What’s a voluntary disclosure agreement?

A voluntary disclosure agreement (VDA) is a contract between companies and states. Companies choose to enter into the contract to reduce the amount of outstanding tax, interest or penalties they owe.

How do you know if you have outstanding tax with a state?

If you conduct certain activities in a state and establish nexus, you may be required to pay tax. Common business activities that create nexus include:

• Sales representatives who meet with customers
• Employees who work from home
• Third parties who work or perform services on behalf of your company
• Exceeding a certain volume of sales or transactions in a state (this threshold varies by state)

Sometimes, taxpayers overlook these activities or don’t know state tax laws, and mistakes happen. Businesses find themselves in a situation where they have years of unpaid state taxes. When this happens, VDAs are great solutions to solve the problem.

How do VDAs work? What’s the process?

Understandably, VDA programs vary between states. The names of programs may differ, as well as the rules, agreements and processes. Some states don’t have official programs but will coordinate with you if you come forward. Here’s a generic outline of the VDA process:

1. Your CPA reaches out to the state to request a voluntary disclosure agreement on your behalf. In most cases, your company is anonymous during this stage. Your CPA will provide the state with an estimate of the tax you owe. In addition, they must attest to the following statements:
   • The state hasn’t contacted you about the unpaid tax
   • You aren't currently engaged in a dispute with the state
   • You haven’t filed this type of request before
   • You agree to file all returns required by the state
2. Then, the state sends back the voluntary disclosure agreement. It will include the terms of the agreement, confirmation of waiver penalties, confirmation of the lookback period etc. State responses can take anywhere from two weeks to nine months.
3. You and your CPA will review the agreement.
4. If you choose to continue, you'll sign the agreement and return it to the state. At this point, you lose your anonymity.
5. Your CPA prepares the tax returns and any required registrations. You’ll submit the tax returns with payment for tax, interest and any non-waived penalties.

What are the benefits of a VDA?

The main benefit of a VDA is it saves your business money. Potentially, a lot of money. Here’s how:

1. Typically, the tax and interest you owe are limited to three or four years.
2. States waive or drastically reduce penalties.

Here’s an example. Imagine you created nexus but haven’t filed or paid taxes in Ohio for 15 years. If Ohio discovers this, they could assess the unpaid taxes for all 15 years, plus interest, plus penalties for underpayment, late payment, late filing and failure to file. Your business could be hit with a massive, unexpected tax bill. And, the bill will continue to grow for each tax you haven’t paid (sales tax, use tax, income tax, etc.). But, if you proactively enter into a VDA, Ohio limits the tax and interest you owe to four years. Plus, they may waive all penalties. This is better than paying 15 years of unpaid taxes plus penalties, right?

Can you negotiate the terms of the VDA with the state?

Generally, no. Many states have formalized their VDA programs. Therefore, companies know which terms to expect when they wish to use the program. States have varying terms, but it’s typically better to choose a VDA rather than waiting for the state to catch you and assess all taxes, interest and penalties.

Can I change my mind?

Technically yes, but we don’t recommend it. Once you submit a request to participate in a VDA program, you should feel confident with your facts and want to proceed.If you start the process anonymously, you can change your mind until it's time to sign and submit the actual voluntary disclosure agreement. If you back out, you may forfeit the VDA and its terms. There’s a good chance you won’t be able to ask the state for the same VDA later.Once you sign the agreement, you enter a legal contract with the state. If you attempt to back out of the deal, the state can assess tax, interest and all penalties for all years you should have filed returns.

What’s the catch?

There’s no catch, but timing is important. You must start the VDA process before states determine you haven’t paid taxes and contact you. If a state contacts you first, you usually can’t initiate the VDA process. It’s no longer an option; you have no way to reduce your tax liability. Also, if you register to pay taxes with a state or just started filing taxes, you typically lose the right to a VDA.

I don’t think states will catch me. I’ll risk it.

Are you sure about that? Consider this. If you’ve never filed taxes and should have, the statute of limitations (time to assess tax) NEVER starts. This means the state has an infinite amount of time to catch you. If they do catch you, they can go back to the first day you started taxable activities in their state. Maybe that’s 2020, 2000 or 1987. You're mistaken if you think states are sitting back and accidentally finding non-filers. They’re actively seeking out non-filers. Most states have discovery divisions dedicated to finding taxpayers who haven’t been filing taxes.

Here are some techniques we’ve seen states use to find non-filers:

• Indirect audit procedures: The state audits a company and examines its list of purchases. Then, it looks to see if those sellers paid taxes in the state.
• When a business does work for the city or state, the municipality investigates whether they filed a return.
• The state reviews W-2 wages and finds companies with wages in the state but no tax returns.
• The state attends trade conventions and takes note of companies in attendance. Then, they research whether those companies filed returns.
• The state sees that you filed one type of tax return but not another.

Our accountants have even seen a business get caught because of a LinkedIn post! Don’t risk it. The longer you go without paying taxes, the more your tax bill grows. And, if you have one tax obligation in a state, the chances are good that you have many tax obligations in that state.

5 tips for the VDA process

1. Work with a CPA. You can navigate VDAs alone, but you sacrifice anonymity. The process goes faster with a CPA because they know states’ programs and processes.
2. Tell your CPA everything. Be transparent. If you hide any nexus-creating activities, your agreement could become invalid.
3. During the VDA process, don’t do anything without your CPA’s involvement. Don’t register for tax, file a return, ignore notices or respond to notices.
4. As soon as you perform any business activities outside your home state, notify your CPA.
5. Tell your CPA right away if you detect an issue involving local or state taxes. Waiting may magnify the issue.

Examples

Consider the following examples. In the first example, we share the many tax liabilities that may result from one employee working in another state. In the second, we show how the VDA process can significantly reduce a company’s tax bill.

1. Business A is an S corporation located in Michigan. One employee works from home in Illinois. As the employer, you may need to withhold payroll taxes and file state unemployment taxes in Illinois for that employee. The business may need to file an income tax return in Illinois and pay tax both at the business level and on behalf of the owner. Plus, Business A may need to collect sales tax from customers and assess use tax on any purchases.
2. Business B has an employee working in Ohio. The business filed commercial activity tax and sales tax in Ohio, but it didn’t file or pay income tax. Ohio discovered this and assessed taxes back to 2013, resulting in a $3 million tax bill. A voluntary disclosure agreement could have limited the tax bill to $1 million.

States with VDA programs

Again, voluntary disclosure agreements are great ways to limit outstanding tax bills. States offer these programs because they receive unexpected revenue with little effort. And taxpayers benefit from huge savings and reduced risk. If you think you have nexus in select states, contact Doeren Mayhew's business tax accountants today! If you don’t know whether you have a taxable presence in other states, discuss this with your accountant ASAP. It’ll save you in the long run.

Author

By Elizabeth Potocki, Tax Shareholder