What Is a VDA (Voluntary Disclosure Agreement) and Do You Need One?

In the complex world of business taxation, understanding and complying with various tax obligations can be a daunting task. Among the myriad of tax requirements, sales and use tax often stands out as a particularly challenging area, especially for businesses operating across multiple states. If you're a business owner, you may have heard about Voluntary Disclosure Agreements (VDA) and wondered whether you need one. This article will take a look at what a VDA is, how it relates to your tax liabilities, particularly concerning sales taxes, and whether it could be beneficial for your business.

What is a Voluntary Disclosure Agreement (VDA)?

A Voluntary Disclosure Agreement (VDA) is a legal agreement between a taxpayer and a state tax authority. This agreement allows businesses to voluntarily disclose any unpaid or underreported taxes in exchange for certain benefits, typically including reduced penalties and interest, and, in some cases, the avoidance of criminal prosecution.

VDAs are particularly common in the realm of sales and use tax, where businesses may unknowingly have uncollected or unremitted sales taxes due to various factors such as expanding into new states, acquiring businesses, or simply not fully understanding their tax obligations. By entering into a voluntary disclosure agreement, businesses can come forward to correct these mistakes without the fear of severe penalties or legal consequences.

Businesses engaging in interstate transactions are at particular risk and should regularly review their sales tax compliance to avoid potential liabilities. The complexity of sales tax nexus and varying local sales taxes presents significant challenges, including economic nexus laws.

The importance of sales and use tax compliance

Sales and use tax compliance is a critical aspect of running a business, particularly for those that operate in multiple states. Sales tax is a consumption tax imposed by the government on the sale of goods and services. As a business, you are responsible for collecting sales tax from your customers and remitting it to the appropriate tax authority. Failure to do so can result in significant tax liabilities, including back taxes, penalties, and interest.

Use tax, on the other hand, is a tax on the use, storage, or consumption of goods and services within a state when sales tax has not been paid. For example, if your business purchases equipment from an out-of-state supplier that did not charge sales tax, you may be required to pay use tax on that equipment.

Non-compliance with sales and use tax obligations can lead to substantial financial burdens for businesses. States are increasingly aggressive in their efforts to collect unpaid taxes, and if your business is found to have unreported or underreported taxable sales, the consequences can be severe. This is where a VDA can be particularly beneficial.

Eligibility criteria for VDAs

Not every business qualifies for a voluntary disclosure agreement (VDA). To be eligible, a taxpayer must not be under audit or have had any prior contact with the tax authority regarding the taxes they wish to disclose. This means if you have previously been in communication with the state about any tax type, including filing returns or receiving inquiries, you may be disqualified from participating.

Moreover, some states have additional stipulations that disallow entry into a VDA program for taxpayers who are already registered for the relevant tax type. This ensures that the program is reserved for those genuinely seeking to rectify past non-compliance, rather than those attempting to avoid penalties post hoc. Essentially, if you have had prior contact with the state regarding the specific tax type, you are disqualified from engaging in a VDA.

Understanding these eligibility criteria before starting the VDA process can save time and resources, allowing a focus on rectifying tax liabilities efficiently.

How does the VDA process work?

The VDA process generally involves several steps, which may vary slightly depending on the state. However, the typical process includes the following:

1. Initial contact: The process begins with the business (or its representative) contacting the state’s tax authority to express interest in entering into a VDA. This initial contact is often done anonymously through a third party, such as a tax professional, to maintain confidentiality.
2. Disclosure: Once the state tax authority agrees to the VDA, the business will provide a detailed disclosure of its tax liabilities. This includes identifying the types of taxes involved, the periods for which taxes were not reported or paid, and the reasons for non-compliance.
3. Negotiation: After the disclosure, the state will review the information and negotiate the terms of the VDA. This typically includes agreeing on the look-back period (the period for which the business will be required to pay back taxes), the amount of penalties and interest that will be waived, and any other conditions of the agreement.
4. Agreement: Once both parties agree on the terms, the business will sign the VDA. This legally binding document outlines the obligations of both the business and the state, including the amount of tax due, any waived penalties, and the timeframe for payment.
5. Payment and compliance: After signing the VDA, the business must pay the agreed-upon taxes within the specified timeframe. Additionally, the business is expected to remain compliant with its tax obligations going forward.

Benefits of entering a VDA

There are several benefits to entering into a voluntary disclosure agreement, particularly for businesses facing potential sales tax liabilities:

• Reduced penalties and interest: One of the primary advantages of a VDA is the reduction or elimination of penalties and interest on unpaid taxes. States often offer significant concessions in this area to encourage businesses to come forward voluntarily.
• Limited look-back period: Another major benefit is the limited look-back period. Typically, when a state conducts a tax audit, it may go back several years to assess unpaid taxes. However, through a VDA, the look-back period is usually limited to three to four years, significantly reducing the amount of back taxes owed.
• Avoidance of criminal prosecution: For businesses that have significantly underreported or failed to pay taxes, the threat of criminal prosecution is real. A VDA provides a way to come clean without the fear of facing criminal charges.
• Improved business reputation: Voluntarily disclosing unpaid taxes can also enhance a business’s reputation with tax authorities. Demonstrating a willingness to rectify past mistakes can lead to more favorable treatment in future dealings with tax authorities.
• Peace of mind: Finally, entering into a VDA provides peace of mind. Knowing that you have addressed past tax liabilities and are in compliance moving forward allows you to focus on running your business without the looming threat of a tax audit or legal action.

Do you need a VDA?

Deciding whether to enter into a VDA depends on several factors, including the extent of your tax liabilities, your business’s financial situation, and your risk tolerance. Here are some scenarios where a VDA might be beneficial:

• Expansion into new states: If your business has recently expanded into new states, you may not have been aware of the sales and use tax obligations in those states. A VDA can help you address any uncollected sales tax from past transactions in these new jurisdictions.
• Acquisitions: If your business has acquired another company, you may have inherited tax liabilities from the acquired entity. A VDA can help you manage these liabilities and avoid penalties.
• Unintentional non-compliance: If your business has unintentionally failed to comply with sales tax regulations, whether due to a lack of knowledge or an oversight, a VDA can provide a way to correct these mistakes without facing harsh penalties.
• Potential audit: If you believe your business is at risk of being audited, entering into a VDA before an audit can be a proactive way to mitigate potential liabilities. Once an audit begins, the opportunity to enter into a VDA typically disappears.

The role of a tax professional

While the VDA process may seem straightforward, it can be complex, particularly when dealing with multiple states and various types of tax liabilities. This is where the expertise of a tax professional becomes invaluable. A tax professional can help you navigate the VDA process, negotiate favorable terms with the state, and ensure that your disclosure is accurate and complete.

Moreover, a tax professional can help you assess whether a VDA is the right choice for your business. They can analyze your specific situation, including the potential tax liabilities, the likelihood of an audit, and the benefits of entering into a VDA versus other options, such as contesting the tax liability.

Conclusion

A Voluntary Disclosure Agreement (VDA) can be a powerful tool for businesses with outstanding sales tax liabilities. By entering into a VDA, you can significantly reduce penalties and interest, limit your look-back period, and avoid the risk of criminal prosecution. However, deciding whether to pursue a VDA requires careful consideration of your business’s circumstances and the potential benefits.

If you suspect that your business may have unreported taxable sales or other tax liabilities, it’s essential to act sooner rather than later. The longer you wait, the greater the risk of discovery by tax authorities, which could result in more severe consequences. Consulting with a tax professional can help you determine the best course of action and ensure that your business remains compliant with all applicable tax laws.

In the ever-evolving landscape of state taxation, staying informed and proactive is key to managing your sales tax liability and safeguarding your business’s financial health. Whether or not you choose to enter into a voluntary disclosure agreement, understanding your tax obligations and taking steps to address any issues is crucial for long-term success.

Do you need help with your sales tax compliance? Book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.

Frequently Asked Questions

Who is eligible for a VDA?

Only taxpayers who are not currently under audit and have had no prior contact with tax authorities related to the specific tax type are eligible for a Voluntary Disclosure Agreement (VDA).

What are the benefits of a VDA?

A VDA provides significant benefits such as penalty waivers, limited look-back periods, and reduced financial risk, making it an advantageous option for businesses aiming to resolve tax liabilities effectively.

How do I apply for a VDA?

To apply for a VDA, submit a detailed online application while adhering to state-specific regulations. Ensure that all necessary information is included for a smooth process.

What is a look-back period?

A look-back period refers to the timeframe, usually three to four years, during which past tax liabilities are evaluated. This assessment is crucial for ensuring accurate tax compliance and reporting.

How do I maintain compliance after a VDA?

To maintain compliance after a VDA, it’s crucial to register for future taxes, file returns timely, and thoroughly understand the relevant tax laws. This proactive approach helps avoid future liabilities.