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State Tax Amnesty Programs: The Advantages and Disadvantages Editor: Author: Editor’s note: Mr. Peterson chairs the AICPA Tax Divisions State & Local Tax Technical Resource Panel (TRP). Ms. Nakamura is a member of the TRP. For more
information about this column, contact Mr. Peterson at
dfpeterson@larsonallen.com
or Ms. Nakamura at
Tax amnesty programs offer qualified taxpayers an opportunity to clear outstanding tax liabilities in exchange for a complete or partial abatement of interest and penalties that might otherwise be imposed. In addition, they provide states and localities much-needed revenue without the costs associated with audit and enforcement. Although the programs are generally a win for taxpayers and tax administrators alike, taxpayers should address a number of important considerations before signing on to any amnesty program. This column summarizes some of those considerations, and cautions readers to speak with their tax adviser before taking any action.
States Motivation for Amnesty In general, amnesty programs are intended to improve overall compliance with tax laws by eliminating underreporting errors and adding nonfilers to the tax rolls. In addition, they give states and localities an easy way to generate a one-time revenue boost, with the hope of continued revenue flow through improved compliance. Most importantly, they are a quick solution to budget shortfalls, which have been significant in recent years. For example, a study by the National Conference of State Legislators (NCSL) found that states are running a $2.5 billion cumulative budget gap for 2004.1 While the 2004 gap represents an improvement over the 2003 gap of $25.7 billion, the improved financial outlook may be short-lived; the states project a $35 billion cumulative budget gap for 2005, with little opportunity for an easy fix (such as the use of rainy day funds, which many states raided in 2003 and 2004). A second NCSL study indicates that budget gaps may well increase as a result of various unfunded mandates that it says Congress and the administration shifted to the states. At last count, the study asserts, the cost of implementing Federally mandated programs was estimated at $29 billion, or 6% of overall general fund revenues, for fiscal 2004, and $34 billion, or 7% of overall general fund revenues, for fiscal 2005.2
Amnesty Programs in General Generally, amnesty programs are offered pursuant to specific statutory authority or as a matter of administrative grace.3 While some programs offer amnesty for local, as well as state, taxes,4 others5 leave it up to local taxing jurisdictions to decide whether they will participate in an amnesty program. Interest and penalty waivers: The most common feature of an amnesty program is the waiver of all penalties and a complete or partial waiver of interest. For example, under a Kansas amnesty program offered from Oct. 1Nov. 30, 2003, qualifying taxpayers received an abatement of all penalties and interest owed on outstanding liabilities remitted during the amnesty period.6 Under a North Dakota amnesty program offered from Oct. 1, 2003Jan. 31, 2004, taxpayers received a waiver of all penalties and 75% of the interest that would have otherwise been assessed on overdue taxes.7 Taxpayers participating in Maines amnesty program received an abatement of all civil and criminal penalties and 50% of the interest that might have otherwise been imposed on amounts remitted under the program.8 Note of caution: The reduced interest rate and penalty provisions are somewhat of a carrot and stick approach to tax collection. More often than not, states follow amnesty with increased penalties and stricter enforcement.9 For example, Florida offered tax amnesty from July 1Oct. 31, 2003.10 During the amnesty period, interest on outstanding liabilities was assessed at 75% or 50% of the statutory prime rate (the higher percentage was imposed on taxpayers already being audited). After amnesty, interest rates on delinquent taxes increased from prime to prime plus four percentage points, retroactive to Jan. 1, 2000. New York adopted a similar strategy during an amnesty period that ran from Nov. 18, 2002Jan. 31, 2003.11 Participants had penalties waived and received a two percentage-point reduction in the interest rate on their outstanding liabilities. However, starting April 1, 2003, interest rates increased an additional two percentage points over pre-amnesty levels, resulting in an overall swing of four percentage points in the interest rate. Virginia legislation offered taxpayers a chance to clear past liabilities during an amnesty period that ran from Sept. 2Nov. 30, 2003, and granted a waiver of 50% of the interest otherwise due and all penalties.12 However, eligible but nonparticipating taxpayers are subject to an additional 20% penalty on any unpaid amounts after amnesty. Illinois took a more severe posture as to post-amnesty interest. It offered amnesty from Oct. 1Nov. 15, 2003, and provided a waiver of all interest and penalties for payments made during the amnesty period.13 Taxpayers with outstanding liabilities that qualified for amnesty, but that did not participate, became subject to penalties of 200% of the pre-amnesty interest and penalties. The increased post-amnesty interest and penalty provisions raise several concerns for taxpayers and tax administrators. One is how to handle penalties and interest owed on issues arising as a result of a court challenge or policy clarification subsequent to amnesty, but that affects years to which amnesty applied. With many of the increased interest rates and penalties mandated under the statute, and limited ability for waiver outside a reasonable-cause exception, increased interest and penalty costs may be an unintended outcome in certain situations. As one practitioner noted, even well-intentioned taxpayers may be caught in the penalty dragnet that seems to be intended for more long-term delinquencies. For example, if some states apply the increased penalty provision literally, an assessment under appeal during the amnesty period that is resolved against the taxpayer after the program ends would be subject to increased penalties, even though the taxpayer acted in good faith. This could be a major trap for the unwary; taxpayers will need to seriously consider the ultimate downside of such an outcome. Taxes and tax periods: In general, amnesty programs apply to most taxes administered by a taxing agency and to all tax periods open under the statute of limitations (SOL). However, some states may limit the type of taxes and the length of lookback for administrative ease or other reasons. For example, Floridas amnesty program applied to qualifying tax liabilities due before the first day of the amnesty period.14 Similarly, Texass amnesty program, which ran from March 11March 31, 2004, applied to all state and local taxes administered by the Comptroller of Public Accounts, including local option taxes, except unclaimed property and Public Utility Com-mission gross receipts assessments, for all filing periods with reports due before Feb. 1, 2004.15 Maine also included liabilities outstanding up to its amnesty program start date.16 In contrast, Arizona limited amnesty filings to all taxes administered by the Department of Revenue (DOR) or an Arizona county (except estate and property taxes) and owed from Jan. 1, 1983Dec. 31, 2001.17 Similarly, Illinois limited its amnesty program to taxes owed for tax periods ending after June 30, 1983, and before July 1, 2002.18 The fixed starting point may be due in part to earlier amnesty programs in those states.19 Kansass amnesty program applied to income and privilege tax liabilities due for tax periods ending on or before Dec. 31, 2001.20 A Dec. 31, 2002, start date applied to other select taxes, including sales and use, withholding and severance. Missouris amnesty program, which ran from Aug. 1Oct. 31, 2003, applied to qualifying taxes due and unpaid before Jan. 1, 2003.21 Similarly, Virginias program did not apply to any outstanding assessment for which the assessment date was less than 90 days prior to the programs start date, or for any liability arising from failing to file a return for which the due date was less than 90 days prior to the first program day.22 In addition, amnesty did not apply to income tax liabilities for periods beginning on or after Jan. 1, 2002. New York City offered a program from Oct. 20, 2003Jan. 23, 2004, limited to select taxes and liabilities arising or transactions occurring on or before Dec. 31, 2001.23 Amnesty did not apply to resident and nonresident income taxes and sales and use taxes, which are administered by the state. By limiting amnesty to older liabilities, the program appears to have kept to the administrations intended goal to clean its books of millions of dollars of old and bad debt.24 Definition of qualifying taxpayer varies by state: In general, amnesty programs are designed to be broadly applicable. Accordingly, they often apply to taxpayers currently filing returns, as well as to those that have not registered with the taxing agency. In addition, state programs may apply to taxpayers currently under audit or in the administrative appeals process. Almost always excluded from amnesty are taxpayers that are under a criminal investigation or those that have been convicted of violating a state revenue law.25 For example, Texass amnesty program applied to taxpayers that: (1) did not file a required return or report; (2) misrepresented, understated or omitted any tax liability on a previously filed return; (3) erroneously claimed a credit or deduction; (4) had an outstanding bill with the Comptroller or a private agency representing the Comptroller; (5) were undergoing or scheduled for an audit; or (6) had a liability that was the subject of a formal protest or an administrative hearing.26 In contrast, New Yorks program was not available to taxpayers with more than 500 employees nationally or whose combined filing group had more than 500 employees nationwide.27 Similarly, Arkansass amnesty program, which runs from July 1Sept. 30, 2004, does not apply to taxes, penalties and interest recorded on the account records of the Director of the Department of Finance, any state tax for which the Director has issued a notice of proposed assessment, and any amount that a taxpayer expects to become due as a direct or indirect result of a pending or completed audit or investigation that the taxpayer knows is being conducted by any Federal, state or local taxing authority.28 Amnesty applications, tax returns and payment: In general, states will require taxpayers coming forward under amnesty to submit an application disclosing information about operations. In addition, most states will require taxpayers to file all outstanding returns; however, some states may allow a taxpayer to file a spreadsheet listing its liability for the various tax years.29 With the ultimate goal of getting revenue, states will require that taxpayers remit outstanding liabilities by the close of amnesty or shortly thereafter.30 Failure to timely remit amounts owed often results in penalties and interest assessments. Some states will allow taxpayers to enter into installment payment arrangements; however, interest generally applies to installment payments received after amnesty ends.31 Watch for waiver of appeal rights: To guarantee that amnesty collections are not subsequently reduced by refund claims, various states require taxpayers to waive their rights to payments made under amnesty. For example, taxpayers that participated in the Colorado tax amnesty program during June 2003 were required to waive the right to file a refund claim or seek administrative or judicial review regarding any tax liability presented during amnesty.32 Similarly, taxpayers that participated in Floridas amnesty program waived their rights to appeal taxes reported under it.33 In addition, if the taxes were already the subject of a pending informal protest, or administrative or judicial proceeding, a taxpayer was required to withdraw the protest or withdraw from the proceeding to participate in the amnesty program. Under the Texas program, taxpayers were required to waive their appeal rights for any appeal or assessment that was the subject of a protest or administrative hearing. Per the Comptrollers office, prepayments and estimates remitted during the amnesty period were available for refund; however, the refund may be limited under the states $250,000 refund cap rules, unless it is requested within 120 days of the original returns original or extended due date.34 Missouris amnesty provisions stated that taxpayers that elected to participate were deemed to have made an express and absolute relinquishment of all administrative and judicial appeal rights.35 Arizonas tax amnesty statute included comparable language.36 Participants in the North Dakota amnesty program had to agree to withdraw any pending protest or proceedings on the tax and interest covered under the amnesty application and to not refile any protest or proceedings.
Publicity The success of an amnesty program is often tied to how well the program is publicized. For example, Joan Wagnon, Secretary of the Kansas DOR, attributes the increased awareness of her states amnesty program to the assistance of the Kansas Association of Broadcasters, who developed, produced and aired a public service announcement about the program. Those efforts, coupled with the support of tax professionals, contributed to the states success in generating over $23.6 million, well in excess of the $19.5 million estimate.37 That outcome is dwarfed by the success of the Illinois amnesty program, which generated over $500 million. The Illinois DOR sent program notices to 180,000 taxpayers; approximately 70,000 made amnesty payments.38 Preliminary figures suggest that 90% were individuals, although they accounted for only 5% of total collections, at an average of $400 each. The remaining 95% came from corporate income taxpayers. Of that, roughly $150 million was from companies paying income taxes they thought they would eventually owe as a result of IRS audits for tax periods covered by amnesty. That success is in marked contrast to the results of an earlier Maryland amnesty program during which the state hoped to generate $70 million in revenue.39 The program, which ran from Sept. 1Oct. 31, 2001, generated only $40 million, approximately $21 million from personal income tax and $4 million from corporate income tax,40 with more than 70% of total collections being received in the last week of amnesty41 The shortfall occurred despite approximately $1 million spent for an aggressive advertising campaign.42 Texas took a novel approach to its amnesty program, called Project Pay Up, and waited until the day before the program began to post an announcement to its website. While the program ultimately generated about $379 million, far in excess of the $50 million projected,43 one could question the decision not to promote the program with more fanfare.
Measuring Success One issue that receives scant attention when states tout their amnesty results is how they account for revenues. States that include amounts received from taxpayers currently under audit or those with outstanding liabilities in their amnesty totals may overstate a programs true success. Although offering such taxpayers an opportunity to pay liabilities early may speed collection and reduce costs associated with litigation, those revenues represent amounts the state may well have received at the close of the audit. In addition, by providing amnesty to such taxpayers, states may actually shortchange themselves due to the loss of interest and penalties. For example, Illinois generated over $500 million during its amnesty program.44 The Illinois DOR estimates that approximately $175 million of the total amount collected was new money that would not have been collected absent amnesty, compared to initial government estimates of $40 million. If over $325 million actually represents amounts that would have been collected anyway, the state may have lost a lot of interest and penalty revenue by permitting the payment of those taxes under amnesty. Conversely, collections from taxpayers already in the system may be a bit overstated. If taxpayers viewed the interest and penalty waiver provisions as a significant incentive to concede issues they otherwise would have challenged, a state might have collected more than may eventually have been due. Taxpayers may have weighed the additional tax expense against the litigation costs and the potential for significant interest and penalties if they did not succeed. That analysis may have resulted in taxpayers seeing amnesty as the more reasonable choice to limit potential exposures and the complexities those exposures might have created for financial-reporting purposes. The North Dakota Tax Department announced on March 22, 2004, that it collected $6.9 million during its amnesty program.45 Included is $6.1 million from taxpayers paying off existing tax liabilities, most of which had been included in the state budget forecast. Taxpayers also paid on tax audits and filed amended returns that increased their original tax liabilities. Of the total amount collected through amnesty, the Department received about $806,000 from 185 new taxpayers filing returns dating back as far as 1976. The Department noted that it received a total of 752 amnesty applications, some containing returns dating back to the 1970s. Sixty-one percent of the taxpayers applying for amnesty were individuals, 25% were businesses, 8% were corporations and 6% were applications for miscellaneous taxes. The Department believes that the program was somewhat of a compliance litmus test. The fact that only 185 new filers were added to the existing base of 375,000 taxpayers suggests that there is a high level of voluntary compliance by North Dakota taxpayers, the Department says. The Arizona DOR noted in its December 2003 TaxNews that it collected $73 million, far in excess of its $25 million goal. However, $22 million of the total amount collected represented money the DOR believes it would have collected through existing audit programs. The DOR reasons that its overall results were a great success, because it spent less than $75,000 in direct expenses (e.g., advertising, printing, postage, telephones and temporary employees); it called the results a phenomenal return on its investment (i.e., $1,000 for each $1 spent). The results of New York Citys recent amnesty program may more accurately reflect new revenues. The Commissioner of the New York City Department of Finance, announced on March 4, 2004, that the citys business tax amnesty generated $80 million.46 In general, the program granted a penalty waiver and limited interest to amounts that accrued after Oct. 19, 2000. Interest accrued before Oct. 20, 2000, was waived. While that amount may seem small when compared to Illinois, or the $520 million adjusted gross revenues collected in New York State,47 it should not be overlooked. The $80 million far exceeds the $20 million that the Office of Management and Budget originally asked the Department to collect. More importantly, the citys amnesty program specifically excluded taxpayers granted amnesty for the same tax under a previous program, those subject to a pending field or desk audit, as well as those currently making installment payments of back taxes, among others.
Law Changes May Provide Amnesty Window The recent successes of state tax amnesty programs may be due to an increased focus on tax shelters in recent years. For example, California enacted tax shelter legislation in 2003 that mirrors the proposed Federal legislation in many respects.48 The legislation generally incorporates the Federal definitions of listed and reportable transactions, and authorizes the Franchise Tax Board (FTB) to identify for California income or franchise tax purposes other transactions as having a potential for tax avoidance or evasion.... The legislation contains penalty and nonpenalty provisions. Many penalty provisions retroactively apply for any penalty assessed on or after Jan. 1, 2004, on any return for which the SOL on assessments has not expired. The nonpenalty provisions are generally effective starting Jan. 1, 2004. The California legislation included a type of amnesty program called the Voluntary Compliance Initiative (VCI) program; it ran from Jan. 1April 15, 2004, and generated approximately $1 billion, more than 10 times initial expectations.49 The VCI program applied to liabilities attributable to the use of abusive tax avoidance transactions50 for tax years beginning before Jan. 1, 2003. The program offered two options, VCI without appeal or VCI with appeal; taxpayers had to apply one of these options to all years. In brief, the VCI without appeal provisions allowed the FTB to waive and abate penalties for an understatement for all years that the taxpayer elected to participate in the program, by filing amended returns reporting all income and losses without regard to the use of abusive tax avoidance transactions. The taxpayer had to (1) pay all taxes and interest due and (2) agree not to file refund claims for amounts paid in connection with abusive tax shelters. The FTB could not waive or abate penalties imposed on a tax assessment that became final before Dec. 31, 2003. While VCI with appeal was similar in form to VCI without appeal, the former allowed a taxpayer to file refund claims. In addition, the taxpayer could file an appeal to the State Board of Equalization (SBE) after the later of action by the FTB on the claim or the later of one of the following: (1) 180 days from the date of a final IRS determination as to the transaction; or (2) four years from the date a refund claim was filed or one year after full payment of all taxes, including penalties and interest. Taxpayers that did not prevail on their claims were subject to an accuracy-related penalty in effect prior to Oct. 2, 2003. The taxpayer was required to pay that penalty, if assessed, before its appeal. The FTB could not waive penalties imposed on an assessment of taxes that became due or payable before Dec. 31, 2003. Texas legislation enacted in 2003 that amended statutory provisions dealing with property tax compliance beginning in the 2003 tax year adopted somewhat of a velvet glove approach to nonfilers.51 The legislation was enacted to resolve ongoing disputes between taxpayers and assessors in many Texas counties, where some taxpayers asserted that the reporting provisions of property laws were directory, not mandatory, because the statutes did not impose a penalty on failing to file a report. The legislation adopted penalties for the failure to properly disclose the requisite information for 2003, and effectively declared 2001 and 2002 returns to be safe from audit, if the information for 2003 was timely provided. Maryland legislation pending as this column went to print would build on a 2003 settlement offer to intangible holding companies.52 That offer provided taxpayers a one-time opportunity to pay outstanding assessments by Jan. 30, 2004, at a reduced penalty rate.53 The offer was also extended to other similar holding companies scheduled for audit, and companies not yet identified. The latter group had until March 1, 2004, to take advantage of the offer. The proposed legislation would require the Comptroller to administer a settlement period from July 1Dec. 31, 2004, during which taxpayers could elect to have additional income tax calculated for tax years beginning on or after Jan. 1, 1996, and ending on or before Dec. 31, 2003. The additional tax would be calculated as though otherwise deductible payments were added back to the taxpayers Federal taxable income, or as though the payee was subject to the Maryland corporation income tax. All penalties would be waived, interest would not exceed 6.5%, and, for tax years beginning before Jan. 1, 1996, no taxes would be assessed.
Other Considerations State amnesty programs may offer taxpayers under IRS examination an opportunity to avoid penalties and interest from IRS adjustments and revenue agents reports, even in situations when the IRS audit is still open. In addition, state amnesty programs may provide taxpayers an opportunity to clear liabilities that they did not focus on before, such as withholding tax and unclaimed property. A business that employs sales representatives to travel to various states to solicit sales of tangible personal property may not be subject to corporate income tax if the representatives activities are protected under P.L. 86-272. However, the representatives may be subject to individual income tax in the states to which they travel. The obligation to report and pay tax on individual income earned in a state often begins with the employer, who bears the burden of withholding the proper amount of state tax on income that an employee earns in the various states. Employees subject to withholding include line employees, as well as officers, directors and other executives paid wages under an employment agreement. Failure to properly withhold income taxes often leads to significant exposure for unremitted taxes, in addition to penalties and interest. Another important consideration is voluntary disclosure. A number of states give taxpayers an opportunity to enter into voluntary disclosure agreements (VDA) to bring their accounts up to date. While provisions vary by state, VDA programs generally allow the taxpayer to limit the lookback period to the most recent three or four tax years and provide a waiver of penalties that might otherwise be assessed on outstanding liabilities; such programs may also limit interest. VDAs are generally negotiated on behalf of a taxpayer on an anonymous basis by the taxpayers representative, with taxpayer-specific information disclosed only after the agreements terms are formalized. As with amnesty, VDA programs may be offered pursuant to legislative authority or administrative grace,54 and may or may not remain in effect during amnesty. For example, the Massachusetts DOR revoked its VDA program shortly after the legislature enacted an amnesty program.55 The DOR cited the difference in lookback periods as the most pressing reason for denying program participation. The VDA program was reinstated on Aug. 29, 2003, well after the amnesty program ended on Feb. 28, 2003.56 The reinstated program limits the lookback period to the three most recent tax years, and allows the DOR to waive penalties for reasonable cause. Florida is actively promoting its VDA program to taxpayers that missed amnesty.57 The program limits the lookback period to the three years immediately preceding the VDA application postmark date. In general, penalties are waived, unless tax has been collected and not remitted. In that case, a 5% penalty applies. While interest is assessed at the statutory rates, the ability to limit the lookback period can result in significant savings for taxpayers. Alternatively, taxpayers may want to consider asking the state whether they qualify for a managed audit.58 Generally available only to taxpayers with an established filing history, managed audit programs allow taxpayers to conduct a self-audit by using state-specific guidelines. As with VDA, managed audits generally provide a waiver of penalties and may limit interest. One of the main advantages is the ability to conduct the self-audit during a more reasonable time frame, and avoid the last-minute rush that most amnesty filers experience.
Conclusion Amnesty gives taxpayers an important opportunity to clear past exposures and limit costs associated with penalties and interest. However, given the significant lookback period and the waiver of appeal rights, it is not for everyone. VDAs or managed audits might be more appropriate to a specific situation, especially if nonfiling exposures are significant. Accordingly, taxpayers should carefully analyze all their options before signing on the dotted line. |
