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Voluntary disclosure as a means of satisfying unmet state tax obligations.

What happens when a taxpayer discovers that it has had a taxable presence in a foreign state for several years but has neither filed a return there nor paid tax to that state? Is there any procedure available by which the taxpayer can ensure that no criminal investigation will result from this oversight? What about civil tax penalties? What about the unpaid tax for those past years, not to mention the interest on unpaid tax, interest on unpaid penalties and interest on unpaid interest?

An administrative procedure known as voluntary disclosure may be what the taxpayer needs to solve these problems. Voluntary disclosure is a process by which a taxpayer, who is clearly subject to a state's taxing jurisdiction (i.e., has nexus with that state) but has not filed or paid tax, can (if eligible) voluntarily approach the state to register as a taxpayer and make a negotiated payment, in exchange for the state "cutting off" some of the back-tax ability, all civil penalties (sometimes criminal penalties as well) and perhaps some interest. (This article does not address voluntary registration in exchange for an agreement by a state not to audit prior years. That technique is better suited to a separate discussion.)

Voluntary disclosure is different from tax amnesty. In a typical tax amnesty program, a state waives all criminal penalties for a short period of time, after which it embarks on a crackdown of delinquent taxpayers. Though limited in time, amnesty is generally available to any taxpayer.

Voluntary disclosure, by contrast, often comes without any specific promise regarding criminal investigation or prosecution. Moreover, voluntary disclosure is generally open-ended, meaning that it is available at any time. Finally, it is typically available only to taxpayers that have never filed a tax return or paid any tax in a particular jurisdiction for the tax at issue.


A flurry of significant events in state and local taxation beginning in the late 1950s heightened the usefulness of voluntary disclosure as a tool to resolve unmet state tax obligations. In Northwestern States Portland Cement Co. v. Minnesota, 358 US 450 (1959), the U.S. Supreme Court ruled in favor of state taxing power, holding that a foreign state may constitutionally levy a tax on the net income from interstate commerce earned by an out-of-state business. The resulting hue and cry from the business community led to the enactment, also in 1959, of P.L. 86-272, by which Congress set restrictions on states' ability to impose net income taxes on certain multistate businesses.

In 1967, in National Bellas Hess, Inc., 386 US 753 (1967), the Supreme Court ruled against state taxing power, holding that a foreign state may not impose a use tax collection obligation on an out-of-state taxpayer whose only connection to the taxing state is by common carrier or the U.S. Postal Service.

The states viewed P.L. 86-272 and National Bellas Hess as setbacks to their taxing authority. In response, they created the Multistate Tax Commission (MTC) in the late 1960s, to enforce state revenue laws, promote uniformity in state revenue statutes and preserve federalism in matters of state taxation.

Early voluntary disclosure agreements apparently involved out-of-state businesses agreeing to register and collect sales tax on a prospective basis, for only a set number of years in the future. The number of future years may have been tied to the number of years under audit for potential back-tax liability.

Today, voluntary disclosure agreements require not only prospective collection but payment of some back taxes as well. Indeed, most voluntary disclosure programs declare that tax and interest for a minimum number of open back-tax years (the lookback period) must be paid, in addition to registration and prospective compliance. Most states forgive all civil tax penalties during the lookback period and may grant partial relief on interest. Absent fraud, states agree never to audit tax years prior to the lookback period, which is where the real benefit to taxpayers lies: when a state wipes away back taxes, interest and penalties, taxpayers may achieve significant savings. Finally, while many states do not expressly waive criminal sanctions, they rarely risk the success of their voluntary disclosure programs by opening a criminal investigation on a taxpayer that voluntarily comes forward to pay its tax liability.

How to Begin the Voluntary Disclosure Process

In several states, voluntary disclosure authority comes from a particular statute, which outlines the state's voluntary disclosure qualifications and parameters. Taxpayers can obtain any regulations promulgated under the statute, along with administrative notices and announcements. In states where the voluntary disclosure program is not statutory but is administered by the Departments of Revenue (DORs) under their general administrative authority, a taxpayer can gain familiarity with the voluntary disclosure program by reading all administrative pronouncements available. After learning about the program from these sources, the final step in getting started is making contact with the person who administers the program. A taxpayer should not let that administrator know its identity. In addition, a taxpayer should never call from its own phone. Finally, the taxpayer should make certain that the person to whom it is speaking is the appropriate official within the DOR who administers the voluntary disclosure for the particular tax type at issue.

Finally, and perhaps most important, states with nonstatutory voluntary disclosure programs can be fairly flexible, even novel, in the approach they take to resolve a taxpayer's particular situation. This is because statutory language offering a "one-size-fits-all" approach is not present to bind a state that administers a nonstatutory program.

Voluntary Disclosure Agreement Details

Preserving taxpayer anonymity is crucial until the taxpayer fully negotiates an acceptable agreement. The typical agreement generally requires the following disclosures:

* A general description of what items the taxpayer manufactures or sells or what services it provides and the typical nature of the transactions into which the taxpayer enters in the normal course of its business;

* How the taxpayer markets its products or services or both in the state, including a description of any other nexus-creating activities;

* The date on which nexus (or potential nexus) first occurred;

* For sales and use-tax, whether the taxpayer collected tax from customers but did not remit those funds (if this is the taxpayer's situation, the practitioner should make sure he knows how states with criminal statutes for collected-but-unpaid sales tax handle these disclosures in the context of a voluntary disclosure proceeding before identifying the taxpayer);

* For use tax, a general description of purchases that the taxpayer, made, but for which it paid no use tax;

* A description of all prior contacts between the taxpayer and the DOR. Note: For some states (e.g., Ohio), receipt of a "nexus questionnaire" is not fatal to making voluntary disclosure; for others, such a contact precludes voluntary disclosure.

Generally, it is the taxpayer's responsibility to submit the first draft of a proposed voluntary disclosure agreement. The state reviews that draft and may suggest changes, some of which might be material to the taxpayer's financial position. To avoid surprise, taxpayers should not only work out an agreement with the DOR in principle, but also an agreement that includes as much detail as possible, before submitting the first draft of the voluntary disclosure agreement.


With state nexus rules becoming marginally more clear over the years (though their application remains difficult) and the rapidly growing increase in state taxing enforcement, along with an exponential increase in the number of disclosures of taxpayer information between taxing authorities at every level, voluntary disclosure has become a popular and effective tool for taxpayers to reduce back-tax liability and become properly registered to pay the appropriate state taxes.

The State & Local Taxation Technical Resource Panel is currently working on putting together a state-by-state listing of voluntary disclosure program contacts and criteria, and hopes to have that list available at the AICPA Website ( by the end of December 2000.


Editor's note: Ms. Boucher chairs the AICPA Tax Division's State & Local Taxation Technical Resource Panel. Mr. Lundeen is a member of that panel.

If you would like more information about this column, contact Ms. Boucher at karen.j.boucher@ or Mr. Lundeen at (630) 573-8600 or

Karen J. Boucher, CPA Arthur Anderson LLP Milwaukee, WI

William Lundeen, CPA, J.D., LL.M. Clifton Gunderson LLC Oak Brook, IL
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Author:Lundeen, William
Publication:The Tax Adviser
Geographic Code:0JSTA
Date:Sep 1, 2000
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