A Voluntary Disclosure Agreement (VDA) can be a great tool to address past sales tax obligations, but it’s important to consider all the pluses and minuses and ensure you make the right decision for your business when it comes to mitigation efforts.
When companies determine on their own (not from a tax authority or audit) that they have historical risk concerning sales tax obligations and exposure, one of the primary options for mitigation is a VDA. Almost all states provide some version of these agreements, which offer companies the chance to come forward and disclose that they have sales tax exposure and past obligations in exchange for avoiding penalties.
In the right situation, a VDA can save you a ton of money.
How do VDAs work?
A VDA is a legal means for taxpayers to self-report back taxes owed for income, sales, property, and other tax types. In exchange for voluntarily reporting the tax due, states generally grant a taxpayer a waiver of penalty and also a limited look-back period – which has the potential to significantly reduce the tax due.
If back taxes are not disclosed but are instead discovered through an audit, the taxpayer is at a disadvantage and will end up being assessed various penalties, plus interest plus all historical tax due.
There are two main qualifications for your business to be accepted into a VDA program. You cannot have already registered in the state, and you cannot have already been contacted by the state for an audit or for questions about your sales/use tax exposure.
When do VDAs work best?
VDAs can be most beneficial in three situations (these can be intertwined):
You have previous non-compliance and exposure dating back five or more years. A “limited look-back period” means the tax jurisdiction will only hold you responsible for back taxes for, typically, three or four years. If you owe taxes beyond this look-back period, then the tax from these older periods are generally waived (provided you have not collected the tax).
We’ve had scenarios where companies have approached us with $15,000 of tax due for the last three years but $200,000 past due in the fifth and sixth years. In this situation, the VDA is extremely attractive: The state will forgive the $200,000 that is outside the look-back period in exchange for the $15,000 due during the look-back period. (In such a VDA, you usually have to pay the interest on the taxes due during the look-back period.)
States can always audit the VDA periods, but so long as there were no material or intentional misstatements of fact, the state will not audit beyond the look-back period.
You’ve collected the sales tax but have yet to register and remit to the state. Generally, states will waive the penalties. Even if the waiver isn’t for the complete amount, you can still often avoid 25-50% penalties.
You look to sell your business or otherwise seek outside capital and have previously not complied. Outstanding sales tax obligations are becoming more of an issue under the due diligence of acquiring companies or investors.
Escrow funds can be set aside due to large sales tax liabilities. In some cases, we’ve seen the purchasing company or primary investor force the seller to do VDAs before going through with the transaction to mitigate prior exposure.
With a VDA, there is an opportunity to go back to your customers and understand if they have self-reported the use tax or paid the tax under audit. Additionally, depending on your contracts and relationship with your clients, you may have the opportunity to invoice them for the sales tax due.
If a VDA is such a great money-saver for taxpayers, why do states do them? Simply, a state cannot find and audit every business that is not in compliance. States would prefer for businesses to voluntarily comply. A VDA allows the state to welcome in new taxpayers and get cash up-front for the previous 36 to 48 months of non-compliance. That taxpayer is now registered to continue collecting/remitting prospectively.
The waiver of penalty and the limited look-back is equitable for both parties. VDAs aren’t for everybody – they can be very expensive cash flow-wise – but in the right circumstances, they can be a great opportunity.
Learn more about VDAs on our most recent “Hot Topic” webinar.
If you need help understanding your sales tax obligations and whether a VDA would be the right course of action for your business, get in touch. TaxConnex has experts to help answer these questions and to help you establish an ongoing process to ensure you remain compliant – even with the frequently changing rules of sales and use tax.