Penalty for Failing to Disclose Reportable Transactions

Prior to the AJCA, taxpayers had to disclose on their returns certain information about reportable transactions (including listed transactions) in which they participated. They were not, however, subject to a specific penalty for failing to do so. Rather, the failure to disclose such a transaction jeopardized the taxpayers ability to claim that any income tax understatement resulting from the undisclosed transaction was due to reasonable cause, and that the taxpayer had acted in good faith.

New Law

AJCA Section 811, adding Sec. 6707A, creates a new penalty for any taxpayer who fails to include with any return or statement any required information on a reportable transaction (as determined by Treasury under the Sec. 6011 regulations to be a transaction with tax avoidance or evasion potential). The penalty, which applies regardless of whether the transaction ultimately results in a tax understatement and in addition to any accuracy-related penalty, is $10,000 for a natural person and $50,000 for all others. For a listed transaction, the penalty is $100,000 for a natural person and $200,000 for all others.

Authority to rescind: The IRS will rescind any portion of the penalty if:

1. The violation does not involve a listed transaction; and

2. Rescinding would promote compliance and effective tax administration.

When deciding whether to exercise that authority, however, the Service will consider whether:

1. The taxpayer has a history of compliance;

2. The violation is due to an unintentional mistake of fact; and

3. The penalty would be against equity and good conscience.

The AJCA provides that, notwithstanding any other provision, any IRS determination on rescinding the penalty may not be reviewed in any judicial proceeding.

Nontax reporting: Taxpayers re-quired to report periodically under Section 13 or 15(d) of the Securities and Exchange Act of 1934 must disclose in their reports the payment of:

1. A penalty imposed for failing to disclose a listed transaction;

2. An understatement penalty resulting from a failure to disclose a listed or reportable transaction; and

3. A gross valuation misstatement penalty under Sec. 6662(h) that resulted from failing to disclose a listed or reportable transaction.

Disclosure does not depend on the penaltys materiality to the report and will occur after:

1 The taxpayer has exhausted administrative and judicial remedies; or

2. Payment (if earlier).

A failure to disclose the penalty in the report is treated as not disclosing a listed transaction, which will subject the registrant to a $200,000 penalty.

Effective Date

The provision is effective for returns and statements due after Oct. 22, 2004.

Implications

Experience demonstrates that disclosures on Form 8886, Reportable Transaction Disclosure Statement, are required of many types of transactions, even ordinary business transactions that taxpayers may not otherwise understand to be tax-shelter transactions. Thus, the severity of the new legislations penalty provisions, from a financial and reputational perspective, combined with the onerous task of identifying each and every reportable transaction, should make complying with Sec. 6011 a high priority for all taxpayers. Taxpayers, particularly large corporate taxpayers, need to develop internal processes and controls to facilitate compliance with these rules.

From Paul Manning, Washington, DC