Tax shelters are not new and neither are state amnesty programs. What is new is on May 9, 2007, the Multistate Tax Commission (MTC) in partnership with 22 states launched the Multistate Voluntary Compliance Program (VCP), a limited amnesty program for tax shelter participants. Details of the VCP can be found on the MTC Web site. The program runs from May 1, 2007 through October 1, 2007 and applies to tax years beginning before January 1, 2006. The VCP gives taxpayers a uniform and streamlined way to come clean on their Abusive Tax Shelters in any of the participating states. Qualified applicants will receive abatement of some or all of the otherwise applicable penalties, depending on the state. Most states (14) abate all applicable penalties, while the remaining states grant only partial penalty relief. Refer to the MTC Web site for details regarding each state’s policies.

Participating States

* Grant only partial penalty relief; all others abate all applicable penalties.

Who Can Participate in the VCP?

Taxpayers eligible to participate in the Voluntary Compliance Program are those who 1) used an Abusive Tax Shelter to reduce taxable income or income tax liabilities and 2) filed returns in one of the participating states, or failed to file as a result of participating in an Abusive Tax Shelter.

For purposes of this VCP, an Abusive Tax Shelter is a “tax avoidance transaction” or “abusive tax avoidance transaction.” The definition explicitly includes “Listed Transactions” as identified by the IRS (See IRS Notice 2004-67 (IRB 2004-41) and subsequent additions/deletions for the most current list). However, because an Abusive Tax Shelter can include transactions that affect only state taxes, and would therefore not be addressed by the IRS, the VCP broadens the definition to include any other transaction “devised for the principal purpose of avoiding state or federal income tax (and similar business activity taxes).”

What Is Required to Be Filed for the VCP?

Taxpayers have the option of participating in one or all of participating states and must submit the following information:

• Form MTC-VCP-1

• An amended or initial return with the tax computed without the abusive tax shelter

• Payment of tax due and

• Federal Form 8886 for each abusive tax shelter generating an amended or initial tax return.

Taxpayers must use a 2005 or later version of IRS Form 8886 to provide a “concise but comprehensive description” of the transaction. Failing this requirement will disqualify the taxpayer from participation, but the states will give taxpayers a chance to amend deficient descriptions. Only one Form 8886 is necessary to report essentially the same transaction and can be duplicated for multiple years and/or states. In addition to describing the transaction, participating taxpayers must also provide the name and address of the tax shelter promoter and, if available, any person or organization that advised the promoter with respect to the transaction.

What Factors Should Taxpayers and Tax Advisors Consider?

Expect Widespread Dissemination of Tax Shelter Information

The VCP covers 22 states, but any information gathered in the program is not confidential and can be shared not only with other participating states, but also with nonparticipating states as well as with the IRS, subject only to the confidentiality laws that generally govern tax return data disclosure. Most states have signed memorandums of understanding with other states and the IRS that permit the exchange of tax shelter information, including lists of participants, promoters, and descriptions of the tax shelter transactions. Since a condition of participation is identifying the tax shelter promoter and advisors to the promoter one can expect states to gather a wealth of leads from that data. Ongoing cooperative efforts between the states and the IRS on abusive tax shelter matters are robust and have been very successful. As a result, taxpayers can expect revenue departments across the country to aggressively pursue any identified participants who did not take the opportunity to come forward. Therefore, it may be in the taxpayer’s best interest to participate in the VCP and to file initial/amended tax returns with all states where there is a potential tax shelter liability, potentially including states not participating in this VCP.

New Penalty Statutes

The Small Business and Work Opportunity Tax Act of 2007, enacted on May 25, expands the federal return preparer penalty provisions under Internal Revenue Code Section 6694 to apply to any position below "more likely than not" that is not disclosed, and any position below "reasonable basis," even if disclosed. The change applies to all federal tax returns — not just income tax returns. Tax return preparers should evaluate their own exposure to tax shelters and potential preparer penalties in light of the scope of these new rules.

Effect of FIN 48

FIN 48 applies to all income tax positions for 2007 calendar year corporations. Taxpayers are unlikely to meet the FIN 48 “more likely than not” standard for their abusive tax shelter transactions and will be faced with reversing the tax benefits of those transactions and accruing applicable interest and penalties. In the case of tax shelters, the penalties and interest could equal or exceed the tax due. Therefore, participating in the VCP reduces both the actual financial exposure and the financial statement adjustment necessary to come into full compliance with FIN 48.

Conclusion

The net seems to be closing on abusive tax shelter transactions. Taxpayers with remaining exposure to abusive tax shelters should strongly consider the VCP. Participation reduces tax uncertainty in a number of states on favorable terms, cleans up the balance sheet and facilitates the transition to FIN 48.

LeAnn Luna is an assistant professor and holds a dual appointment with the Department of Accounting and Information Management and the Center for Business and Economic Research, both at The University of Tennessee.