Arizona’s Voluntary Compliance Initiative Imposes a Short Deadline on
Taxpayers Involved in Abusive Tax Avoidance Transactions
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On February 14, 2005, Arizona joined the list of states who are actively
pursuing taxpayers involved in listed tax shelter transactions. Arizona’s
Voluntary Compliance Initiative (VCI) is an effort by the Arizona Department
of Revenue (ADR) to encourage taxpayers who are involved in abusive tax
shelter arrangements to voluntarily disclose these transactions to the ADR.
VCI enables Arizona taxpayers to disclose their involvement in any IRS “listed
transaction” on a penalty-free basis for tax years before December 31, 2003.
The period for taxpayers to participate in the VCI program began on February
14, 2005 and will end on April 1, 2005. Participants must pay the taxes
and interest due to the ADR by May 13, 2005. Though the VCI deadlines are
extremely short and fall during the height of tax-filing season, affected
Arizona taxpayers should strongly consider participating in the VCI.
|"VCI enables Arizona taxpayers
to disclose their involvement in any IRS ‘listed transaction’ on
a penaltyfree basis for tax years before December 31, 2003."
The Arizona VCI was modeled after the Connecticut Abusive Tax Shelter
Compliance Initiative (CATSCI), which was in effect from June 16, 2004 through
July 31, 2004. The CATSCI was a successful state program that also allowed
Connecticut taxpayers to voluntarily disclose their participation in IRS
listed transactions to the Connecticut Department of Revenue in exchange
for a waiver of any civil or criminal penalties. The CATSCI was a huge success,
earning several million dollars for Connecticut, and Arizona piggybacked
its own VCI program onto Connecticut’s with hopes of achieving similar revenue
All Arizona taxpayers involved in any IRS “listed transaction,” whether
still in audit status, having previously settled other issues for the same
tax year or still undetected, can participate in Arizona’s VCI. Listed transactions
are tax shelters which are designated by the IRS as tax avoidance transactions.
(For more information regarding listed transactions, visit http://www.irs.gov/businesses/corporations/article/0,,id=120633,00.html).
Typical listed transactions use offshore or abusive trusts, employee leasing
arrangements, home-based businesses, employment taxes, many levels of pass-through
entities which are designed to artificially create losses or derivative
financial products and complicated structures to inflate basis..
Taxpayers who wish to participate in the VCI must notify the ADR of their
election by sending Form AZ-VCI, Election to Participate in the Arizona
Tax Shelter Voluntary Compliance Initiative on or before April 1, 2005.
Participating Arizona taxpayers must attach the original Federal return
and all schedules, any Federal amended return and relevant schedules, and
any original or amended Arizona returns to the Form AZ-VCI. Taxpayers who
agree to participate in the VCI must (1) concede 100% of the claimed artificial
losses or concede the entire gain mitigation strategy used to shelter income,
(2) pay all additional tax and interest due, and (3) comply with any ADR
Tax Shelter Unit request for additional information. Any Arizona taxpayer,
non-resident taxpayer with Arizona source income, or corporation doing business
in Arizona that knowingly or unknowingly participated in a listed transaction
is eligible to apply. Any affected Arizona taxpayer who is currently under
state or Federal audit is also entitled to apply. Married Arizona taxpayers
may participate in the VCI either jointly or on an individual basis.
|"Taxpayers who are eligible to
participate in the VCI, but choose not to, could face serious repercussions,
including penalties of up to 75%, interest and possible criminal
prosecution when warranted."
Taxpayers who are eligible to participate in the VCI, but choose not
to, could face serious repercussions, including penalties of up to 75%,
interest and possible criminal prosecution when warranted. However, a taxpayer
can eliminate this exposure by taking advantage of the VCI.
Many states, such as Arizona and California have information sharing
agreements with the Internal Revenue Service. Any taxpayer involved in a
listed transaction with the Internal Revenue Service will likely see his
tax information shared with the ADR as a result of an IRS investigation
or audit. Arizona expects to send some 2,000 notices this month to Arizona
taxpayers due to their identified participation in a listed transaction.
These taxpayers could face serious penalty consequences and potential criminal
prosecution for their failure to take advantage of the Arizona VCI.
As an added incentive to entice shelter participants to apply, the VCI
has the ability to waive (in addition to the forgiveness of 100% of the
penalties) some of the interest due. Moreover, the VCI can, but is not required
to, allow some taxpayers some deductions that would otherwise not be allowable
on an audit. These settlement incentives are executed by closing agreement
after a taxpayer has completed the Form AZ-VCI. Though the waiver on interest
or the additional deductions are not an entitlement as a matter of course,
the ADR has stated that it will consider these options on a case-by-case
basis. After receiving all related documentation and information, the ADR
will prepare and mail the Arizona taxpayer a closing agreement detailing
the fact that the taxpayer may not appeal any issue that the settlement
relates to nor dispute the amounts paid under the VCI agreement.
Taxpayers who cannot pay the full tax liability due by the May 13, 2005
deadline have the option to enter into an installment agreement. Installment
agreements are not awarded automatically by the ADR. The taxpayer must request
an installment agreement when he or she files his Form AZ-VCI by the April
1, 2005 deadline. The payment terms and amounts of an installment agreement
will be decided by the ADR on a case-by-case basis.
Some taxpayers have faced difficulty in determining the amount of tax
due to the state of Arizona from participation in the VCI. For example,
many shelter participants have filed no Federal tax return, though the VCI
requires an original Federal tax return to be submitted with the taxpayer’s
VCI application. In such cases, the taxpayer may submit a pro-forma Federal
tax return. Likewise, the IRS is seeing an increase in expedited requests
by Arizona taxpayers for information regarding their Federal accounts. While
the IRS understands the short deadlines under the VCI, the IRS may not be
able to honor all requests by the timeline. The ADR recommends taxpayers
estimate the tax deficiency they may have due in this instance. The ADR
has stated that it will honor the penalty waiver on the entire amount estimated
by the taxpayer who wishes to participate in the VCI program. If the taxpayer
estimates a lower amount than is ultimately due to the IRS, the VCI penalty
waiver will only apply to the amount the taxpayer offers as a tax deficiency.
Thus, taxpayers should not estimate their liabilities too conservatively.
The Arizona VCI program comes on the heels of California’s newest Tax
Amnesty program, effective February 1, 2005 through March 31, 2005, which
applies to all taxpayers, not just shelter participants. The VCI is one
of many state-imposed programs targeted at taxpayers who participate in
abusive tax avoidance transactions.
Arizona has stated that taxpayers who are eligible to apply, but don’t,
will receive “no leniency” from the ADR in a future audit. With the increased
information sharing agreements between state taxing agencies and the IRS,
it would seem all eligible Arizona taxpayers should promptly and seriously
consider taking advantage of the VCI to avoid substantial civil and criminal
This Alert was written by
G. Michelle Ferreira,
Harry J. Friedman and
Barbara T. Kaplan. Please
contact Ms. Ferreira at (650) 328-8500, Mr. Friedman at (602) 445-8000,
Ms. Kaplan at (212) 801-9200 or your Greenberg Traurig liaison if you have
any questions regarding the subject matter of this Alert.
© 2005 Greenberg Traurig
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This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
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individual legal needs.