IRS Releases 2002 Guidelines for “Adequate Disclosure”

If Sec. 6662 applies to any portion of an underpayment of tax required to be shown on a return, an amount equal to 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 amount of the understatement exceeds the greater of 10% of the amount of tax required to be shown on the return for the tax year or $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal holding company). Sec. 6662(d)(2) defines an understatement as the excess of the amount of tax required to be shown on the return for the tax year, over the amount of 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 amount of the understatement is reduced by the portion of the understatement attributable to any item with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed on the return or on a statement attached to the return, and there is a reasonable basis for the tax treatment of such item by the taxpayer.

In general, this revenue procedure provides guidance in determining when disclosure is adequate for purposes of Sec. 6662(d). 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.

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 that 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.

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

(a) Medical and dental expenses: Complete lines 1 through 4, supplying all required information.

(b) Taxes: Complete lines 5 through 9, supplying all required information. Line 8 must list each type of tax and the amount paid.

(c) Interest expense: Complete lines 10 through 14, supplying all required information. This section does not apply to (1) amounts disallowed under Sec. 163(d) unless Form 4952, Investment Interest Expense Deduction, is completed or (2) amounts disallowed under Sec. 265.

(d) Contributions: Complete lines 15 through 18, 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) Form 1120, Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, provided:

(a) The amount of the deviation from the financial books and records is not the result of a computation that includes the netting of items; and

(b) The information provided reasonably may be expected to apprise the Service of the nature of the potential controversy concerning the tax treatment of the item.

(4) Foreign tax items:

(a) International boycott transactions: Transactions disclosed on Form 5713, International Boycott Report.

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

(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.

Rev. Proc. 2002-66, IRB 2002-42

REFLECTIONS: Rev. Proc. 2002-66 applies to any return filed on 2002 tax forms for a tax year beginning in 2002, and to any return filed on 2002 tax forms in 2003 for short tax years beginning in 2003.