11th Sep 2014
The answer to that is when you know or suspect a problem. Do not wait for the IRS or state tax authority to come knocking. Address it head on by seeking professional advice as soon as possible.
Take the illustrative case of James Vaughn, (Vaughn v. Commissioner, 114 AFTR 2d.) as an example of what not to do. Mr. Vaughn was involved in a late 90’s tax scheme called Bond Linked Issue Premium Structure (BLIPS). Basically it purported to allow a higher basis in a partnership sale and take losses against the sale to wash out gains. The idea was a bit preposterous; in fact, Mr. Vaughn testified that he knew it was wrong when he signed his returns. Needless to say in 2002, the accounting firm that cooked up this idea came under investigation and the tax scheme fell through. The accountants then warned their clients, including Mr. Vaughn, that the tax scheme had been exposed and the clients needed to participate in the IRS voluntary disclosure program.
So from here you are thinking: Mr. Vaughn went to see a tax attorney, worked through the problems, or maybe he got an IRS notice in the mail and then went to his attorney. Well, neither of those things happened. Mr. Vaughn got divorced, remarried, and divorced again. He spent millions, bought fancy furniture and cars, and gave no thought to his IRS matters. Now fast forward to 2006, Mr. Vaughn is bankrupt. IRS refuses to release past claims in bankruptcy stating that he willfully evaded paying his taxes. Mr. Vaughn countered that he never got a notice so he could not have willfully done anything. IRS, the tax court, and the U.S. Court of Appeals all took a very different view, if you knew it was wrong when you did it, the act is willful and you should know the tax is owed. Whether or not the IRS comes knocking isn’t the issue. Now in addition to being bankrupt, the taxpayer in this situation will likely owe back taxes, penalties, and interest dating back over ten years, when he could have had it fixed back in 2002.
So the moral of this is, people get caught up in difficult situations and do things that they shouldn’t with their taxes. Regardless of why you got into the situation you have, don’t wait on the IRS to come to you, seek legal help before the IRS finds you first.