The Tax Times: No Civil Fraud Penalty? Inside the IRS’s New Voluntary Disclosure Proposal

The IRS has just opened a 90‑day window—through March 22, 2026—for public comments on a proposal to overhaul its Criminal Voluntary Disclosure Practice, including a more “streamlined” penalty framework and tighter timelines for compliance. For taxpayers with potential criminal exposure and the advisors who represent them, this proposal is both an opportunity and a warning.

What The IRS Is Proposing

The proposal would reshape how the Voluntary Disclosure Practice (VDP) works from preclearance through closing agreement, with an emphasis on speed, full payment, and standardized penalties.

Key elements include:

· A defined “Disclosure Period”

o The disclosure period would generally cover the most recent six years of delinquent or amended income tax returns and related international information returns and FBARs.

o Taxpayers must still identify all years of noncompliance on Form 14457, even though the IRS will typically focus on this six‑year window for filing and penalty purposes.

· A three‑month completion deadline

o Once CI grants conditional approval, taxpayers would have only three months to file all delinquent or amended returns, all required international information returns, and all FBARs.

o Within that same three‑month period, they must also execute all required agreements (closing agreement, statute extensions, penalty and FBAR agreements) and pay all tax, penalties, and interest in full.

· Mandatory electronic Form 14457

o All applicants must use the electronic Form 14457, Voluntary Disclosure Practice Preclearance Request and Application.

o The form must identify every year of noncompliance and include a full and accurate description of the taxpayer’s willful conduct, including income streams, entities, and foreign accounts or assets.

The New Penalty Framework

The proposed penalty structure is intended to be clear, predictable, and consistent across all disclosures:

For delinquent returns, failure-to-file penalties apply for each year in the Disclosure Period; failure-to-pay penalties do not apply.
For amended returns, a 20-percent accuracy-related penalty applies for each year in the Disclosure Period.

This replaces the current 75% civil fraud penalty for one year, currently required by the Voluntary Disclosure Procedure.

For delinquent or amended FBARs, penalties apply per year and are subject to annual inflation adjustments.
For delinquent or amended international information returns (e.g., Forms 5471, 8938), the IRS contemplates penalties of up to 10,000 dollars per return, per year during the disclosure period.

These penalties will be integrated into the overall VDP settlement, rather than left entirely to separate exam discretion.

Criminal Exposure And Enforcement Risk

The fundamental trade‑off of the VDP remains: come in early, tell the full truth, and pay in full to avoid a criminal recommendation.

· Protection from criminal referral (with caveats)

o Taxpayers who make a timely, truthful, and complete voluntary disclosure and fully comply with the proposed terms “will not be recommended for criminal prosecution” by CI.

o However, the IRS reminds taxpayers that voluntary disclosure does not automatically guarantee immunity; CI retains discretion in egregious cases.

· Consequences of failing to follow through

o CI may rescind conditional approval if the taxpayer fails to meet filing, payment, or agreement‑execution requirements within the deadlines.

o Noncompliant taxpayers may then face full civil examination and potential criminal investigation, with exposure to all applicable penalties outside the VDP framework.

What This Means For Your Clients

For taxpayers with serious compliance issues—especially those with willful offshore, digital asset, or long‑running domestic underreporting—the proposed changes raise the stakes for early, strategic engagement.

· Need for readiness before preclearance

o Because the proposal compresses the timeline to just three months post‑conditional approval, taxpayers will need much of the factual and documentary heavy lifting done before Form 14457 ever goes in.

o Advisors should evaluate records, reconstruct income, and scope the full set of returns and FBARs in advance to avoid defaulting inside the program.

· Renewed emphasis on modeling risk vs. reward

o A more formulaic penalty structure should make it easier to model the cost of entering VDP versus the risk of detection and full‑bore enforcement.

o For some taxpayers, especially those with large undisclosed foreign balances or digital asset activity, the program may still be expensive—but the alternative could be far worse.

Tax professionals who have seen the evolution of voluntary disclosure—from offshore initiatives to today’s CI practice—now have a rare chance to shape the next iteration.

Thoughtful, experience‑based comments between now and March 22, 2026, may help determine whether the “new and improved” VDP truly encourages compliance or simply raises the barriers to coming in from the cold.