State tax amnesty programs: the advantages and disadvantages.

• Author: Nakamura, Karen

Editor's note: Mr. Peterson chairs the AICPA Tax Division's State & Local Tax Technical Resource Panel (TRP). Ms. Nakamura is a member of the TRP.

For more information about this column, contact Mr. Peterson at dfpeterson@larsonallen.com or Ms. Nakamura at karen.m.nakamura@us.pwc.com.

Tax amnesty programs offer qualified taxpayers an opportunity to clear outstanding tax liabilities in exchange for a complete or partial abatement of interest and penalties that might otherwise be imposed. In addition, they provide states and localities much-needed revenue without the costs associated with audit and enforcement.

Although the programs are generally a "win" for taxpayers and tax administrators alike, taxpayers should address a number of important considerations before signing on to any amnesty program. This column summarizes some of those considerations, and cautions readers to speak with their tax adviser before taking any action.

States' Motivation for Amnesty

In general, amnesty programs are intended to improve overall compliance with tax laws by eliminating underreporting errors and adding nonfilers to the tax rolls. In addition, they give states and localities an easy way to generate a one-time revenue boost, with the trope of continued revenue flow through improved compliance. Most importantly, they are a quick solution to budget short falls, which have been significant in recent years. For example, a study by the National Conference of State Legislators (NCSL) found that states are running a $2.5 billion cumulative budget gap for 2004. (1) While the 2004 gap represents an improvement over the 2003 gap of $25.7 billion, the improved financial outlook may be short-lived; the states project a $35 billion cumulative budget gap for 2005, with little opportunity for an easy fix (such as the use of "rainy day" funds, which many states raided in 2003 and 2004). A second NCSL study indicates that budget gaps may well increase as a result of various "unfunded mandates" that it says Congress and the administration shifted to the states. At last count, the study asserts, the cost of implementing Federally mandated programs was estimated at $29 billion, or 6% of overall general fund revenues, for fiscal 2004, and $34 billion, or 7% of overall general fund revenues, for fiscal 2005. (2)

Amnesty Programs in General

Generally, amnesty programs are offered pursuant to specific statutory authority or as a matter of administrative grace. (3) While some programs offer amnesty for local, as well as state, taxes, (4) others (5) leave it up to local taxing jurisdictions to decide whether they will participate in an amnesty program.

Interest and penalty waivers: The most common feature of an amnesty program is the waiver of all penalties and a complete or partial waiver of interest. For example, under a Kansas amnesty program offered from Oct. 1-Nov. 30, 2003, qualifying taxpayers received an abatement of all penalties and interest owed on outstanding liabilities remitted during the amnesty period. (6) Under a North Dakota amnesty program offered from Oct. 1, 2003-Jan. 31, 2004, taxpayers received a waiver of all penalties and 75% of the interest that would have otherwise been assessed on overdue taxes. (7) Taxpayers participating in Marne's amnesty program received an abatement of all civil and criminal penalties and 50% of the interest that might have otherwise been imposed on amounts remitted under the program. (8)

Note of caution: The reduced interest rate and penalty provisions are somewhat of a "carrot and stick" approach to tax collection. More often than not, states follow amnesty with increased penalties and stricter enforcement. (9) For example, Florida offered tax amnesty from July 1-Oct. 31, 2003. (10) During the amnesty period, interest on outstanding liabilities was assessed at 75% or 50% of the statutory prime rate (the higher percentage was imposed on taxpayers already being audited). After amnesty, interest rates on delinquent taxes increased from prime to prime plus four percentage points, retroactive to Jan. 1, 2000.

New York adopted a similar strategy during an amnesty period that ran from Nov. 18, 2002-Jan. 31, 2003. (11) Participants had penalties waived and received a two percentage-point reduction in the interest rate on their outstanding liabilities. However, starting April 1, 2003, interest rates increased an additional two percentage points over pre-amnesty levels, resulting in an overall swing of four percentage points in the interest rate.

Virginia legislation offered taxpayers a chance to clear past liabilities during an amnesty period that ran from Sept. 2-Nov. 30, 2003, and granted a waiver of 50% of the interest otherwise due and all penalties. (12) However, eligible but nonparticipating taxpayers are subject to an additional 20% penalty on any unpaid amounts after amnesty. Illinois took a more severe posture as to post-amnesty interest. It offered amnesty from Oct. 1-Nov. 15, 2003, and provided a waiver of all interest and penalties for payments made during the amnesty period. (13) Taxpayers with outstanding liabilities that qualified for amnesty, but that did not participate, became subject to penalties of 200% of the pre-amnesty interest and penalties.

The increased post-amnesty interest and penalty provisions raise several concerns for taxpayers and tax administrators. One is how to handle penalties and interest owed on issues arising as a result of a court challenge or policy clarification subsequent to amnesty, but that affects years to which amnesty applied. With many of the increased interest rates and penalties mandated under the statute, and limited ability for waiver outside a reasonable-cause exception, increased interest and penalty costs may be an unintended outcome in certain situations. As one practitioner noted, even well-intentioned taxpayers may be caught in the "penalty dragnet" that seems to be intended for more long-term delinquencies. For example, if some states apply the increased penalty provision literally, an assessment under appeal during the amnesty period that is resolved against the taxpayer after the program ends would be subject to increased penal ties, even though the taxpayer acted in good faith. This could be a major trap for the unwary; taxpayers will need to seriously consider the ultimate "downside" of such an outcome.

Taxes and tax periods: In general, amnesty programs apply to most taxes administered by a taxing agency and to all tax periods open under the statute of limitations (SOL). However, some states may limit the type of taxes and the length of lookback for administrative case or other reasons.

For example, Florida's amnesty program applied to qualifying tax liabilities due before the first day of the amnesty period. (14) Similarly, Texas's amnesty program, which ran front March 11-March 31, 2004, applied to all state and local taxes administered by the Comptroller of Public Accounts, including local option taxes, except unclaimed property and Public Utility Commission gross receipts assessments, for all filing periods with reports due before Feb. 1, 2004. (15) Maine also included liabilities outstanding up to its amnesty program start date. (16)

In contrast, Arizona limited amnesty filings to all taxes administered by the Department of Revenue (DOR) or an Arizona county (except estate and property taxes) and owed from Jan. 1, 1983-Dec. 31, 2001. (17) Similarly, Illinois limited its amnesty program to taxes owed for tax periods ending after June 30, 1983, and before July 1, 2002. (18) The fixed starting point may be due in part to earlier amnesty programs in those states. (19) Kansas's amnesty program applied to income and privilege tax liabilities due for tax periods ending on or before Dec. 31, 2001. (20) A Dec. 31, 2002, start date applied to other select taxes, including sales and use, withholding and severance.

Missouri's amnesty program, which ran...