State voluntary disclosure programs: A practice guide

Editor: Brian Myers, CPA

Voluntary disclosure programs (VDPs), facilitated through voluntary disclosure agreements (VDAs), provide taxpayers with an essential mechanism to rectify past noncompliance with state tax obligations. As states increasingly invest resources into promoting and managing VDPs, these programs offer a proactive avenue for taxpayers and their advisers to address prior liabilities.

This column explores the intricacies of VDAs, offers insights into state-specific programs, and outlines strategies for successfully negotiating prior liabilities and ensuring future tax compliance.

Understanding VDAs

VDAs are contracts between taxpayers and state tax authorities designed to resolve past tax liabilities in exchange for favorable conditions. These conditions typically include a limited lookback period and the waiver of penalties. VDAs are especially beneficial for out-of-state entities seeking to properly register with a state and ensure ongoing tax compliance. Importantly, VDA eligibility generally hinges on the taxpayer voluntarily coming forward. In several states, even receiving a nexus questionnaire does not automatically disqualify a taxpayer from participating in a VDA.

Statutory vs. nonstatutory programs

VDAs are administered either statutorily (as in California and Connecticut) or administratively (as in Maryland and New York). Statutory programs are codified in statute and tend to offer less flexibility, while nonstatutory programs allow tax authorities more discretion in tailoring agreements to the taxpayer’s specific circumstances.

Typically, VDAs require the taxpayer to settle tax liabilities for a defined number of prior years — referred to as the “lookback period” — and maintain tax compliance going forward. Most programs limit the lookback period to three or four years, although this can extend in certain states or under specific circumstances. While penalties are often waived, interest is usually assessed in full.

VDPs vs. amnesty programs and managed audits

It is crucial to differentiate VDPs from other tax-compliance mechanisms. Unlike amnesty programs, which are offered broadly for a limited time and can include penalty and interest relief, VDPs are available continuously and focus on addressing past noncompliance. Managed audits, in contrast, are designed for registered taxpayers to expedite the audit process and are not intended for taxpayers who have not complied with return filing requirements.

The role of intermediaries

A significant advantage of VDPs in most states is the ability for taxpayers to approach state tax authorities anonymously through an intermediary, such as an accountant or attorney. This anonymity allows taxpayers to negotiate the terms of the VDA before revealing their identity, offering an additional layer of protection and flexibility. 

The negotiation process typically begins with the submission of a draft proposal that includes:

• A brief description of the taxpayer’s business and its duration of operation;
• The point at which nexus or potential nexus was established with the state;
• Details of the taxpayer’s activities in the state, such as property ownership or employment;
• Any prior contact with the state, such as receiving a nexus questionnaire or audit notice;
• Proposed terms of the agreement, including the number of years for disclosure, penalty waivers, and payment schedules;
• An estimated schedule of taxes due, broken down by type and year;
• Details of any collected taxes, such as sales and use taxes, that were not remitted; and
• Descriptions of purchases made without paying use tax.

Multistate Tax Commission’s role

The Multistate Tax Commission (MTC) plays a significant role in facilitating voluntary tax compliance through its National Nexus Program. This program allows taxpayers to resolve potential tax liabilities with multiple states simultaneously.

Through the MTC’s program, taxpayers or their representatives can anonymously approach any or all of the 39 member states to negotiate settlement terms for state sales/use tax and/or income/franchise tax liabilities. The MTC’s policy of nondisclosure of taxpayer identities to states that do not accept the proposed settlement adds an additional layer of security for participants.

However, tax practitioners often find that direct negotiation with individual states can result in better terms, particularly in cases involving substantial tax liabilities, highly complex matters, or when dealing with a large number of states. Nevertheless, the MTC program remains a valuable option for those seeking to resolve tax liabilities across multiple jurisdictions efficiently.

Practical considerations before submitting a VDA proposal

A few of the numerous practical considerations that taxpayers should explore before submitting a VDA proposal are highlighted below:

Does the outstanding tax liability involve a single tax or multiple taxes? Taxpayers should understand that VDAs are not risk-free. In those states where a VDA proposal can be submitted for a single tax, a taxpayer should consider whether liability exists among any other taxes. A taxing authority may audit other tax types following a VDA. However, some states require all taxes to be addressed upon request.

Does the taxpayer meet the VDA requirements? Many factors may affect the availability of a VDA. Is the taxpayer registered? Has the taxpayer been contacted by the taxing authority regarding the tax at issue, whether through a nexus questionnaire or other communication? Is the taxpayer under audit for the tax at issue? Has the taxpayer filed returns for the years at issue, or has the taxpayer filed returns for the tax at any time before the period of noncompliance?

Most states will not allow a taxpayer to proceed with a VDA if the taxpayer is already registered for the tax at issue or has been contacted by the taxing authority. 

Is the taxpayer prepared to execute the VDA? Many factors determine how much time a VDA may take to complete, including the availability and condition of the data, the complexity of the issue, and the number of states involved. Whether engaging a service provider to represent the taxpayer or performing the VDA on their own, the taxpayer may find states require detailed transaction data and rate schedules.

The taxpayer must be prepared to present the data or amended returns in a timely fashion once a VDA is executed. Additionally, VDA periods can be audited, emphasizing the importance of accurate and thorough data gathering.

Is the taxpayer prepared for increased and ongoing tax compliance? While some VDAs are requested to close out matters when a business is sold or is dissolved, most VDAs are requested due to ongoing business activity within the taxing jurisdiction. Once a VDA is executed, the taxpayer may be responsible for ongoing tax compliance.

For example, a sales tax VDA may result in ongoing monthly sales tax returns that must be filed without delay after the VDA period. New tax-compliance obligations may require additional employee time, new software functionality or implementations, and increased costs to facilitate compliance.

Is the taxpayer aware of the administrative nuances with submitting a VDA? Once a VDA is submitted, the period and transactions covered by the VDA are generally closed. Taxpayers will be unable to file subsequent refund claims for transactions occurring in the period later identified as exempt. It is critical that any uncertainty about whether tax applies to any transaction covered by the VDA is considered in the original VDA request.

Post-COVID-19 pandemic taxing authority VDA review may be longer than expected: Particularly in the post-pandemic environment, state taxing authorities have fewer staff. In the authors’ experience, state responses to VDA proposals have taken over a year to process in some cases due to a backlog of requests, although more recent data suggests review times are shortening in some states. Taxpayers or their service provider need to be familiar with state practice before filing a VDA request.

State-specific VDP details

To illustrate the diversity and complexity of VDPs, the AICPA State and Local Taxation Technical Resource Panel developed an AICPA practice guide on “Navigating State Voluntary Disclosure Programs (VDPs)” that includes the above material and “State-Specific VDP Details,” which include state-by-state snapshots of VDPs across the states. The AICPA plans to keep this guide material updated on the AICPA State and Local Tax Advocacy Resources page, along with dozens of other valuable resources.

This AICPA practice guide on navigating state VDPs, including the “State-Specific VDP Details” resource, demonstrates the varying nature of VDPs across states, including whether each state has a standard agreement, its lookback period, and whether waivers are available for penalties and/or interest. It also includes state revenue department addresses, phone numbers, links to their VDP webpages, and email addresses for the VDP programs of the listed states.

While most states offer formalized programs with standard agreements, there is often room for negotiation depending on the taxpayer’s circumstances.

Proactive engagement is key

VDAs provide a valuable opportunity for taxpayers to address past tax liabilities while limiting exposure to penalties and reducing the number of years subject to assessment. Engaging proactively with state tax authorities, often through a knowledgeable intermediary, is key to securing favorable terms and ensuring future tax compliance.

Whether choosing state-specific programs or leveraging the MTC’s multistate approach, taxpayers looking to regularize their state tax obligations need a clear understanding of VDAs and the negotiation process.

For more detailed information, companies and tax practitioners are encouraged to contact the authors of this article and consult the respective state’s department of revenue or equivalent agency and seek expert guidance tailored to their unique situation.

Contributors

Karen A. Lake, CPA, is a director of tax services with Berkowitz Pollack Brant Advisors + CPAs in Fort Lauderdale, Fla. Mo Bell-Jacobs, J.D., is senior manager of State and Local Tax, Washington National Tax, at RSM US LLP in the Washington, D.C., area. Brian Myers, CPA, is a partner at Crowe LLP in Indianapolis. Myers is chair, Bell-Jacobs is immediate past chair, and Lake is a member of the AICPA State and Local Taxation Technical Resource Panel. For more information about this column, contact thetaxadviser@aicpa.org.