity is revealed, no legal mechanism limits a sales tax audit of prior periods. The applicant that has not filed sales tax returns in the past has not started the statute of limitations framing for these prior periods. To avoid having to substantiate exemptions for all prior-year sales, the applicant's tax representative should always request the inclusion of sales tax in a voluntary disclosure agreement.

Spreadsheets vs. Actual Returns

Applicants should always request spreadsheet returns, rather than actual returns, for prior periods. Spreadsheet returns typically save the applicant professional fees, because most voluntary disclosure practitioners have developed a standard template for the states in which they practice.

Tax advisers can more quickly complete spreadsheet returns with the appropriate information and revise them more efficiently than actual returns. Many states will accept a spreadsheet return for sales or use tax purposes. However, states generally do not accept spreadsheet returns for income or franchise tax purposes.

Local Jurisdictions

In addition to becoming compliant with state tax filing requirements, applicants should also consider voluntary disclosure for local jurisdictions that levy taxes on businesses. For example, local jurisdictions in Michigan, Ohio and Kentucky levy their own taxes on businesses. Any state voluntary disclosure plan should also consider potential prior exposure at the local level, as states sometimes share taxpayer information with their local jurisdictions.

FROM GARY PERIC, J.D., CPA, OAK BROOK, IL