IRS Releases 2004 Guidelines for Adequate Disclosure

In general, Rev. Proc. 2004-73 provides guidance in determining when disclosure is adequate for purposes of Secs. 6662(d)(2)(B)(ii) and 6694(a)(3). The taxpayer must furnish all required information in accordance with the applicable forms and instructions, and the money amounts entered on these forms must be verifiable.

Law

If Sec. 6662 applies to any portion of an underpayment of tax required to be shown on a return, 20% of the portion of the underpayment to which the section applies is added to the tax. The penalty rate is 40% for certain gross valuation misstatements. Under Sec. 6662(b)(2), Sec. 6662 applies to the portion of an underpayment attributable to a substantial understatement of income tax.

Sec. 6662(d)(1) provides that there is a substantial understatement of income tax if the understatement exceeds the greater of 10% of the tax required to be shown on the return for the tax year, or $5,000 ($10,000 for a corporation other than an S corporation or a personal holding company). Sec. 6662(d)(2) defines an understatement as the excess of the tax required to be shown on the return for the tax year, over the tax shown on the return, reduced by any rebate (within the meaning of Sec. 6211(b)(2)).

For an item not attributable to a tax shelter, Sec. 6662(d)(2)(B)(ii) provides that the understatement is reduced by the portion attributable to any item if the relevant facts affecting the items tax treatment are adequately disclosed on the return or on a statement attached to the return, and a reasonable basis exists for the items tax treatment by the taxpayer.

Sec. 6694 imposes a $250 penalty on a return preparer for filing a return or refund claim that results in an understatement of liability due to a position for which the preparer knew, or should have known, that there was not a realistic possibility of being sustained on the merits, and such position was not disclosed in accordance with Sec. 6662(d)(2)(B)(ii).

Procedure

Additional disclosure of facts relevant to, or positions taken with respect to, issues involving any of the items set forth below is unnecessary for purposes of reducing any understatement of income tax under Sec. 6662(d), provided the forms and attachments are completed in a clear manner and in accordance with their instructions. The money amounts entered on the forms must be verifiable, and the information on the return must be disclosed in the manner described below.  An amount is verifiable if, on audit, the taxpayer can demonstrate its origin (even if the IRS does not ultimately accept that amount) and the taxpayer can show good faith in entering that number on the applicable form. The taxpayer must clearly identify an item entered on a line with no preprinted description (such as other expenses). For example, to disclose a bad debt for a sole proprietorship, the words bad debt should be printed on the line of  Schedule C that shows the bad debt.

(1) Form 1040, Schedule A, Itemized Deductions: 

(a) Medical and dental expenses: Complete lines 14, supplying all required information.

(b) Taxes: Complete lines 59, supplying all required information. Line 8 must list each type of tax and the amount paid.

(c) Interest expense: Complete lines 1014, supplying all required information. This section does not apply to amounts disallowed under (1) Sec. 163(d) unless Form 4952, Investment Interest Expense Deduction, is completed or (2) Sec. 265. 

(d) Contributions: Complete lines 1518, supplying all required information. Merely entering the amount of a donation on Schedule A, however, will not constitute adequate disclosure if the taxpayer receives a substantial benefit from the donation shown. If a contribution of property other than cash is made and the amount claimed as a deduction exceeds $500, the taxpayer must attach a properly completed Form 8283, Noncash Charitable Contributions, to the return. This section will not apply to any contribution of $250 or more unless the contemporaneous-written-acknowledgment requirement of Sec. 170(f)(8) is satisfied.

(e) Casualty and theft losses: Complete Form 4684, Casualties and Thefts, and attach to the return. Each item or article for which the taxpayer claims a casualty or theft loss must be listed on Form 4684.

(2) Certain trade or business expenses (including the following six expenses as they relate to the rental of property): 

(a) Casualty and theft losses: The procedure outlined above must be followed.

(b) Legal expenses: The amount claimed must be stated. This section does not apply, however, to amounts properly characterized as capital expenditures, personal expenses or nondeductible lobbying or political expenditures, including amounts required to be (or that are) amortized over a period of years.

(c) Specific bad debt charge-off: The amount written off must be stated.

(d) Reasonableness of officers compensation: Form 1120, Schedule E, Compensation of Officers, must be completed when required by its instructions. The time devoted to business must be expressed as a percentage, as opposed to part or as needed.  This section does not apply to golden parachute payments, as defined under Sec. 280G. It does not apply to the extent that remuneration paid or incurred exceeds the $1 million-per-employee-remuneration limit, if applicable.

(e) Repair expenses: The amount claimed must be stated. This section does not apply, however, to any repair expenses properly characterized as capital expenditures or personal expenses.

(f) Taxes (other than foreign taxes): The amount claimed must be stated.

(3) Differences in book and income tax reporting:

(a) Form 1120, Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return; and 

(b) Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More, Form 1120: Column (b), Temporary Difference, and Column (c), Permanent Difference, of Part II (reconciliation of income (loss) items) and Part III (reconciliation of expense/deduction items).

The information provided must be reasonably expected to apprise the Service of the nature of the potential controversy concerning the items tax treatment. If the information provided does not do so, Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, must be used to adequately disclose the item (see Part II of the instructions for those forms).

An item reported on a line with a preprinted description, shown on an attached schedule, or itemized on Schedule M-1, may represent the aggregate amount of several transactions producing that item (i.e., a group of similar items, such as amounts paid or incurred for supplies by a taxpayer engaged in business).  In some instances, the potentially controversial item may involve a portion of the amount disclosed on the schedule. In these instances, the IRS will not be reasonably apprised of the potential controversy by the amount disclosed; the taxpayer must use Form 8275 or Form 8275-R regarding that portion of the item.  Also, the combining of unlike items will not constitute adequate disclosure.

(4) Foreign tax items:

(a) International boycott transactions: Transactions disclosed on Form 5713, International Boycott Report. Schedule A, International Boycott Factor (Section 999(c)(1)); Schedule B, Specifically Attributable Taxes and Income (Section 999(c)(2)); and Schedule C, Tax Effect of the International Boycott Provisions, must be completed when required by their instructions.

(b) Treaty-based return position: Transactions and amounts under Sec. 6114 or 7701(b), as disclosed on Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b).

(5) Other: 

(a) Moving expenses: Complete Form 3903, Moving Expenses, and attach to the return.

(b) Employee business expenses: Complete Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses, and attach to the return. This section does not apply to club dues or to travel expenses for any nonemployee accompanying the taxpayer on the trip.

(c) Fuels credit: Complete Form 4136, Credit for Federal Tax Paid on Fuels, and attach to the return.

(d) Investment credit: Complete Form 3468, Investment Credit, and attach to the return.

The Service invites comments on Schedule M-3 issues (see Rev. Proc. 2004-73, Section 4.01(3)). In particular, it requests comments on whether (1) the adjustments to arrive at line 11, Part I of the schedule, net income (loss) per income statement of includible corporations, may provide adequate disclosure; and (2) the condition that the IRS be apprised of the nature of the potential controversy is necessary for Schedule M-3.

Rev. Proc. 2004-73, IRB 2004-51, 999

REFLECTIONS: Rev. Proc. 2004-73 applies to any return filed on 2004 tax forms for a tax year beginning in 2004, and to any return filed on 2004 tax forms in 2005 for short tax years beginning in 2005. Guidance for returns filed for 2003 is provided in Rev. Proc. 2003-77. Rev. Proc. 2004-73 is basically the same as Rev. Proc. 2003-77, except for requiring identification of items without a preprinted description, adding guidance on Schedule M-3 and aggregation of items under one description on Schedule M-1.