Revenue problems for states could be a blessing to some taxpayers. State tax collectors, looking to bring in as much money as possible with the least possible effort, are turning to tax amnesties. Amnesties enable delinquent citizens to come clean about their tax transgressions, pay the due amount and receive exoneration for penalties and interest.

In 2009, amnesties were offered in Alabama, Arizona, Connecticut, Delaware, Maryland, Louisiana, Maine, Massachusetts, New Jersey, Oregon, Virginia and Wisconsin.

In 2010, a couple more state amnesties will soon be under way.

New York’s Penalty and Interest Discount, or PAID, will allow some taxpayers to save up to 80 percent of the penalty and interest on Empire State tax debts. The program begins Jan. 15 (the state will send letters to eligible taxpayers) and runs through March 15.

Pennsylvania will hold an amnesty from April 26 to June 18, during which Keystone State collectors will waive 100 percent of penalties and half of the interest for tax delinquents who come forward.

And Maine’s governor, fresh off a successful fall amnesty program, wants to conduct two more tax forgiveness programs.

Even if there’s no official amnesty program in your state, you still might be able to pay off your old debt with minimal penalty. Many states allow delinquent filers to set things right with state tax collectors via ongoing voluntary compliance programs.

However, it’s the official state and, in some cases, lower-level government tax amnesty programs that attract the most attention.

What’s covered?

The Federation of Tax Administrators has tracked these programs since 1982. In that time, 42 states, the District of Columbia, New York City and the U.S. commonwealth of the Northern Marianas Islands have offered their residents the chance to pay back taxes.

The various amnesties vary widely in length and scope, but almost every type of overdue tax has at one point in some state been eligible for settlement.

The common thread among amnesties is the opportunity for participants to avoid some or all associated penalties and interest. The possibility of civil or criminal prosecution also is usually waived when delinquent filers fess up during an amnesty period.

Plus, tax amnesties limit the tax examination look-back period, says Kathleen Thies, an analyst with the tax software and publishing company CCH.

“If you’re audited under normal circumstances, the auditors could look back at 10 years or more of returns,” says Thies. “But if you come forward in an amnesty program, the look-back would be much shorter. You don’t have to worry about a tax examiner looking back over your taxes until the end of time. You won’t be on the hook for taxes not paid many, many years ago.”

State benefits, problems

Amnesties also are sweet deals for states, especially in tough economic times when tax revenues shrink.

“We definitely see them in times of budget shortfalls,” says Thies. “The cost of having to initiate and conduct an audit and find nonfilers is very expensive for the state. So when they are already up against a budget crunch, by waiving at least a portion of interest and penalties, they can jump-start their own coffers by getting people who would otherwise be difficult to find.”

But Mark Robyn, an analyst with the Washington, D.C.-based Tax Foundation, says amnesties actually could end up costing states.

“The biggest downside in our view is that an amnesty is unfair treatment of different taxpayers,” says Robyn. “It creates a situation where law-abiding taxpayers who are paying taxes on time are paying for those who aren’t.”

And fully or partially waiving the penalties that are usually associated with noncompliance could cause some people to use amnesties as an unconventional tax strategy.

“Knowing that the state will hold a tax amnesty every three or four years, taxpayers could decide to hold onto their money to invest it or spend it and then take advantage of the next time the state offers amnesty,” says Robyn.

Undermining tax confidence

Amnesties also can undercut the purpose of the tax system.

“It undermines people’s perception of taxes and their willingness to pay taxes on time when it appears that those who don’t pay taxes don’t pay a price for their noncompliance,” says Robyn. “Confidence in the tax system erodes.”

Such damage to tax collection methods might not be a problem if states were more like Alabama than Massachusetts when it comes to amnesties. The Bay State held three tax amnesties in just seven years, whereas in 2009, Alabama conducted its first tax free-pass period in 26 years.

Federal fallout

Tax amnesties also could present problems for filers who, in addition to not paying state tax bills, have neglected their federal obligations.

The IRS Fed/State Program is a partnership between the IRS and most states to enhance voluntary compliance with all tax laws.

When some of the shared information is on previously unreported state income, you can expect the IRS to make sure it got a return from you about the money on the federal level. If not, it’s going to want its cut now.

Despite the downsides, for taxpayers and states, amnesties are likely to continue.

“We will probably see states turn to amnesties more as the economy goes bad and they have trouble raising revenue. It is a quick way to bring in money that may have gone uncollected to a large extent,” says Robyn. “But that doesn’t make it sound tax policy.”

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