What you need to know about the IRS’s new voluntary disclosure practice

Since the U.S. tax system was implemented, some taxpayers have willfully violated tax laws. Because violations can result in criminal prosecution due to intentional conduct, taxpayers sometimes seek ways to settle tax matters from previous years, often with the goal of avoiding criminal penalties.

To encourage taxpayers to come forward and regain compliance with tax laws, the IRS has historically offered a program called Voluntary Disclosure Practice (VDP). Under this program, taxpayers can disclose their intentional conduct, file accurate original or amended tax returns, and pay any outstanding taxes and interest. In exchange for all of this and a penalty for fraud, the IRS typically agrees not to prosecute the case. To participate in the VDP, taxpayers must meet certain requirements, such as being timely, cooperative, and providing full and adequate disclosure. And since no law specifically authorizes the VDP, taxpayers who wish to participate in the VDP should comply with the administrative requirements set by the agency.

Significantly, in June 2024, the IRS quietly revised its VDP program. While the changes are minor, they represent some significant departures from the previous version of the VDP. Therefore, taxpayers and tax professionals should take note of the new requirements, many of which are explained in more detail below.

Email communication

Generally, a voluntary disclosure requires three steps. First, taxpayers must submit information on Part I of an IRS Form 14457. Application and pre-approval for voluntary disclosure practice. Part I requires the taxpayer to present an identity card (ieName, social security number and address), the nature of the disclosure (iedomestic or offshore, inheritance and gift taxes, or payroll taxes) and identifying the entities and financial accounts involved in the non-compliance.

Second, when IRS-CI grants pre-approval, taxpayers must submit additional information in Part II of Form 14457. Part II requires taxpayers to provide, among other things, an estimate of the amounts at issue and an explanation of the non-compliance (see below for more information on the explanation). In most cases, IRS-CI denies pre-approval when disclosure is not made in a timely manner—that is, when the IRS already has the information of the non-compliance from its own sources or from other third-party sources.

Third, if IRS-CI issues a preliminary acceptance, IRS-CI assigns the case to an IRS examiner. The examiner contacts the taxpayer and requests all original and amended tax returns. If the returns are accepted, the taxpayer enters into a final agreement and pays the outstanding tax debt, interest, and a fraud penalty (up to 75%).

Prior to the June 2024 changes, the IRS directed taxpayers to fax or mail Parts I and II of completed Form 14457 to the IRS-CI. With the changes, taxpayers can now email this information to the IRS-CI. Accordingly, the new Form 14457 will ask the taxpayer and their representative to provide email addresses if that communication option is preferred.

Narrative of non-compliance

In the past, the IRS has required taxpayers to disclose facts related to noncompliance in a report. Although the new Form 14457 similarly requires this information, it also specifies that the taxpayer must address certain “subsections,” including: (i) the parties involved; (ii) the banks/financial institutions involved; (iii) the interactions with advisors and advice given; (iv) the specific acts of noncompliance; and (v) “other relevant facts.”

New “Willful” box

In previous versions of the VDP, taxpayers detailed their intentional conduct in the narrative. In some cases, taxpayers sought to disclose facts while protecting themselves against a finding of intentionality. Or they were not intentional at all—rather, they sought to use the VDP for strategic purposes based on their unique facts.

To prevent all of this, the revised Form 14457 now requires taxpayers in Part II to check a box expressly admitting that they acted willfully. In addition, the new Form 14457 indicates that a taxpayer’s failure to check the box “results in an automatic denial of the VDP” without “the possibility of appeals or reinstatements.”

Another new box

Prior to the June 2024 changes, taxpayers were not expected to have prepared original and/or amended tax returns when first contacted by the IRS auditor (iein Step 3). The revised Form 14457 changes this and requires taxpayers to check a box in Part II specifically stating that they have “prepared and will retain all necessary documents to present to the auditor upon initial contact, including, but not limited to, delinquent and/or amended tax returns, bank statements, and financial reports.” To avoid any doubt, the new instructions for Form 14457 also make this point clear by stating that “[t]Taxpayers should have their documents prepared, packaged and ready to present to the auditor upon first contact.”

New focus on full payment

The new instructions on Form 14457 also emphasize the requirement of full payment. Before the June 2024 changes, the IRS suggested that taxpayers who were unable to make full payment could request “other payment arrangements.” The new instructions on Form 14457 strongly suggest that taxpayers must pay all tax debt, interest, and the fraud penalty in full to participate in the VDP.

Digital assets

The old version of Form 14457 included questions about “virtual currency.” The current version of Form 14457 relabels virtual currency as “digital assets” and requires more information about these types of disclosures. For example, this part of the form requires identifying information about any centralized digital asset exchanges and transactions recorded on a public blockchain. Since digital assets have been a hot topic with the IRS, the changes to Form 14457 requiring more details are not surprising.

Diploma

The VDP continues to provide protections for taxpayers at risk of criminal prosecution. However, given the new changes and Form 14457, taxpayers should make sure they fully understand the new terms of the VDP before making a voluntary disclosure. Taxpayers who do not follow the new guidelines face significant risks, including the possibility that the IRS will reject the voluntary disclosure entirely.