Over the past several years, the focus for many CFOs, controllers, and tax directors has shifted from rate reduction to risk management. One way to reduce state tax reserves and related risk due to FAS 109/FIN 48 and FAS 5 is through voluntary disclosure agreements (VDAs). VDAs can be entered into when a taxpayer comes forth on its own accord, without being contacted, to notify a state or local jurisdiction that it has underpaid taxes.
The standard for nexus for sales and use taxes is physical presence, but in corporate taxation, several state courts have held that physical presence may not be necessary if an "economic" nexus exists.1 Therefore, based upon taxpayer activities, nexus may occur despite lack of an office or permanent physical presence. The trends toward increasing the relative weight of the sales apportionment factor and sourcing sales for service businesses based upon customer location may cause a surprising amount of tax due. A state-specific exposure analysis will help the taxpayer prioritize and determine remediation strategy. A company that has multistate activity and may unwittingly be exposed to tax, interest, and penalties resulting from not filing returns may wish to enter into a VDA.
Voluntary Disclosure Process
The Multistate Tax Commission’s (MTC’s) VDA program serves as a central point of contact in coordinating VDAs with participating states. This program can be helpful, particularly if requesting VDAs for a large number of states. Another option is to request a VDA through each individual state. Regardless, the process begins by having a taxpayer representative submit an anonymous letter.2 The letter should describe the activity the company has in the state, when nexus first existed, and the proposed terms for the VDA. Some states will allow you to include multiple taxes within one VDA letter; others will require you to send different VDA letters for each tax type. Some states and localities, such as New York State and New York City, will allow you to file a combined request. Others, such as Pennsylvania and Philadelphia, require you to enter into separate VDAs with the locality. Analyze each state’s requirements because the information requested varies by state.
The state will review the request and either request additional information, send an agreement that incorporates your terms, or send an agreement with modified terms. Most states allow you to negotiate the terms, but some states are inflexible. Two common agreement requirements are that the company has not been contacted by the state for the particular tax that is the subject of the VDA and that there has not been any collected, but unremitted, sales tax.
Value of VDAs
One of the most important benefits of a VDA is that it can result in the release of a financial statement reserve. Another valuable aspect is the limitation on the number of years for which the taxpayer will be required to file returns (the "look-back period"). The look-back period generally ranges from three to four years for sales and use tax, and three to six years for corporate tax, instead of having to file returns from the date when nexus was first established in the state. Pennsylvania, for example, has non-negotiable look-back periods of three years plus the current year for sales and use taxes, and five years plus the current year for corporate taxes. New Jersey, specifically with respect to taxpayers who did not file corporate taxes based upon the economic nexus standard set forth in Lanco Inc. v. Director,3 generally has a look-back period to 1996.
With a VDA, states generally abate most or all penalties, and some, such as Texas, may abate some or all interest. An exception is New Jersey, which will not abate its post-amnesty penalties. There are the rare states that may allow a reduction in tax due, depending upon case-specific facts.
Amnesty
An alternative to VDA filing is to participate in a state’s amnesty program. Periodically, states need to raise revenue, and thus offer an amnesty to delinquent taxpayers. In return for coming forward voluntarily, states sometimes offer waivers of penalties and, in some cases, interest. The problem with many amnesty programs relative to VDAs is that they are typically only open for a limited period of time - such as two to three months - and may not allow for limited look-back periods. During 2007, Texas and Iowa offered amnesty programs.
Conclusion
VDAs can be a valuable tool for both states and taxpayers. States collect unanticipated tax revenues and add new taxpayers to the rolls for future filings. The taxpayer pays less tax and interest due to the limited lookback period, penalties are generally waived, and in many cases financial statement reserves can be released.
For taxpayers or practitioners who are considering VDAs, helpful resources include the following:
-- The MTC (www.mtc.gov) handles approximately 85 multistate cases annually, according to Tom Shimkin of MTC.
-- The Pennsylvania Revenue Department has a well-established VDA program (www.revenue.state.pa.us; choose "Business Taxpayers;" select "Voluntary Disclosure Program"). Alicia Fetrow, voluntary disclosure liaison, indicated that Pennsylvania usually has about 200 open VDA cases and has seen an average annual increase of VDA-related collections of 12 percent over the past five years.
-- AICPA’s Tax Section maintains a Voluntary Disclosure Practice Guide (http://tax.aicpa.org/ Resources/State+and+Local), which includes a list of state-specific contacts for voluntary disclosures.
1 Lanco Inc. v. Director, 908 A.2d 176 (N.J. 2006), cert. denied, No. 06-1236 (U.S. June 18, 2007); MBNA America Bank NA v. Tax Commissioner, 640 S.E.2d 226 (2006), cert. denied, No. 06-1228 (U.S. June 18, 2007).
2 There are some states such as Illinois that will not allow the VDA to be done on an anonymous basis.
3 Lanco Inc. v. Director, 908 A.2d 176 (N.J. 2006), cert. denied, No. 06-1236 (U.S. June 18, 2007).
Candice I. Polsky, CPA, JD, is manager at SMART Business Advisory and Consulting LLC in Devon. She can be reached at cpolsky@smartgrp.com.
Matthew D. Melinson, CPA, is managing director at SMART Business Advisory and Consulting, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at mmelinson@smartgrp.com.
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