Voluntary Disclosure vs. Managed Audit: Choosing the Best Path to Reduce Tax Risk

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Tax compliance can often be a complex and daunting process for businesses. When discrepancies arise, companies must decide between two potential courses of action: entering into a Voluntary Disclosure Agreement (VDA) or opting for a Managed Audit. Both options have distinct advantages and disadvantages, and choosing the right path is crucial to minimizing tax risk and financial exposure. This guide will explore the differences between VDAs and Managed Audits, providing insight into when each approach is best suited for what businesses need to know when making their decision.

Understanding the Differences Between Voluntary Disclosure and Managed Audit

Both VDAs and Managed Audit are methods to address tax discrepancies, but they differ significantly in terms of process, timeline, and outcomes.

A VDA is a strategic solution where a business voluntarily discloses its non-compliance with tax laws to state tax authorities. By doing so, a business can eliminate penalties charges that would normally apply in an audit. VDAs are usually beneficial for companies that have not been in compliance for years, have not yet been audited but have realized they need to correct their past mistakes before they are discovered by the authorities.

The main advantage of a VDA is the opportunity for businesses to settle their liabilities without undergoing the full scrutiny of an audit. VDAs offer businesses a structured path to compliance with lower financial risks, and favorable terms, such as limited look-back periods and waived penalties.

A Managed Audit is conducted by a business under the supervision of tax authorities and its tax advisors. This can occur when a business has already been flagged for potential non-compliance or has been selected for audit by the taxing authority. During a Managed Audit, the business gathers documents, performs the audit, and prepares reports under the guidance of expert tax advisors who help manage the process.

Managed Audits are usually initiated when a business is already in the process of being audited, offering a way to manage the audit process while ensuring that findings are accurate. The business may benefit from reduced penalties and interest if it cooperates fully during the audit. However, the scope and timeline are controlled by the tax authorities.

Pros and Cons of Each Approach for Corporations

Both VDAs and managed audits present unique opportunities for businesses to resolve tax compliance issues, but each comes with its own set of advantages and disadvantages.

VDA

Pros:

1. Proactive Compliance: A VDA allows businesses to come forward voluntarily, making it ideal for businesses that wish to address their non-compliance before they are discovered by state tax authorities and potentially subjected to a state tax audit.
2. Reduced Penalties and Interest: One of the most significant advantages of a VDA is that it often results in a complete waiver of penalties. This can result in substantial financial savings.
3. Control over the Process: Since a VDA is initiated by the business, companies have greater control over the timeline and negotiation of terms. This can lead to a more predictable and structured resolution.
4. Minimized Audit Risk: By resolving the issue through a VDA, businesses can avoid the potential disruption and financial uncertainty that comes with an audit.

Cons:

1. Eligibility Constraints: A business cannot pursue a VDA if it is already under audit.
2. Complex Process: Although VDAs can offer relief, the process of disclosing liabilities and negotiating terms with tax authorities can be complex and resource intensive. Professional expertise is essential to ensure that the terms are favorable.
3. No Guarantee of Complete Relief: While penalties and interest are often reduced or waived, there is no guarantee that all tax liabilities will be minimized. The tax authorities still have the final say on the terms of the agreement.

Managed Audit Program

Pros:

1. Penalty Waivers: In some cases, tax authorities offer penalty reductions or waivers if the business conducts its own audit under a managed program, particularly if the company shows cooperation throughout the process.
2. Substantiated Findings: Since the company conducts the audit itself, it has more control over the documentation and findings, which can result in a more accurate representation of the business’s tax position.
3. Detailed Understanding of Liabilities: A managed audit provides the company with a deeper understanding of its financial situation, which can be valuable for future tax planning.

Cons:

1. Time-Consuming and Resource-Intensive: A managed audit requires substantial time and resources, as the company must allocate personnel to conduct the audit and manage the process.
2. Disruptive: Being under audit can be disruptive to daily operations, as tax authorities scrutinize the business’s financial records. The company must dedicate significant resources to respond to inquiries and gather the necessary documentation.
3. Uncertain Outcome: Unlike a VDA, a managed audit is not always a guaranteed path to reduced penalties or interest. The business could still face significant financial penalties depending on the findings of the audit.

When Should a Business Choose a VDA?

A VDA is most beneficial when a business has not yet been audited but suspects non-compliance with sales tax laws. Businesses should consider a VDA in the following scenarios:

1. When a Business Has Identified Past Non-Compliance: If a business realizes it has missed filing or paying sales taxes in certain jurisdictions, it can use a VDA to correct the issue before the tax authorities discover it.
2. When Expanding into New States: Companies that are expanding into new states may uncover tax compliance issues during their expansion process. A VDA is an effective way to address past liabilities and ensure compliance moving forward.
3. When Seeking Predictability and Cost Control: VDAs offer predictability in terms of liabilities and penalties. Businesses looking to manage their tax risks proactively, with a clear understanding of potential costs, should consider a VDA.
4. When a Business Values Efficiency: VDAs provide a faster route to resolution compared to audits. Companies looking to minimize disruption and settle tax matters quickly may opt for a VDA.

When Is a Managed Audit the Preferred Option?

A Managed Audit is the preferred option when a business is already under audit or when the tax authority has initiated an investigation into the business’s tax records. Businesses should consider a Managed Audit in the following scenarios:

1. When Under Audit: If the tax authorities have already flagged the business for non-compliance, the company can opt for a managed audit. This option allows the business to manage the audit process and negotiate findings with the help of experienced tax professionals.
2. When Penalty Relief is Offered: Some tax authorities offer managed audits as a way to waive penalties or reduce interest charges, making this a good option if penalty mitigation is a priority.
3. When the Business Has Strong Tax Records: If the business believes its tax records are in good standing but is still under investigation, a managed audit provides an opportunity to prove compliance and resolve issues while minimizing penalties.
4. When the Business Has the Resources to Handle the Process: Managed Audits require substantial time and internal resources to conduct, so businesses that have the manpower and expertise to handle the audit should consider this option.

Key Considerations by State: What You Need to Know

The decision between VDA vs. Managed Audit often depends on the state in which the business operates. Each state has its own rules regarding VDAs and Managed Audits, so businesses must understand the state-specific regulations to make an informed decision.

1. VDA Policies: Some states have specific voluntary disclosure programs with varying terms for penalties and look-back periods. It’s crucial to understand the details of these programs before entering into a VDA.
2. Managed Audit Eligibility: Not all states provide this option, and the eligibility criteria vary.
3. Negotiation Leverage: States with more favorable tax environments may be more open to negotiating terms for a VDA, while others may have more stringent requirements. A business’s approach to negotiation can significantly impact the outcome.
4. State-Specific Compliance Risks: Some states may be more aggressive in pursuing audits, while others may offer more lenient terms for VDAs. Understanding a state’s approach to tax compliance can help businesses choose the most appropriate path.

Conclusion

In conclusion, both VDAs and Managed Audits offer viable paths for businesses looking to address non-compliance. The choice between the two depends on the business’s specific circumstances, including its compliance history, financial situation, and risk tolerance. For businesses seeking guidance through this process, partnering with tax professionals can ensure the best possible outcome. By leveraging their expertise, businesses can reduce the complexities of tax compliance and navigate the best course of action for mitigation.

How Bennett Thrasher Can Help

Bennett Thrasher’s State & Local Tax practice is ready to help you mitigate your risks in this uncertain tax landscape. For more information, you can contact one of our State & Local Tax Partners: Stephen Bradshaw, Dee Green, Brian Sengson, or Peter Stathopoulos, Or call 770.396.2200.

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