Tax return preparers and advisers often use the word “disclosure” but many taxpayers do not understand what it means. Kevin E. Thompson, CPA says “I understand most taxpayers misunderstanding disclosure. I’m not sure most preparers know what it means. And some taxpayers may also think of it in a negative way or are suspicious about disclosing information that could invade their privacy.”
It can also be perceived as more work or a risky venture. No one wants to risk an audit if they can help it and will try to avoid doing anything that would trigger an audit.
The fact is: Disclosure can help prevent risk in many cases. Thompson says “we are looking to avoid two types of risk. First and foremost, appropriate disclosure of certain transactions can avoid an examination. Second, it can reduce the incidence of penalties.”
What is disclosure?
Disclosure is an “explanation” of income or expense. How much should be disclosed depends on what your legal requirements are and what you do. Sometimes the IRS requires one especially if a point is in question on an item you are claiming.
There are multiple instances in which it is beneficial even though it may not be required. It may get you out of paying penalties and can prevent the IRS from extending a usual three-year limitation period for the assessment of your income tax.
You could get a penalty if you underestimated your income tax. However, you can avoid the penalty if you make a disclosure. A disclosure plus a reasonable basis for your tax position is a better strategy.
How to make a disclosure
The best way is to use an IRS form 8275 or 8275R. In most cases, Form 8275 is preferable. If you use form 8275R, it is recommended that you get professional advice as it may trigger audits while form 8275 will not. How much you disclose is also important as many people tend to go overboard. Do not send attachments or long-winded arguments about the law. The IRS will ask you for more information if it is needed. You want to disclose enough detail to satisfy the IRS, but still, make your disclosure short and clear.
Thompson says “Navigating the Internal Revenue Code is difficult. It’s best to consult your tax professional about any disclosures you may need.”