Full Disclosure: Why VDAs Can Be a Business’s Best Friend

Voluntary disclosure agreements with state taxing authorities are a valuable pathway for businesses looking to resolve tax issues, avoid penalties, and get back into compliance. 

Navigating complex tax regulations, compliance, and reporting can be daunting for those who operate a business in multiple states. With all states that maintain a sales tax moving toward economic nexus as the determinator of tax responsibility, more taxpayers than ever may soon find they have unexpected tax obligations. As such, many taxpayers will also find that they have fallen out of compliance. This can be a costly and time consuming matter to resolve, however a voluntary disclosure agreement (VDA) may offer a valuable pathway for businesses looking to resolve past tax issues, avoid costly penalties, and get back on the compliance train.

VDAs, generally, allow businesses to voluntarily disclose previously unreported tax liabilities typically in exchange for a limited look-back period and abatement of penalties. This blog discusses why requesting a VDA can be a strategic decision to rectify errors, maintain good standing with tax authorities, and limit costs.

The Application Process

Although the specific VDA initiation and application process can vary by state, most are similar. Generally, the initial VDA application request requires a taxpayer to provide basic information such as the tax years at issue, the type(s) of tax liability, and in some states a liability estimate.

A taxpayer can initiate the VDA process themselves. If they wish to remain anonymous until an application is approved, most states allow an accountant or lawyer to file the VDA application on their behalf. Once the application process is initiated, the taxpayer or their representative will be contacted by the state. At this point, the state will likely request that the taxpayer or their representative provide additional details concerning the specific liabilities.

Some states will require a taxpayer to fill out a business activities questionnaire that provides information regarding the taxpayer’s business activities and how long the taxpayer has been operating in the state. It is important to note that filing the initial VDA application does not guarantee the taxpayer a VDA. Rather, the taxpayer must also meet certain eligibility requirements and sign the finalized VDA.

Eligible and Ineligible Taxpayers

Eligibility criteria to participate in VDA programs vary by state, but most states agree on two key factors. First, the taxpayer seeking a VDA must not have been previously contacted or audited by the state. Some states also require that the IRS has not contacted the taxpayer regarding a similar liability. Second, a taxpayer must not have previously registered with the state for the specific tax type being disclosed in the VDA program (e.g., corporate taxes, sales and use taxes).

Not every tax is eligible for a state’s VDA program. However, most states offer VDA programs for corporate tax and sales and use tax obligations. It is important to closely review a state’s specific requirements and exclusions when evaluating whether a VDA is the appropriate course of action. If a taxpayer does decide to move forward with a VDA, it is important that they remain current on the tax liability moving forward because they will not be able to file another VDA for the same tax type.

VDA Benefits

A VDA program can provide taxpayers with multiple benefits. One that is particularly appealing is a limited look-back period for the tax liability. Generally, states agree to a limited look-back period of three to five years if a taxpayer is approved for a VDA. Taxpayers who are not proactive about compliance take the risk that, if found by the taxing authority, they could be subjected to an unlimited look-back period – plus interest and penalties.

Another key benefit of VDA programs is the penalty abatement. States will generally abate penalties if a taxpayer initiates a VDA prior to being contacted by the state regarding the outstanding tax liability. Some states also include a waiver of a portion of the interest. Depending on the number of years at issue and the size of the tax liability, the savings from penalty abatement combined with the limited look-back can be significant.

Finally, an often-overlooked benefit of a VDA agreement is that it can save on the costly legal fees associated with defending an audit or filing an appeal of an assessment. This, of course, must be weighed against the fees associated with preparing and filing a VDA and potential penalties that could be abated (or imposed if the VDA is not filed).

It is important for businesses to continue reviewing and monitoring their tax compliance and proactively address any issues that arise. If a taxpayer discovers they have an outstanding tax liability, a VDA may be the most cost-effective way to bring the business back into compliance.

Olivia Y. Klein, an associate with Chamberlain Hrdlicka in Philadelphia, focuses her practice on state and local taxes. She may be reached at olivia.klein@chamberlainlaw.com.

Jennifer W. Karpchuk is a state and local tax partner at Holland & Knight in Philadelphia.

Sign up for PICPA's weekly professional and technical updates by completing this form.

Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.