If you're listening to this and thinking, "I might not be in compliance with my state tax obligations," you're not alone. Many real estate professionals find themselves in this situation, and the good news is there's a solution: Voluntary Disclosure Agreements (VDAs). During my recent conversation with Rich Hedley, our state and local tax expert, we explored how VDAs can be a lifeline for businesses facing compliance issues.
Here's something that might surprise you: if you never file a tax return in a state where you have nexus, there is no statute of limitations. This means if you've had business activity in a state for 10 or even 20 years without filing, that state could theoretically go back and assess tax, penalties, and interest for the entire period.
Let that sink in. Ten years of back taxes, penalties, and interest can be financially devastating. This is exactly why voluntary disclosure agreements exist and why they're so valuable.
Voluntary disclosure agreements allow businesses to come forward and resolve their compliance issues in a structured, beneficial way. Here's how the process typically works:
The process starts anonymously. You don't have to reveal your identity initially. Instead, you write up the facts and circumstances of your situation. Every state handles this differently—some have online applications, others require a formal letter—but the key is that you can explore your options without immediately exposing yourself.
During this anonymous phase, you explain your situation and present how you want to pay the tax. You're essentially negotiating the terms before revealing who you are.
The state will either accept or reject your voluntary disclosure proposal. If they accept, you move to the next phase.
Once accepted, you reveal your identity and begin the formal process of filing past tax returns and paying the associated taxes.
The advantages of going through the VDA process are substantial:
Limited Lookback Period: Instead of facing unlimited exposure, states typically limit the lookback period to three or four years maximum. This alone can save you thousands or tens of thousands of dollars.
Penalty Abatement: Most states (though not all) will abate all penalties associated with the non-compliance. This means you're typically only paying the actual tax owed plus some interest.
Certainty: You know exactly what you owe and can put the compliance issue behind you permanently.
Here's a critical point: VDAs only work if the state hasn't already contacted you. Once a state has reached out to you about compliance issues, the voluntary disclosure option is typically off the table.
This is particularly important for real estate investors because when you have physical presence (like rental properties), states are more likely to discover your activity and contact you directly. Economic nexus situations are often harder for states to detect, but physical presence is more obvious.
The key takeaway? As soon as you realize you have nexus in states where you haven't been filing, act quickly to explore VDA options.
VDAs absolutely work for physical presence situations, including rental real estate non-compliance. Whether you're a Virginia resident who didn't realize you needed to file in North Carolina for your rental property there, or you have a more complex multi-state situation, VDAs can provide a path forward.
The success of the VDA process depends largely on timing and proper presentation of your situation. This is where working with experienced tax professionals becomes crucial.
If you suspect you might have state compliance issues, don't let fear or procrastination make the situation worse. The longer you wait, the more interest accumulates, and the higher the risk that the state discovers your situation on their own.
VDAs represent a proactive approach to resolving compliance issues on favorable terms. While it's always better to be compliant from the start, VDAs provide an excellent second chance to get things right.
Remember, states want to collect the tax they're owed, but they also recognize that voluntary compliance is better than enforcement actions. VDAs represent a win-win scenario that can save you significant money and stress while getting you back into compliance.
If you have questions about whether you might benefit from a VDA, don't hesitate to reach out to qualified tax professionals who can evaluate your situation and guide you through the process.