How can a voluntary disclosure agreement reduce my business’s unpaid state taxes and penalties?

A voluntary disclosure agreement (VDA) is a written contract between a business with back taxes and a state revenue agency. The goal of a VDA is to help tax delinquents come forward voluntarily and mitigate monetary obligations and reduce the associated penalties.

Determine if a Business Has a Tax Responsibility

A nexus is comprised of various factors that, when combined, can determine if a business has a tax responsibility in a state.

• Keeping sales reps who meet with potential customers and drum up business in the state can create nexus.
• Employing people who work out of their homes in the state can establish nexus.
• Hiring other businesses, like architects or designers or service providers, to come in and do some work or perform some service for you, if they come into the state, can also give you nexus.
• Depending on the state, there may even be a threshold in terms of sales or transactions where if you’ve done more than a certain number, you can end up with nexus.

You may miss these activities, or not understand what the state’s tax law is. What ends up happening is that years of unpaid tax accrue, and the business ends up with a problem. A VDA is a fantastic way to address this problem.

The VDA Process

Specifics of the VDA programs, and their names, will vary by state. Some states have no formal program, but they will still usually be willing to work with you if you come forward. Basically, the steps go like this:

The first step in the VDA process is that your CPA asks the state for a VDA on your behalf. They’ll usually do this anonymously, without identifying your company. Then the CPA will usually estimate how much tax you owe and attest to a number of things, such as:

• Your company has not been contacted by the state agency.
• Your company is not in current dispute with the state agency.
• The state revenue agency has never received an inquiry or application from your company seeking a VDA.
• The company commits to filing every return the state requires for however many years the state expects.

The CPA will then get a copy of the VDA from the state and usually review it to see if they agree to waive penalties and other such conditions as well as how many years the lookback period might be. It can take a state anywhere from two weeks to nine months to reply, so be patient.

Once you have the VDA, you and the CPA can sit down and analyze the terms.

Once you agree to it, you sign it and send it back to the state. Now you aren’t anonymous anymore, so make sure you’re fully aware of what you’re committing to.

Next, your CPA will prepare all the required returns for the state, plus any registrations, that are due. You’ll send those in and pay the tax, interest and whatever penalties weren’t waived. That should complete the process.

Multiple Benefits

A VDA has multiple benefits that could result in the tax burden and penalties becoming significantly more manageable.

• In most cases, the payment that you’ll make will cover the tax and interest for only the last three or four years.
• The state will waive or reduce the penalties.

Say you have nexus in Ohio but don’t know it. Your company for fifteen years has failed to file. When they figure out that you’ve been doing business with them all this time and not filing, and you haven’t made them one cent, they could assess you fifteen years of tax and interest and penalties for underpaying, late payment, late filing, not filing. Typically, if you have nexus, you may have to file income tax, sales tax, use tax. Any of those taxes can rack up a lot of interest and penalties for you. And when they decide you’re late and when they assess you all the tax and the interest and the penalties for 15 years’ worth of sales, you may not have the money to pay that. That’s where the use of a VDA becomes very attractive and beneficial. Even in a circumstance like this, the payment you’ll make (or agree to) will be the tax and interest only for the last four years. The state may waive all the penalties.

Pretty much you get what you get. Usually, you can’t negotiate terms; a lot of states have a formal VDA program. But it’s much better to come forward voluntarily.

You can withdraw your application, but I don’t suggest it. As long as you’re anonymous, if you decide you don’t want to proceed with the application for a VDA, you can back out of the deal. But they may not offer you the same terms or the VDA again. Once you sign it it is a binding legal contract and if you back out the state agency can assess tax, interest and all penalties for every year.

There’s no real catch, but you have to start the process before the state finds out and comes looking for you. Once the state agency reaches out and says “Hey where have you been?” then you can’t usually do a VDA. If you have registered with the state, or have recently begun to file, you generally don’t qualify for a VDA either.

Don’t assume that your mistake somehow flew under the state agency’s radar. How long is the statute of limitations, you ask? Well, if you never file, it doesn’t start to tick! That means they can go back to your very first day. Even if that’s in 2020, 2000 or 1987. Most states have a discovery division whose only job is to sniff out businesses that aren’t filing.

Indirect audits occur when a state decides to audit one of your customers. They will look at what your customer paid for all the expenses it claimed and check to see if your company paid state tax.

A lot of city governments check to see if businesses who are doing city/state government work have filed their returns.

One of the ways that states find non-filers is to go through the W-2 wage records. They look at the wage databases and cross-reference that with employers that are filing in the state.

When you go to a trade show (or any event!) a state revenue agency might simply walk the floor and take down a list of which companies are there. Then they will check to see if you filed.

Sending sales or income tax returns but not use tax returns will often tip off the state to a non-filer.

You should never rely on the “I think I won’t get caught” gambit. What happens is years and years of back tax and fees and interest add up on you. The longer you wait to come forward, the more the obligation. And if you missed one, you probably missed the others too.

Use a CPA. A lot of CPAs do VDAs because if you do one yourself, you don’t have the advantage of anonymity; also, their knowledge and experience means it gets done faster.

Be totally honest. If you don’t tell your CPA every bit of activity that created nexus, and the state finds out, you could be risking the VDA being invalidated.

Once you apply for a VDA, don’t do anything without your CPA’s advice until it’s complete. It’s also very important that, while the VDA is in progress, you handle all your business with the state via the CPA and not on your own.

If you call on a customer or solicit business or do any work for a customer in a different state, talk to your CPA immediately.

If you get some notice or bill or any document that mentions a state or city/county tax agency, immediately make your CPA aware. Jumping on the problem is important.

If you skip doing a VDA, you may discover your obligations the hard way.

Say you run an S corporation in Michigan. Later, you hire an employee to work out of his home in Illinois. You might owe Illinois payroll withholding and unemployment tax for this person. You might have to file an income tax return at the entity level and for the owner. You might need to collect sales tax and pay use tax on what you buy.

Second example: say you file Ohio sales tax and commercial activity tax returns but not Ohio income tax. So they get smart and they do some digging and find out, wait a minute, you haven’t been filing income tax with us! The assessment goes back to 2013 and totals $3 million.

Why would a state agree to a VDA? The state has the opportunity to gather a pile of money, basically for free, and they have almost no extra expenditure. You, in the meantime, save a fortune and reduce the risk. As soon as you realize what’s happening, talk to your accountant and get the process started.