Wisconsin has joined 22 other states participating in the Multi-State Tax Commission’s Voluntary Compliance Program. Under the program, the Wisconsin Department of Revenue will waive all civil and criminal penalties that could be asserted against a business or individual taxpayer in connection with certain tax avoidance transactions disclosed in the program.
The catch is that the Multi-State Tax Commission must receive a taxpayer’s amended (or initial) tax returns, a description of the tax shelter and a payment of any tax due before Oct. 1, 2007.
Only taxpayers that have participated in an “abusive tax shelter” in years before Jan. 1, 2006, may use the program to avoid tax-related penalties. Under this program, an “abusive tax shelter” is broadly defined as a transaction with the principal purpose of avoiding federal income tax or Wisconsin income or franchise taxes.
Generally, such transactions are identified by the IRS as tax avoidance transactions, or “listed transactions,” in published IRS guidance and any transactions substantially similar to those listed. Not all abusive tax shelter transactions, however, are listed by the IRS, as the IRS does not identify transactions that only intend to escape state taxation.
Whether a taxpayer should participate in the Voluntary Compliance Program is a decision that should be made following a thorough analysis of the transaction and the consequences of disclosure.
Not all tax-saving strategies are abusive tax shelters. As the widely respected Judge Learned Hand explained, “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury.” The corollary, of course, is that one must at least pay the amount of tax required by the law. It is the cross section of these two statements in which abusive tax shelters originate.
The IRS has identified many of the transactions that it considers abusive, however, before a disclosure under this program is made, the legitimacy of a beneficial tax planning technique should be considered. A taxpayer that makes a disclosure, files returns and pays tax under the program (subject to limited exception) will irrevocably waive any right to claim a refund of the tax paid in connection with the returns filed. That is, even if the tax treatment is subsequently upheld in court, a taxpayer participating in the program is contractually prohibited from amending its tax returns to claim a refund.
If a disclosure is made, it should be complete with respect to all affected states. Participation in the Voluntary Compliance Program is not anonymous. A taxpayer’s participation in the program will be shared with all other states involved in the program and the IRS. These other states can independently investigate whether returns should have been filed in their state and will not be prohibited from assessing penalties unless the program was also utilized with respect to that state. The IRS may also pursue its own remedies if the federal issue is not properly addressed.
As the time frame for participation in the program is limited, interested taxpayers should not delay the preparation of the required submissions. Moreover, the funds necessary to pay the taxes should be obtained. However, the potential waiver of penalties for any transaction that occurred before 2006 may be well worth the additional cost incurred to participate in the program.
From a technical standpoint, a taxpayer that desires to participate in the penalty waiver program must satisfy the below eligibility and filing requirements.
If a tax return was filed taking advantage of an abusive tax shelter, or if a tax return was not filed on the basis of participation in a tax shelter, the taxpayer can participate in the program if certain requirements are satisfied. These are:
1. The taxpayer has not been informed by the Department of Revenue that an audit or criminal investigation is being (or will be) conducted relating to the tax avoidance transaction;
2. The taxpayer has not received a final federal audit report from the IRS, if the changes or corrections relate to the tax avoidance transaction and are required to be reported to the Department; and
3. The taxpayer has not misrepresented facts relating to the tax avoidance transaction.
Participation in the program requires that the taxpayer prepare and submit amended or initial tax returns, a VCP-1 disclosure form and indicate that the returns are submitted under the program. A Form 8886, Reportable Transaction Disclosure Statement, comprehensively describing the nature and workings of the abusive tax shelter must also be submitted. In some circumstances, a citation to IRS guidance may be a sufficient description. The submission must also include the identity of any promoter or advisor involved in the use of the tax shelter. Lastly, the submission must include a payment of the tax due, however, interest need not be paid until the state sends a bill for that amount.
This Voluntary Compliance Program is only available to those who have failed to file tax returns or who have understated their tax liabilities in connection with an abusive tax shelter. Taxpayers that have failed to pay a required tax without tax shelter involvement may be eligible for Wisconsin’s and/or the Multi-State Tax Commission’s Voluntary Disclosure Programs. The Voluntary Disclosure Programs are another mechanism that can allow taxpayers to avoid penalties on unpaid tax and unfiled returns where a tax shelter was not involved.