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Reportable Transactions—What Tax Advisers Need To Know
Co-Editors:
T. Chris Muirhead, CPA
Author: Editor’s note: Mr. Holub is the former chair of the AICPA Tax Division’s Tax Practice Management Committee. Mr. Muirhead is the Chair of the AICPA Tax Division’s Tax Practice Improvement Committee. Ms. Schaefer is a member of that Committee. For more information about this column, contact Mr. Holub at (813) 222–8555 or stevenh@apcpa.com, or Ms. Schaefer at (262) 923–5161 or schaeferr@sva.com. After the American Jobs Creation Act of 2004 (AJCA), reportable transactions have new importance to tax advisers and their clients, causing them extra concern. The risks for not disclosing such transactions have become significant. Although it was once felt that disclosure guaranteed an IRS audit, nondisclosure under the new rules creates even more problems. Most tax advisers recommended disclosure only if they had knowledge that a client participated in a tax shelter. The only nondisclosure penalty was a substantial underpayment penalty. However, under the AJCA, new disclosure requirements for returns and statements due after Oct. 22, 2004 make noncompliance very costly. Tax advisers, as return preparers, could be liable for penalties, because they are viewed as the experts, whether or not they know about a reportable transaction. As such, clients have to be informed of additional requirements for preparing and filing returns, and tax advisers need to be able to identify reportable transactions. Reportable Transactions According to Regs. Sec. 1.6011-4(b), there are six categories of reportable transactions (unless otherwise noted, the rules generally apply to transactions entered into after Feb. 27, 2003): 1. Confidential transaction: A transaction in which (1) an adviser places a limit on disclosure by the taxpayer of the transaction’s tax treatment or structure, to protect the confidentiality of tax strategies; and (2) the adviser has been paid a minimum fee of $50,000 by noncorporate taxpayers, or $250,000 by corporate taxpayers (effective for transactions entered into after Dec. 28, 2003). 2. Contractual protection: A transaction for which a taxpayer or related party has the right to a refund of all or part of the transaction fees paid, but only if (1) all or part of the intended tax consequences are not sustained under audit or (2) the fees were contingent on realizing tax benefits. The fees had to be paid to a person who made an oral or written statement as to the transaction’s potential tax consequences. Rev. Proc. 2004-65 lists exceptions for fees based on the Sec. 51 work opportunity credit, the Sec. 51A welfare-to-work credit, the Sec. 45A(a) Indian employment credit and state tax liabilities. 3. Loss transactions: Any transaction that results in a loss of (1) at least $10 million in a single tax year or $20 million in any combination of tax years for corporations or partnerships with only corporate partners, or $2 million/$4 million, respectively, for individuals, S corporations, trusts or all other partnerships; or (2) $50,000 in a single tax year for individuals or trusts stemming from a foreign currency transaction under Sec. 988. There are exceptions in Rev. Proc. 2004-66 for assets with qualifying basis, casualty/involuntary conversion losses, certain mark-to-market and hedging losses, factoring transactions under Sec. 1221 and basis determinations under Sec. 338(b), and other types of transactions. 4. Significant book-tax differences: This applies to any transaction in which the amount for tax purposes of any item differs by more than $10 million gross from the amount for book purposes. This applies to Securities and Exchange Commission reporting companies and entities with more than $250 million in gross assets. There are exceptions in Rev. Proc. 2004-67 for any item for which the (1) book loss/expense is reported before or without a tax loss/deduction or (2) tax gain/income is reported before or without book gain/income. There are also 33 other specific exceptions. If a company required to file Schedule M-3, Net Income (Loss) Reconciliation For Corporations With Total Assets of $10 Million or More, files it with a timely filed original return, it would be deemed under Rev. Proc. 2004-45 to have satisfied the disclosure requirements for book/tax purposes. 5. Brief holding period: A transaction for which a taxpayer claims a tax credit that exceeds $250,000 (including foreign tax credits (FTCs) and credits passed through to the taxpayer), if the taxpayer held the underlying asset giving rise to the credit for less than 46 days. There are exceptions in Rev. Proc. 2004-68 for (1) certain sales in the ordinary course of business involving FTCs; (2) brief holding periods due to certain hedges or guarantees; (3) transactions with debt instruments with terms of 45 days or less, if the holding period equals the term; and (4) transactions with FTCs from withholding taxes on nondividend income or gain not disallowed under Sec. 901(l). 6. Listed transactions: These are specific transactions as shown in the exhibit (as of July 21, 2005). The IRS can modify listed transactions at any time; see www.irs.gov/businesses/corporations/article/0,,id=120633,00.html for updates. Penalties Under Sec. 6707A, taxpayers who fail to disclose reportable transactions can be subject to penalties for nonlisted transactions of $10,000 for natural persons and $50,000 for all others (per occurrence), and for listed transactions of $100,000 for natural persons and $200,000 for all others (per occurrence). These penalties are effective whether or not a client is aware of having entered into in a reportable transaction or participated in one. According to Sec. 6707A(d)(1), the IRS may rescind all or a portion of the penalty if a reportable transaction is not a listed transaction and rescinding the penalty would promote compliance and effective tax administration. There is no authority to rescind penalties for listed transactions. Also, Sec. 6707(d)(2) provides that the penalties cannot be reviewed by any court, although a taxpayer could contest whether a transaction was reportable and, based on that determination, whether a penalty should have been imposed. Besides
the penalties noted above, the AJCA also added a new accuracy-related
penalty under Sec. 6662A. A 20% understatement penalty may be levied if
a reportable transaction was adequately disclosed, and a 30%
understatement penalty if it was not disclosed. However, a reasonable
cause exception, under which an understatement penalty will not apply,
may be available under Sec. 6664(d) if (1) the transaction was
adequately disclosed, (2) substantial authority exists and (3) the
taxpayer reasonably believed that the treatment was more likely than not
the proper treatment; see Sec. 6664. Under Sec. 6664 Under the AJCA, there is an extended statute of limitations for reportable transactions if a taxpayer fails to submit a required disclosure; see Rev. Proc. 2005-26. The time for the assessment of tax on the reportable transaction will not expire before one year after the earlier of the date (1) on which the required information is submitted to the IRS or (2) the material advisor meets the list-maintenance requirements for the undisclosed reportable transaction in response to an IRS request. Material Advisors Under Sec. 6111(b)(1), a material advisor is any person who provides any material aid, assistance or advice related to organizing, managing, promoting, selling, implementing, insuring or carrying out any reportable transaction, and who directly or indirectly derives income in excess of $50,000 for such advice or assistance, when substantially all the tax benefits are provided to natural persons ($10,000 in the case of listed transactions), and $250,000 in any other case ($25,000 in the case of listed transactions). Material advisors must prepare and maintain a list of persons to whom they provide such advice or assistance, furnish such list to the IRS on request, and file Form 8264, Application for Registration of a Tax Shelter. Form 8886 If a transaction has to be disclosed, Form 8886, Reportable Transaction Disclosure Statement, must be completed and attached to an original or amended return. The form must also be filed with the IRS Office of Tax Shelter Analysis. If taxpayers are unsure whether they participated in a reportable transaction, they may want to consider filing Form 8886 to avoid penalties. Conclusion Today, the IRS is investigating tax shelters on a regular basis. It continuously adds to the reportable transaction list and has been increasing penalties. There is no indication that it intends to let up soon. As a result, tax advisers will need to work more closely with their clients to determine whether they have reportable transactions.
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