Procedure & Administration
Temp. Regs. Expand IRS Offset Authority
The IRS has issued tempo rary regulations under Sec. 6411 relating to the computation and allowance of tentative carryback adjustments (i.e., tentative refunds) (TD 9355). The temporary regulations also serve as the text for proposed regulations (REG-118886-06). In general, the temporary regulations provide that the IRS can credit or reduce a tentative refund by unassessed liabilities determined in a notice of deficiency or identified in a proof of claim in a bankruptcy proceeding. (See Temp. Regs. Secs. 1.6411-2T and 1.6411-3T.) These regulations effectively change an IRS position that has been in effect for 30 years. In connection with the temporary regulations, the Service has also issued three revenue rulings relating to this issue: two that provide examples of how the IRS’s crediting rights work and one that specifically revokes the 30-year-old position. (See Rev. Ruls. 2007-51, 2007-52, and 2007-53.)
Background
The general rules covering the IRS’s authority to refund or credit overpayments are found in Secs. 6402(a) and 6411(b). Under Sec. 6402(a), the Service may credit the amount of any overpayment, including interest, against any tax liability of the person who made the overpayment and refund the balance (subject to certain other nontax debts). Likewise, Regs. Sec. 301.6402-1 provides that the IRS may credit any overpayment of tax against an outstanding liability for any tax owed by the person with the overpayment.
Sec. 6411(a) permits a taxpayer to apply for a quick refund of taxes by carrying back a net operating loss (NOL), a net capital loss, or an unused business credit to a prior tax year for which taxes were paid. Corporations (other than S corporations) use Form 1139, Corporation Application for Tentative Refund, to apply for a quick refund. Form 1139 must be filed within 12 months after the end of the tax year in which the NOL, net capital loss, or unused credit arose. The corporation must file its in come tax return for the tax year no later than the date the Form 1139 is filed.
Sec. 6411(b) provides that within 90 days from the date that the Form 1139 is filed, the Service may make a limited examination of the application to discover omissions and computational errors and to determine the amount of the decrease in tax (refund). If there are no omissions or errors, the refund is then applied against certain items, including any tax or installment “then due” from the taxpayer. Any amount not so credited is refunded to the taxpayer.
Previous IRS Position
Since neither Sec. 6402(a) nor Sec. 6411(b) define “outstanding liability” or any tax “then due,” respectively, questions were sometimes raised, especially by agents during the examination pro cess, as to whether the IRS can credit an overpayment or tentative carryback adjustment against an unassessed liability. Notwithstanding these questions, until the temporary regulations and the related revenue rulings were issued, the IRS’s position on crediting a tentative refund against an unassessed liability was well settled. Specifically, in Rev. Rul. 78-369, the IRS held that an application for tentative refund from the carryback of an NOL timely filed on Form 1139 (or Form 1045, Application for Tentative Refund, for individuals) must be allowed provided the application contains no omissions or computational errors, even though, in the carryback year, a deficiency had been proposed. This taxpayer-friendly revenue ruling was sufficient to dissuade even the most aggressive revenue agent from pursuing the issue. See also General Counsel Memoranda 35225, 36521, and 38768 for consistent conclusions.
Temporary Regulations
The temporary regulations, which are effective for Forms 1139 submitted on or after August 27, 2007, provide that the IRS may credit or reduce the tentative refund by certain unassessed liabilities. Specifically, Temp. Regs. Sec. 301.6411-3T(d)(iii) provides that the tentative refund may be reduced by unassessed liabilities determined in a statutory notice of deficiency, un assessed liabilities identified in a proof of claim filed in a bankruptcy proceeding, or other unassessed liabilities in rare and unusual circumstances. The preamble to the temporary regulations notes that the IRS intends to adopt procedures re quiring IRS National Office review be fore a credit or reduction of a tentative refund by an unassessed liability that con stitutes a rare and unusual circumstance.
Therefore, under the temporary regulations, an unassessed liability determined in a statutory notice of deficiency or identified in a proof of claim effectively becomes a tax then due for purposes of Sec. 6411(b). This interpretation, however, appears to be inconsistent with Sec. 6213, which generally prohibits the IRS from assessing and collecting on a deficiency determined in a notice of deficiency (for a year not before the court) during the 90-day period the taxpayer has to file a petition in the Tax Court, or, if a petition has been filed, until the decision of the Tax Court becomes final.
Rev. Rul. 2007-53
The preamble to the regulations provides that the temporary regulations “clarify” the rules relating to tentative refunds being reduced by certain un assessed tax liabilities. However, in light of Rev. Rul. 78-369, these regulations appear to represent a change of position. Consistent with this being a change of position rather than a mere clarification, in conjunction with the temporary regulations, the IRS issued Rev. Rul. 2007-53, which revokes Rev. Rul. 78-369. The revenue ruling states that “the Internal Revenue Service has determined that Rev. Rul. 78-369 is inconsistent with the regulations under section 6411 of the Internal Revenue Code.”
Rev. Ruls. 2007-51 and 2007-52
Also in connection with the temporary regulations, the IRS issued Rev. Ruls. 2007-51 and 2007-52. Each of these revenue rulings provides examples detailing the crediting authority of the Service under Secs. 6402 and 6411 when there is an unassessed liability. Rev. Rul. 2007-51 covers unassessed liabilities determined in a notice of deficiency, and Rev. Rul. 2007-52 deals with unassessed liabilities identified in a bankruptcy proof of claim.
Rev. Rul. 2007-51 provides examples of how the Service will credit an overpayment against unassessed tax liabilities for which a notice of deficiency has been sent to the taxpayer. The ruling states that for purposes of the crediting provisions of Sec. 6402(a), a tax liability for a tax year arises no later than the date on which the Service sends a notice of deficiency to the taxpayer that identifies the nature and amount of the tax liability. Therefore, consistent with the temporary regulations, an unassessed liability determined in a statutory notice of deficiency effectively becomes a tax then due for purposes of Sec. 6411(b), and the Service can credit a carryback adjustment under Sec. 6411(b).
Rev. Rul. 2007-52 provides examples of how the Service will credit an overpayment against unassessed tax liabilities that are identified in a proof of claim filed in a bankruptcy case. This ruling states that under Sec. 6411(b), the IRS may credit a tax decrease resulting from a tentative carryback adjustment against a tax liability identified in a bankruptcy proof of claim. According to the ruling, a proof of claim filed by the Service in the bankruptcy case represents a specific administrative determination of the nature and amount of the tax debt. Therefore, in the bankruptcy context, the IRS maintains that it has the authority to make credits under Secs. 6402(a) and 6411(b) against income tax liabilities identified in a proof of claim in a bankruptcy case.
Observation
In reaching the above conclusions, both revenue rulings acknowledge that neither Sec. 6402 nor the regulations specify when any liability arises for purposes of determining when the IRS may credit an overpayment. Similarly, the revenue rulings provide that neither Sec. 6411(b) nor the regulations specify when a tax liability is then due for purposes of determining when the IRS can credit a carryback adjustment. How ever, both rulings summarily state:
Although sections 6402(a) and 6411(b) do not require a deficiency determination or assessment as a prerequisite to the Service crediting an overpayment or a carryback adjustment to a tax liability, the Service generally does not make such credits until the tax liability is determined with specificity.
Rev. Rul. 2007-51 then provides that when the Service issues a notice of deficiency, it has determined the tax liability with specificity. Likewise, Rev. Rul. 2007-52 provides that when a taxpayer is a debtor in bankruptcy, a proof of claim filed by the IRS represents a specific administrative determination of the claim’s nature and is entitled to a presumption of regularity.
The position articulated in the temporary regulations and associated revenue rulings with respect to the IRS’s ability to credit a tentative adjustment against an unassessed liability represents a significant departure from the IRS’s longstanding practice. Moreover, such conclusions may even be contrary to the Internal Revenue Code and the Bankruptcy Code. As such, it is possible that the IRS’s position could be challenged. Nevertheless, when advising clients about submitting claims or Forms 1139 (or Forms 1045 for individuals), it is now important to ascertain whether any unassessed liabilities exist that may reduce or eliminate a refund.
From Walter S. Goldberg, J.D., LL.M., Washington, DC
IRS Issues Reporting Requirement for Transactions of Interest
Transactions of interest are a category of reportable trans action described in the regulations under Sec. 6011 (TD 9350). A transaction of interest (TOI) is defined in the preamble to the regulations as a transaction that the IRS and Treasury believe has a potential for tax avoidance or evasion but for which there is insufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. The stated purpose underlying the creation of the TOI category is to enable the IRS to gather information about such transactions. The Service and Treasury will alert the public to their detailed concerns about particular TOIs by issuing notices, regulations, or other forms of published guidance.
On August 14, 2007, for the first time, the IRS identified two TOIs (Notices 2007-72 and 2007-73). Notice 2007-72 identifies transactions involving charitable contributions of a “successor member interest” in a limited liability company (LLC). Notice 2007-73 identifies transactions in which the grantor status of a trust is turned on and off (i.e., toggled) to avoid income tax.
The regulations pertaining to TOIs are effective August 3, 2007, and apply to transactions entered into on or after November 2, 2006.
Notice 2007-72: Contribution of Successor Member Interest
Notice 2007-72 identifies a type of transaction involving a contribution to a tax-exempt organization of a successor member interest in an LLC, the value of which is inflated to allow the taxpayer to claim a potentially excessive charitable contribution deduction for income tax purposes.
A Notice 2007-72 TOI arises when a taxpayer engages in a transaction that has the following general fact pattern:
- The taxpayer acquires, directly or in directly, a successor member interest in an LLC that directly or indirectly owns real property;
- The taxpayer transfers the successor member interest to a tax-exempt organization more than one year after the acquisition; and
- The taxpayer claims a charitable con tribution deduction that is significantly higher than the amount that the taxpayer paid to acquire the successor member interest.
In addition, some variations of this transaction may have the charity agreeing not to transfer the successor member interest for a specified period of time and/or that any sale of the successor member interest will be to a party designated by the taxpayer.
Notice 2007-73: Toggling Grantor Trust Transaction
Notice 2007-73 identifies a type of transaction involving a grantor trust status that is “toggled” to generate an ordinary loss or avoid capital gain for in come tax purposes. A Notice 2007-73 TOI arises when a taxpayer engages in a transaction that has the following general fact pattern:
- A taxpayer contributes options (which are expected to move inversely to each other) to a grantor trust;
- The taxpayer gives a short-term income interest in the trust to another person and retains the remainder (i.e., principal) interest;
- The taxpayer sells the remainder interest to an unrelated third party in which there is no gain recognized (at this point the trust is no longer a grantor trust because the grantor has no interest in, or power over, the trust);
- A delayed power to substitute assets by the taxpayer in the trust instrument again triggers the grantor status of the trust;
- The loss options in the trust are closed out; and
- The taxpayer claims a loss on the closed-out options due to the grantor status of the trust.
A second variation of this transaction involves contributing assets that have no gain position to the trust and, once the power to substitute assets has been triggered, substituting highly appreciated assets for the assets that have no gain position. In this variation, the taxpayer avoids capital gain on the sale of the highly appreciated assets. These transactions usually occur within a short period of time (typically within 30 days).
Effective Dates
The final regulations under Sec. 6011 require that taxpayers entering into TOIs on or after November 2, 2006, must attach a disclosure statement to the tax return for each tax year in which the taxpayer participates in the TOI (Regs. Sec. 1.6011-4(a)). Disclosure on Form 8886, Reportable Transaction Disclosure Statement, must be made on any tax return reporting tax benefits from transactions that are the same or substantially similar to the transactions described in Notice 2007-72, Notice 2007-73, and any future transactions identified as TOIs (Regs. Sec. 1.6011-4(d)). A copy of the disclosure statement must be sent to the Office of Tax Shelter Analysis (OTSA) at the same time any disclosure statement is first filed by the taxpayer with its tax return (Regs. Sec. 1.6011-4(e)(1)).
A special disclosure deadline applies when a transaction is identified as a TOI after the filing of a taxpayer’s tax return (including an amended return) reflecting tax benefits of the taxpayer’s participation in the transaction, but before the end of the statute of limitation for such tax return expires. In such cases, a Form 8886 disclosure must be filed with the OTSA within 90 days after the date on which the transaction became a TOI (Regs. Sec. 1.6011-4(e)(2)).
Example: T entered into a TOI described in Notice 2007-72 after November 2, 2006, and filed its tax return reporting tax benefits from the TOI before August 14, 2007 (the date on which the TOI was identified). Under the final regulations, T is required to file Form 8886 with OTSA within 90 days (i.e., by November 12, 2007) from the date on which the TOI was identified in Notice 2007-72.
There are no disclosure requirements related to TOIs that were entered into before November 2, 2006, because such transactions are not reportable transactions. Therefore, even if a tax payer reports tax benefits related to a TOI on its tax returns filed after November 2, 2006, disclosure is not required if the TOI was entered into before November 2, 2006.
Material Adviser Obligations
An adviser who makes a tax statement about an identified TOI entered into on or after the November 2, 2006, effective date, and who directly or indirectly derives gross income from that TOI in excess of thresholds defined in Regs. Sec. 301.6111-3(b)(3), has disclosure and list maintenance obligations under Secs. 6111 and 6112. Generally, TOI threshold amounts are $50,000 where substantially all of the tax benefits are provided to natural persons and $250,000 for all other entities. However, these amounts may be reduced in published guidance describing the transaction. Notices 2007-72 and 2007-73 do not reduce the standard threshold amounts.
The final regulations under Sec. 6111 provide that when published guidance identifies a TOI that previously was not a reportable transaction, any material advisers to the transaction will be treated as becoming material advisers on the date the transaction is identified as a TOI. Form 8918, Mate rial Advisor Disclosure Statement, must be filed with the OTSA by the last day of the month that follows the end of the calendar quarter in which an adviser became a material adviser with respect to the TOI or in which the circumstances necessitating an amended disclosure occur (Regs. Sec. 301.6111-3(e)). For example, if a practitioner were a material adviser with respect to either of the TOIs described above, the practitioner would have been required to report such status and all other information required on Form 8918 to the IRS on or before October 31, 2007.
Conclusion
Practitioners should closely follow developments in the reportable transactions area to effectively respond to the identification of new TOIs. The first two have been issued, and others can be ex pected from time to time as the Service feels is necessary. When the IRS identifies a TOI, practitioners should work with their clients in evaluating transactions that could be considered the same or substantially similar to the TOI.
It is important for practitioners to closely review the published guidance identifying a TOI because it may contain special disclosure rules for taxpayers and material advisers. In particular, the published guidance may modify the material adviser gross income threshold amounts and provide special taxpayer disclosure rules—especially for TOIs involving S corporations, trusts, trust beneficiaries, partnerships, or matters involving loss carrybacks to prior years. Because TOIs require disclosures from both taxpayers and material advisers, and failure to timely disclose a TOI may lead to the imposition of significant and nonwaivable penalties, it is critical that both practitioners and taxpayers recognize their obligations related to newly identified TOIs.
As a further note, practitioners should consider the collateral state-level impact of TOIs. With the increasing enactment of reportable transaction and material adviser statutes by states, the identification of a TOI (or other re portable transaction) or material adviser status may require state-level reporting obligations in addition to federal re porting requirements.
From James Emilian, CPA, Washington, DC, and Greg Jamouneau, J.D., Chicago, IL
