| ||An Analysis of the IRS’s Voluntary Disclosure Policy |
Allen D. Madison*
* Attorney, Fenwick & West LLP. B.A., Michigan State University, 1989; M.B.A., Michigan State University-The Eli Broad Graduate School of Management, 1992; J.D., Hofstra University School of Law, 1997; LL.M, Georgetown University Law Center, 1998. My Thanks to Messrs. Gerald Kafka, Mortimer Caplin, and James Bruton III, for their comments and perspectives. I also thank Ms. Sayoko Orita for her support while working on this project.
He that takes the procedural sword shall perish with that sword. 1
A. The Voluntary Disclosure Policy
You have a friend that has not paid income taxes for a few years. Since you are an attorney, tax consultant, or accountant, she calls you because she realizes that she probably should become current on her tax liability. She has heard that the Internal Revenue Service has a Voluntary Disclosure Policy that provides protection for a taxpayer who comes forward to the Service and updates her tax liabilities. Do you advise her to walk down to the IRS service center tomorrow and disclose her delinquency? In theory, she should be able to approach the Service safely, make a voluntary disclosure, and expect to be free from prosecution. In practice, however, recent cases highlight problems that can arise in the process.
Since 1919, the Service has been attempting to balance the obvious benefits of having a voluntary disclosure policy with the problem of allowing tax misconduct to go unpunished. Taxpayers gain a "clear conscience" and the opportunity to "put [the] problem behind them and get on with their lives." The obvious benefit to the Service is that if a taxpayer voluntarily comes forward, the Service does not have to spend any money to locate, investigate, and institute collection proceedings against the delinquent taxpayer. However, history has shown that taxpayers often abuse the opportunity to obtain protection from prosecution. As a result, recently the voluntary disclosure process has become much riskier due to the enormous amount of discretion courts have afforded the government.
In section II, this Article discusses the history of the Voluntary Disclosure Policy, including litigation that prompted various changes. Section III provides the legal framework for determining when an agency is required to follow its own rules. Section IV highlights some recent cases and their effect. In particular, section IV focuses on a recent Second Circuit Court of Appeals decision, United States v. Tenzer.
This Article argues that recent decisions have removed some of the certainty that taxpayers should be able to expect from the Voluntary Disclosure Policy, but concludes that change is unlikely. Change is unlikely because there are competing considerations and it appears that the government has settled on how to balance them.
B. United States v. Tenzer
In September 1997, the Second Circuit reinstated a criminal Information against a tax lawyer named James Tenzer. The Southern District of New York had dismissed the Information one year earlier on the grounds that the Service failed to follow its Voluntary Disclosure Policy. The facts surrounding the case illustrate the nature of voluntary disclosure.
Mr. Tenzer failed to file timely tax returns for the years 1976 through 1991, with the exception of 1983, 1984, and 1985.11 When the Service became aware of Mr. Tenzer's delinquency, it treated the case as a civil, rather than criminal, matter. In 1991, Mr. Tenzer retained legal counsel to help him become current on his tax liabilities. With this assistance, Mr. Tenzer attempted to take advantage of the Voluntary Disclosure Policy by filing tax returns for the years for which he owed taxes. Because he did not have enough money to pay the full liability of about $1.3 million, his lawyers initiated negotiations in 1993 for an Offer in Compromise. Mr. Tenzer's team made an Offer in Compromise for between 20 and 25% of his total liability. Had the Service accepted the offer, Mr. Tenzer would have made a valid voluntary disclosure and, thus, may have avoided criminal prosecution.
A grand jury, however, had been investigating a client of Mr. Tenzer's accounting firm. In 1991, in connection with the investigation, an IRS Special Agent served Mr. Tenzer with a subpoena to produce the firm's accounting documents as they related to the investigation of his client. Mr. Tenzer's reaction to the service of the subpoena aroused the Service's suspicions with respect to his personal liabilities. In 1993, the same Special Agent contacted the IRS Collection Officer with whom Mr. Tenzer had been negotiating the Offer in Compromise. This led to a freeze on the Service's collection of Mr. Tenzer's tax liabilities because of his inclusion in the criminal investigation. According to the Service, the Offer in Compromise did not satisfy the requirements of the Voluntary Disclosure Policy. Thus, the Service authorized criminal prosecution of Mr. Tenzer.
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1 Vitarelli v. Seaton, 359 U.S. 535, 547 (1959) (Frankfurter, J., dissenting).