United States: To Disclose Or Not To Disclose: Tax Shelters, Penalties, And Circular 230 In 2014

Last Updated: June 18 2014
Article by Linda Z. Swartz and Jean Marie Bertrand

Most Read Contributor in United States, September 2018

I. TAX SHELTER REGULATIONS

A. Overview

  • Disclosure requirements for participants in "reportable transactions."
  • List-maintenance requirements for "material advisors" with respect to reportable transactions.
  • Disclosure requirements for "material advisors" with respect to reportable transactions.1

II. TAX SHELTER DISCLOSURE REQUIREMENTS FOR PARTICIPANTS

A. Overview

  • Categories of Reportable Transactions2
    • Listed Transactions
    • Confidential Transactions
    • Loss Transactions
    • Contractual Protection Transactions
    • Transactions of Interest entered into on or after November 2, 2006
    • Patented Transactions would constitute a new category of reportable transaction under proposed regulations.3
  • Participant Reporting Obligations
    • Every taxpayer "participating" in a reportable transaction that is required to file a U.S. tax return must:4
    • Mail IRS Form 8886 to the IRS Office of Tax Shelter Analysis for the first year the taxpayer participates in the transaction,
    • Attach IRS Form 8886 to its tax return (and any amended return) for each year in which the taxpayer participates in the transaction,5

and

  • Retain a copy of all documents and other records related to the reportable transaction that are material to an understanding of the tax treatment and tax structure of the transaction until the statute of limitations runs.6 However, taxpayers are not required to retain non-substantive emails and other documents that are not material to the tax treatment or tax structure of the transaction. Taxpayers are also not required to retain earlier drafts of a document if they retain a copy of the final document (or, absent a final document, the most recent draft of the document), and such final document (or most recent draft) contains all the information found in earlier drafts that is material to an understanding of the purported tax treatment or tax structure of the transaction.7
  • A taxpayer's failure to properly disclose a reportable transaction is a strong indication that the taxpayer did not act in good faith with respect to the transaction for purposes of the general reasonable cause and good faith exception to the accuracy related penalty.8 Moreover, a taxpayer that has not adequately disclosed a reportable transaction in accordance with the tax shelter regulations may not rely on the adequate disclosure exception to the accuracy related penalty for disregard of rules and regulations.9 Finally, the regulations deny the "realistic possibility" defense for a taxpayer that disregards a revenue ruling or notice with respect to a reportable transaction.10
  • If a taxpayer requests a ruling on the merits of a specific transaction on or before the date disclosure would otherwise be required, and receives a favorable ruling as to the transaction, the disclosure rules will be satisfied if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.11
  • If a taxpayer requests a ruling as to whether a specific transaction is a reportable transaction on or before the date that disclosure would otherwise be required, the IRS commissioner in his discretion may determine that the request satisfies the disclosure rules if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.12
    • However, the taxpayer's potential disclosure obligation is not suspended while the ruling request is pending.13
  • A protective disclosure filed with respect to a potentially reportable transaction that complies with all disclosure requirements would satisfy a taxpayer's potential obligation to disclose the transaction.14
  • In the case of a taxpayer who is a partner in a partnership, a shareholder in an S corporation, or a beneficiary of a trust, the disclosure statement must be attached to the entity's return for each taxable year in which the entity participates in a reportable transaction.15
    • If a taxpayer receives a timely Schedule K-1 less than 10 calendar days before the due date of the taxpayer's return (including extensions), the taxpayer must file the disclosure statement with the OTSA within 60 calendar days after the due date of the taxpayer's return (including extensions).16
  • If a transaction becomes a listed transaction (discussed in Section II.B., below) or a transaction of interest (discussed in Section II.F., below) after the filing of a taxpayer's return (including an amended return), but before the end of the period of limitations for the taxpayer's final return reflecting the listed transaction, the taxpayer must file a disclosure statement with the OTSA within 90 calendar days after the date on which the transaction became a listed transaction or transaction of interest, whether or not the taxpayer participated in the transaction in that subsequent year.17
  • If a transaction becomes a loss transaction (discussed in Section II.D., below) because the losses equal or exceed the threshold amounts, a disclosure statement must be filed as an attachment to the taxpayer's tax return for the first taxable year in which the threshold amount is reached and to any subsequent tax returns that reflect any amount of loss from the transaction.18

Footnotes

The authors are grateful to Karen Gilbreath and David Miller for their contributions to an earlier version of this outline and to Kathryn Harrington, Stanley Barsky, and Jennifer Wetzel for their excellent updates.

1 On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (the "JOBS Act"), which substantially increased the penalties and sanctions for failing to comply with the tax shelter regulations. In addition, the JOBS Act repealed the tax shelter registration requirements and created new reporting requirements for material advisors.

2 The fact that a transaction is a reportable transaction does not affect the legal determination of whether the taxpayer's treatment of the transaction is proper. Treas. Reg. § 1.6011-4(a).

3 Prop. Treas. Reg. § 1.6011-4(b)(7), 72 Fed. Reg. 54615 (Sept. 25, 2007).

4 Treas. Reg. § 1.6011-4(a), (d).

5 If a reportable transaction results in a loss which is carried back to a prior year, the disclosure statement for the reportable transaction must be attached to the taxpayer's application for tentative refund or amended tax return for that prior year. Treas. Reg. § 1.6011-4(e)(1). In addition, the taxpayer must include the "reportable transaction number" received from material advisors with respect to the transaction on the Form 8886. Treas. Reg. § 1.6011-4(d).

6 Treas. Reg. § 1.6011-4(g). The term "transaction" includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of a plan. Treas. Reg. § 1.6011-4(b)(1).

The documents may include (i) marketing materials related to the transaction, (ii) written analyses used in transaction related decisionmaking, (iii) transaction related correspondence and agreements between the taxpayer and any advisor, lender, or other party to the reportable transaction, (iv) documents discussing, referring to, or demonstrating the purported or claimed tax benefits arising from the reportable transaction, and (v) any documents referring to the business purposes for the reportable transaction. Treas. Reg. § 1.6011-4(g).

7 Treas. Reg. § 1.6011-4(g).

8 Treas. Reg. § 1.6664-4(d).

9 Treas. Reg. § 1.6662-3(a).

10 Treas. Reg. § 1.6662-3(a).

11 Treas. Reg. § 1.6011-4(f)(1).

12 Treas. Reg. § 1.6011-4(f)(1).

13 Treas. Reg. § 1.6011-4(f)(1).

14 Treas. Reg. § 1.6011-4(f)(2).

15 Treas. Reg. § 1.6011-4(e)(1).

16 Treas. Reg. § 1.6011-4(e)(1).

17 Treas. Reg. § 1.6011-4(e)(2)(i).

The statute of limitations on assessment of tax is generally three years after the later of the due date for filing a tax return or the date on which the taxpayer files its return. I.R.C. § 6501(a). Section 6501(c)(10) provides an exception to the general three-year period of limitations for certain listed transactions.

If the obligation to disclose a post-filing listed transaction arises after the expiration of the period of limitations on assessment for a taxable year in which the taxpayer participated in the post-filing listed transaction, section 6501(c)(10) will not reopen or extend the limitations period. However, if the limitations period on assessment has not expired, and the taxpayer fails to disclose the post-filing listed transaction as required by the regulations under section 6011, Section 6501(c)(10) provides that the limitations period on assessment with respect to the undisclosed listed transaction will not expire earlier than one year after the taxpayer discloses the transaction. See generally, Rev. Proc. 2005-26, 2005-1 C.B. 965.

Section 6404(g)(1) generally suspends the imposition of interest, penalties, additions to tax, or additional amounts if the IRS does not contact a taxpayer with possible adjustments to the taxpayer's liability within a certain time period. However, the suspension generally does not apply to interest, penalties, etc. with respect to a listed transaction or an undisclosed reportable transaction. I.R.C. § 6404(a)(2); Treas. Reg. § 301.6404-4(b)(5).

18 Treas. Reg. § 1.6011-4(e)(2)(ii).

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