There are many reasons why taxpayers can owe back state taxes (sales tax, payroll tax, and income tax), penalties and interest, including making bad business decisions, having bad luck, or getting caught doing something inappropriate. Regardless of the reason (assuming it is not a criminal matter), many states have programs that enable taxpayers to "wipe the slate clean." The specifics of these programs vary based on the state, type of tax, and whether the taxpayer voluntarily came forward or was "caught" by the state. The programs states offer most often include: 1) Payment Plans; 2) Voluntary Disclosure Agreements; 3) Amnesty; and 4) Offers in Compromise.
Payment Plan ("Plan")
Most states allow taxpayers to enter into a Plan to pay off back taxes, interest, and penalties. There are a number of important factors taxpayers should consider before agreeing to a Plan. First, interest continues to accrue on the outstanding balance until the liability is completely relinquished. Second, depending on the state and length of the Plan, the state may issue a tax lien/warrant on the taxpayer, which could affect the taxpayer's ability to borrow money and therefore stay in business. Finally, depending on the length of the Plan (typically ranging from 12-18 months), states can require taxpayers to provide detailed financial information before a Plan is approved. The longer the Plan requested, the more financial data the state will likely require. In our experience, the financial information requirement can become a contentious issue. In the case of a company requesting a Plan, not only does the state want to see the financial records of the company, but also its owners.
Voluntary Disclosure Agreement ("VDA")
A VDA is an agreement entered into by a state and taxpayer in situations where a taxpayer proactively discloses prior year(s) tax liabilities previously not known by the state. In return for voluntarily coming forward, states will typically limit the number of back years they will assess tax (typically 3 to 5 years). In addition, depending on the state, all penalties and some amount of interest may also be abated.
VDAs are generally viewed as a win/win by both states and taxpayers. States generate revenue from the VDA and, in most cases, have a new taxpayer on the tax roll. From a taxpayer's perspective, comments like "I am so glad this nightmare is now behind me" or "I can finally sleep at night" are typical.
Most states do not permit a VDA in situations where the taxpayer has already been identified by the state for audit. Therefore, it is critical that once the decision is made to move forward with a VDA, taxpayers begin the process immediately. Once an audit notice is received by the taxpayer, a VDA may no longer be available.
From time to time, states offer amnesty programs to taxpayers that owe back taxes. While some of the terms of the amnesty are similar to a VDA, amnesty programs tend to be more favorable to taxpayers. For example, Louisiana is offering tax amnesty for two months beginning September 23 and ending on November 22, 2013. The program is an opportunity for delinquent taxpayers to resolve their outstanding liabilities and have all penalties and 50% of the interest waived.
Offer in Compromise ("OC")
An OC allows qualified taxpayers that owe state taxes to negotiate a settled amount that is less than the total amount currently due. Typically, states are not obligated to offer or accept a taxpayer's OC. Most states require taxpayers to meet at least one of three conditions in order to be considered for an OC settlement:
- Taxpayer can demonstrate that the past tax liability may not be correct;
- Taxpayer can show that the liability is likely uncollectable in full under any circumstances; and
- The Taxpayer does not contest liability or collectability but can demonstrate extenuating or special circumstances that the collection of the debt would "create an economic hardship or would be unfair and inequitable."
Once the state determines a taxpayer meets one of the above requirements, the taxpayer must provide full financial disclosure of all known assets and liabilities. Based on my experience, this is not an easy process to go through. If the state determines that the taxpayer had undisclosed assets, the OC would become null and void.
There is a famous saying "there is no such thing as a free lunch." States look to maximize revenue from audits, not forgive liabilities. All the above programs have potential negative implications to the taxpayer (e.g., significant financial disclosures, penalties and interest, detailed audits), so it is very important that each program be carefully considered based on the taxpayer's specific facts. Taxpayers should consult with their accountant and/or attorney before finalizing which, if any, of the above-mentioned programs make sense because there are many exceptions to the general rules discussed above depending on the state(s) involved and the type of taxes owed.
David Seiden is a leading authority on state and local tax ("SALT") matters. He is a partner with the accounting and consulting firm Citrin Cooperman, where he leads the firm's SALT Practice. He can be reached at (914) 517-4447 or firstname.lastname@example.org.
Citrin Cooperman is a full-service accounting and business consulting firm with offices in New York City; White Plains, NY; Norwalk, CT; Livingston, NJ; and Philadelphia.