Picture this: You are sitting behind your desk when your phone rings. No, it’s not your spouse calling to find out why you are late for dinner. Although if that was the first thing that came to mind, there might be some hidden meaning in it. Instead, it is a new client. His name is John. John is a resident of New Jersey. John contacts you for advice regarding foreign, unreported bank accounts in the Netherlands. You recommend that John apply to the Offshore Voluntary Disclosure Program.

As part of this process, you file amended federal income tax returns on John’s behalf. John then pays a whopping 27.5% offshore penalty on the highest aggregate balance in his foreign bank accounts during an eight-year look-back period. Finally, John pays additional taxes and penalties for each of the preceding eight years.

At the end of the disclosure process, you sign IRS Form 906, otherwise known as a closing agreement, to settle the liability for the years covered by the disclosure once and for all. Right about now, you are ready to breathe a sigh of relief (or for a glass of bourbon, depending on your pleasure). You might even be ready to give yourself a pat on the back and say, “job well done.” After all, John’s Federal tax issues are resolved. But not so fast. Is your job really done? Not quite.

The question now becomes, “What about state taxes?” Does John have an obligation to notify the New Jersey Division of Taxation about what happened at the Federal level? Absolutely! In fact, failing to do so could have serious consequences. And if you’re sipping your bourbon while saying to yourself, “thank goodness I don’t represent any clients from New Jersey,” you might be humbled to find out that New Jersey is not the only state that imposes such an obligation on its residents. There are many others, including New Jersey’s northern neighbor. You guessed it! Good ‘ole New York.

The purpose of this article is to discuss the reporting obligations that New Jersey taxpayers have in two specific situations: first, when they are participating in the IRS’s Offshore Voluntary Disclosure Program. And second, whenever any change is made to their Federal income tax return. While this article discusses reporting obligations from the point of view of a New Jersey resident, it also has a “New York State of Mind.” Indeed, New York imposes similar requirements on its taxpayers. As in New Jersey, New York offers its own voluntary disclosure program called the New York Voluntary Disclosure and Compliance Program (“NYVDCP”).

Let’s start with some basics. Internal Revenue Code § 6103 authorizes the IRS to share information with state agencies for tax administration purposes. This authorization applies whenever the IRS enters into an agreement with a taxpayer. Very simply, it allows the IRS and state agencies to share information. What type of information? Information about examinations, tax return information, and even employment tax information.

Many tax practitioners mistakenly rely on IRC § 6103 to believe that the IRS will automatically notify the New Jersey Treasury or the New York Treasury about Federal changes to their clients’ returns. But, as will soon be explained, that thinking could prove costly for taxpayers.

Back in 2013, the New Jersey Department of Treasury, Division of Taxation, unveiled the Offshore Compliance Initiative, a voluntary compliance program designed to complement the IRS’s Offshore Voluntary Disclosure Initiative. Its purpose? To identify assets and unreported income from previously sheltered offshore accounts.

So why should New Jersey residents who participate in OVDI concern themselves with New Jersey’s offshore compliance program? For two very good reasons. First, a New Jersey taxpayer who participates in the Federal Disclosure Program is required to participate in the New Jersey equivalent (i.e., “NJOVCI”). And second, if the state discovers that an individual has undisclosed offshore assets and income before a disclosure has been made, then it will be too late to participate in the NJOVCI. In that case, the taxpayer risks the full panoply of penalties not to mention a possible referral to the attorney general’s office for criminal prosecution.

With respect to the first reason, as part of a NJOVCI submission, not only must an applicant inform the New Jersey Division of Taxation that he is participating in the OVDI, but he must also submit a copy of the IRS acceptance letter along with copies of IRS documents reflecting the federal tax examination changes.

With the focus being on the Federal Disclosure Program – which, as we all know, is time-consuming and burdensome enough – it is easy to forget about the NJOVCI submission altogether or to put it off until later. For those who are a little absent-minded or who are not afraid to admit that they have a tendency to procrastinate, here is a word of advice: Do not wait until the Federal Disclosure Program ends to make a NJOVCI submission. It could be disastrous.

While NJOVCI is similar in many ways to the IRS initiative, it differs in one major aspect. Unlike the Federal Disclosure Program, a NJOVCI submission includes two additional tax years: 2003 and 2004. Failure to include these tax years in a NJOVCI submission puts the taxpayer at risk of paying a 50% civil fraud penalty, something that the taxpayer could surely do without. Generally speaking, taxpayers who come forward and timely disclose their tax obligations will avoid the civil fraud penalty altogether.

Are the penalties as severe in NJOVCI as they are in OVDI? In other words, should a New Jersey taxpayer expect to pay the same offshore penalty under NJOVCI as he or she paid under OVDI (i.e., a whopping 27.5% of the highest aggregate balance in the foreign bank accounts during the eight-year look-back period)? The answer is a resounding, “no.” Only two penalties apply: a 5% late payment penalty and a 5% amnesty penalty.

Now is a good time to transition from the duty that a tax practitioner has to make a NJOVCI submission in the specific circumstance when a New Jersey taxpayer is participating in the OVDI to the disclosure duties that apply broadly whenever a New Jersey taxpayer is under Federal examination. Indeed, New Jersey’s Notice of Federal Change requirements are not just limited to those taxpayers who participate in OVDI. On the contrary, such requirements apply to any New Jersey taxpayer who is under Federal examination.

The general rule is that once an IRS audit concludes, tax practitioners have a duty to notify the New Jersey Division of Taxation about any changes that occurred at the Federal level. Specifically, New Jersey taxpayers must notify the New Jersey Division of Taxation whenever they receive one or more of the following:

(1) An IRS notification of a change;

(2) A correction on a Federal income tax return that may affect New Jersey taxable income; or

(3) A notification that there has been a change to the Federal earned income tax credit that may affect the New Jersey earned income tax credit.

The notification must take the form of an amended New Jersey income tax return, which has a firm filing deadline. Indeed, it must be filed within 90 days of receipt of the applicable IRS notification. When does the 90-day period begin to run? On the date that the taxpayer receives a final notification from the IRS.

For example, suppose that Tom receives a Revenue Agent’s Report (RAR) on October 1, 2012. He agrees to the changes reported. Tom learns that these changes have impacted his New Jersey income tax liability. On November 1, 2012, the IRS issues a letter confirming the agreement. On January 30, 2013, Tom files an amended New Jersey income tax return.

Did Tom timely file his amended New Jersey income tax return? The narrow issue is whether the 90-day period began to run on October 1, 2012 – the date that Tom received the RAR – such that the deadline for filing the amended New Jersey tax return would have been December 31, 2012. Or did the 90-day period not begin to run until November 1, 2012 – the date that the IRS issued a letter confirming the agreement – such that the deadline for filing the amended New Jersey tax return would have been January 31, 2013?

Why does this matter? If the 90-day period began to run on October 1, 2012, then the deadline for filing the amended return would have been December 31, 2012. In that case, Tom’s amended return would have been filed late. But if the 90-day period did not begin to run until November 1, 2012, the deadline for filing the amended return would have been January 31, 2013. In that case, Tom’s amended return would have been filed on time.

The short answer is that the 90-day period began to run on November 1, 2012, not October 1, 2012. Why? Once again, the rule is that the 90-day period begins to run on the date that the taxpayer receives a final notification from the IRS. What is meant by a “final notification?” According to New Jersey courts, any letter that confirms the content of a Revenue Agent’s Report serves as a final notification.

The confirmation letter issued by the IRS on November 1, 2012 was just such a letter. Therefore, it should be treated as the operative notice for purposes of triggering the 90-day period. Because the confirmation letter was issued on November 1, 2012, the 90-day period began to run on November 1, 2012.

What does this mean? Very simply that Tom had until January 31, 2013, ninety days after November 1, 2012, to file his amended New Jersey tax return. Because Tom filed his amended New Jersey tax return on January 30, 2013, one day before the deadline, he filed it within the 90-day statutory period. Therefore, a timely filing was made.

New Jersey courts are emphatic that this statutory time period must be strictly enforced, particularly in refund cases. Taxpayers who do not comply with the strict time limit cannot rely on IRS determinations as binding precedent to resolve similar issues pertaining to their New Jersey tax liability.

For example, in Lenox Inc. v. Dir., Div. of Taxation, the taxpayer’s Federal income tax liability was reduced during an examination because the IRS determined that he was entitled to claim additional losses for abandoning two business operation divisions. Subsequently, the taxpayer filed a refund claim with the New Jersey Division of Taxation based on the IRS’s determination. However, that refund claim was filed late. As a result, the New Jersey Tax Court held that the taxpayer could not rely on the IRS’s determination to file a refund claim. To put it bluntly, the taxpayer was “S _ _ _ out of luck.”

The filing of a Notice of Federal Tax Change does not just impact whether a claim will or will not be barred. It also impacts whether the Division of Taxation can begin an audit and make additional adjustments after the statute of limitations period for filing an original return would have expired. The rule is that whenever a Notice of Federal Change is required, the statute of limitations for that year does not begin to run until the Notice is filed. In this way, a Notice of Federal Change is treated as a tax return that must be filed in order to begin the statute of limitations.

What this means is that if a taxpayer fails to file a Notice of Federal Change, the Division of Taxation can commence an audit and make additional adjustments after the statute of limitations period for filing the original return has expired.

Up until now, the discussion has focused exclusively on individuals. How about foreign corporations? What, if any, filing requirements do they have? Foreign corporations that conduct business in New Jersey must file certain forms with the state, including a New Jersey Corporation Business Tax Return.

The penalties for failing to do so are nothing short of severe. But penalties are just the tip of the iceberg. For example, foreign corporations that do not timely file a Notice of Federal Change risk losing the ability to file or maintain lawsuits in New Jersey state and Federal courts.

What are the filing requirements of a foreign corporation that conducts business in New Jersey but is not registered to do business in New Jersey? Such a corporation must file New Jersey Form CBA-1, “Notice of Business Activities Report by a Foreign Corporation.” Once the foreign corporation files its Corporation Business Tax Returns, it can dispense with this filing requirement. However, to the extent that the foreign corporation fails to timely-file its Corporation Business Tax Returns, it is a good practice to file New Jersey Form CBA-1 together with the NJOVCI submission.

The takeaway is this: Taxpayers in New York and New Jersey have a duty to notify their state’s taxing authority whenever a change has been made to their federal tax returns. Practitioners must be mindful of these requirements and file the necessary notices in order to protect their clients’ rights. Indeed, the client deserves nothing less.

In accordance with Circular 230 Disclosure