In more detail

The IRS recently announced changes to its Form 14457, "Voluntary Disclosure Practice Preclearance and Application." The Voluntary Disclosure Practice (VDP) allows taxpayers to rectify past noncompliance and pay past taxes, interest, and penalties in exchange for limiting their criminal exposure. Eligibility requires cooperation with the IRS and disclosure before the IRS commences a civil examination or criminal investigation or before the IRS hears about the noncompliance. Acceptance into the VDP (and immunity from prosecution) is not guaranteed and is based on all the facts and circumstances surrounding the voluntary disclosure. After filling out Form 14457 Part I, a "Preclearance Request," the taxpayer may or may not be approved to enter the VDP. If approved, the taxpayer has 45 days (with one potential 45-day extension) to file all relevant tax returns and financial documents relating to the voluntary disclosure. Generally, when voluntary disclosure comes after the IRS already has information from a third party or its own investigation, the IRS will not accept a taxpayer's VDP application. In addition, taxpayers who have made use of an offshore voluntary disclosure program are ineligible to participate.

Among the changes from the previous 2022 version of the Part I form are alterations to the method of submission, the addition of a check box in which the taxpayer must indicate that their actions were "willful," alterations in the timeline for document production, a change in the payment and penalty provisions, and a more specific noncompliance narrative. The IRS used to require mail or fax submission of the VDP application and supporting documentation. Now, documents can be submitted by e-fax or, atypically for the IRS, unencrypted email. The submitting taxpayer may use encrypted email if they wish by sending the encryption password to the IRS in a separate message, but encryption is not mandatory.

The new "willfulness" check box requires that taxpayers certify that they were "willful in the actions that led to…tax noncompliance," and a failure to formally admit intent will result in automatic denial of access to the VDP with no opportunity for appeal or reinstatement. "The "willfulness" checkbox represents a significant change from past procedure and may make taxpayers less likely to participate in the program. Previously, the VDP process did not require a formal admission of intent—taxpayers detailed their conduct through the narrative explanation or had unique facts that led them to want to use the VDP as a hedge in a non-willful situation. Now, however, such options are off the table. While the taxpayer may want to choose to make the voluntary disclosure, there is a lack of clarity because the term "willful" is not defined on the form. The IRS website merely establishes that "willfulness" is not mistake but an intentional effort to hide assets or tax liability. However, there are different definitions of the term "willful" in different tax contexts, and it is not clear from the instructions on the form whether a civil or criminal definition of "willfulness" applies. Additionally, there are grey areas around when an action is willful versus a mistake or a failure to correct, and different practitioners may have different opinions about whether or not an action was willful. It is not clear from the new form how the IRS will evaluate the taxpayer's admission of willfulness. There is another potential caveat to the new requirement to admit that past tax noncompliance was willful: acceptance to the VDP, even after admitting willfulness, is not guaranteed, and there are ways a taxpayer can lose the benefit of the program (discussed later in this article). If the taxpayer loses VDP benefits or is not accepted into the program despite the admission of willfulness, they are potentially at risk for the admission to be used against them in a civil or criminal proceeding.

One of the ways taxpayers can lose the benefits of the VDP program even after acceptance is reflected in the new timing requirements for document production. Previously, taxpayers were not expected to have documents and all returns ready upon first contact by an IRS agent—instead, they were instructed to wait to prepare the documents for their full VDP disclosure until they were contacted by an IRS examiner after preliminary acceptance. Many taxpayers would begin or at least complete the process of compiling documents, particularly when multiple jurisdictions were involved, once they knew that they had been preliminarily accepted to the VDP. Otherwise, compiling all documents and preparing returns before knowing whether approval would be granted could require significant resources that would be wasted if the taxpayer were refused VDP for another reason. Now, however, the IRS requires that the entire set of returns and financial documents relating to the noncompliance must be ready upon initial contact from an examiner. After receiving preliminary acceptance, taxpayers must submit the full disclosure within 45 days. One 45-day extension is possible; requesting a second will result in removal from the program. Pre-clearance can happen extremely quickly, forcing taxpayers to effectively have all their documents ready before application to the program.

Previously, taxpayers who were unable to make full payment could make payment installment agreements or offers in compromise on amounts owed. Now, the updated VDP requires full payment of all taxes, interest, and penalties as an explicit condition of acceptance. According to the instructions for the form, a civil fraud penalty under section 6663 or a fraudulent failure-to-file penalty under section 6651(f) will necessarily apply to at least one year of all voluntary disclosures, the year with the highest tax liability. A civil revenue officer may require that the taxpayer submit to an interview under oath to determine the viability of proposed payment arrangements. The instructions for the 2022 version of the form required taxpayers to commit to making "good faith arrangements to pay all taxes, interests, and penalties owed," explaining that a taxpayer unable to pay the full amount owed could request that the IRS consider alternative payment arrangements. The new form does not have the good-faith language and states that the taxpayer may request an "alternative full-payment arrangement" before the exam is closed. While there is still a check box on the new form indicating an inability to pay, the instructions indicate that checking the box requires that the taxpayer meet a burden of demonstrating that they cannot pay and that they work out a payment arrangement that will result in full payment. There does not seem to be any flexibility for the IRS to give a taxpayer the opportunity to negotiate a payment plan that fits their means.

Finally, the new form requires a highly specific narrative, including additional disclosure of digital assets. The form again re-emphasizes the necessity of admitting willfulness, stating that the narrative must include a "thorough and detailed" summary of willful acts. In addition, the narrative required in Part II, the disclosure itself, has been expanded. The form now requires the taxpayer to provide detailed descriptions of the roles of all parties involved, all banks and institutions involved, advisor interactions and advice given, specific acts of noncompliance, and other pertinent facts. Rather than a general narrative, the IRS now requires that the taxpayer address certain specific "subsections" of the narrative. Finally, the IRS has changed the questions about "virtual currency" to "digital assets," and now asks for identifying information about centralized digital asset exchanges and transactions recorded on a public blockchain.

The new willfulness admission, shorter time to prepare documents, and mandatory full payment represent significant changes from the prior version of Form 14457. Overall, the IRS' revisions demonstrate a stricter approach towards those taxpayers who might want to voluntarily disclose past tax-related misconduct in order to minimize penalties.