A. Reportable Transactions – Generally

The reportable transactions rules were drafted in an attempt to identify certain transactions that result in a tax benefit and are viewed by the government as abusive or have a high potential for abuse. Reportable transactions are defined by Treasury Regulation Section 1.6011-4. Often these transactions are entirely legitimate; however, the IRS requires that they be disclosed to the government.

The fact that a transaction is a reportable transaction is not supposed to effect the actual legal determination of whether the taxpayer’s corresponding tax treatment of the transaction is correct. Treas. Reg. § 1.6011-4 dictates that taxpayers that have participated in a reportable transaction are required to complete and file a disclosure statement with the associated tax return for every year the taxpayer continues to participate in a reportable transaction. A copy of the disclosure statement is required to be sent to the Office of Tax Shelter Analysis simultaneously with the filing of the disclosure within a tax return.

B. Reportable Transactions – Defined

Reportable transactions are transactions that:

  1. Are the same or substantially similar to transactions identified as tax avoidance transactions and periodically published by the IRS as “listed transactions.”
  2. Transactions that are offered to a taxpayer under conditions of confidentiality and for which the taxpayer has paid an advisor a minimum fee.
  3. A transaction that contains a contractual protection entitling the taxpayer to a full or partial refund of fees if all or part of the projected tax consequences flowing from the transaction are not sustained if challenged.
  4. Loss transactions resulting in the taxpayer claiming a loss under § 165 (Wagering, theft, capital and disaster losses) of $10 million or greater in any single taxable year or $20 million in total in any combination of taxable years for corporations.
  5. Transactions that are the same as or substantially similar to one of the types of transactions that the IRS has identified and labeled a “transaction of interest.”

For more, visit the IRS’s website here: http://www.irs.gov/instructions/i8886/ch01.html

C. Which transactions is the IRS most interested in?

A transaction of interest is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by a notice, regulation, or other form of published guidance as a transaction of interest. It is, moreover, a transaction that the IRS and Treasury Department believe has a potential for tax avoidance or evasion, but for which there is not enough information to determine if the transaction should be identified as a tax avoidance transaction. The requirement to disclose transactions of interest applies to transactions of interest entered into after November 1, 2006. For existing guidance, see Notice 2009-55, 2009-31 I.R.B. 170, available at www.irs.gov/pub/irs-irbs/irb09-31.pdf. The IRS may issue a new, or update the existing, notice, regulation, or other form of guidance that identifies a transaction as a transaction of interest.

D. Can I be subject to penalties if I fail to report my “reportable transaction” to the government? Can my tax advisor also be subject to penalties?

The short answer to these questions is “Yes.” We discuss the nuances of this answer below.

i. Civil Penalties—Generally

The Code provides for several civil penalty regimes that were implemented in an attempt to generate accurate reporting of transactions by taxpayers and practitioners. Under section 6662(a), a 20% penalty is imposed on any portion of an underpayment that is attributable to negligence surrounding the application of codified rules or regulations. It also applies to substantial understatements of income tax, or a substantial valuation overstatement. This penalty is increased to 40% where a gross valuation misstatement occurs and is calculated on 40% of the valuation understatement. The 40% penalty also applies to undisclosed transaction deemed to lack economic substance and to undisclosed foreign financial asset understatements.

ii. Civil Penalties Related to Reportable Transactions (and Tax Shelters)

There is a penalty regime surrounding “reportable transaction understatements” that increase when the underreporting is coupled with non-disclosure and where fraud is deemed to have occurred. Civil penalties can be levied against taxpayers that participate in reportable transactions or abusive tax shelters, and thus understate their tax liability. The penalty for failure to disclose a reportable transaction is $10,000. If the shelter is a listed transaction, the penalty is $200,000 ($100,000 for individuals).

iii. Civil Penalties Applicable to Promoters and Material Advisors

Material advisors can be penalized for their failure to satisfy disclosure requirements reportable on Form 8918, “Material Advisor Disclosure Statement,” where they are deemed to have aided, assisted or advised a taxpayer in connection with a reportable or listed transaction.   If a form 8918 is required to be filed and is not, the penalty is $50,000 for reportable transactions other than listed transactions. If the transaction is a listed transaction, the penalty skyrockets to the greater of $200,000 or 50% of the gross income derived from providing aid, assistance, or advice about the listed transaction. If the failure is intentional the 50% cap increases to 75%. The IRS ordinarily seeks an injunction against the promoter or advisor were additional failures to file the information returns occur after the first Material Advisor Penalty is levied.

iv. What are these “investor lists” that my tax advisor is required to maintain?

The Treasury regulations require that certain listed transactions (and tax shelters) be registered.
Whenever a listed transaction (or a tax shelter) is involved, the Treasury regulations require that the tax advisor who promotes or sells them maintain a list its investors. In turn, the investors in certain shelters and transactions are required to disclose their participation on their tax returns.

Treasury Decision 8875 (http://www.irs.gov/pub/irs-utl/td_8875.pdf) discusses the items that this “list” must include. Among its contents it must include the following:

  1. A detailed description of the tax shelter that describes both the structure of the tax shelter and the intended tax benefits for participants in the tax shelter;
  2. The amount of money invested or to be in- vested by each person who is required to be included on the list;
  3. A summary or schedule of the tax benefits that each such person is intended or expected to derive from participation in the tax shelter, if known by the organizer or seller;
  4. Copies of any additional written materials, including tax analyses and opinions, relating to the tax shelter that have been given to any potential participant in the tax shelter or to any representatives, tax advisors, or agents of potential participants by the organizer or seller or by any other person who has participated in the offering of the tax shelter (excluding any written materials that the organizer or seller has never possessed).

v. May penalties apply if my tax advisor fails to maintain such a list?

Again, the answer is “Yes.” A penalty is imposed on material advisors whom are required to maintain investor lists and fail to keep or make the list available within 20 days after a written request from the IRS under Code Sec. 6708 in the amount of $10,000 for each day of the continued failure that persists after the 20 day notice period. The penalty continues to apply until a “complete” list is supplied. An itemized statement of information including a description of the transaction, and copies of certain documents must also be included with the IRS request.

vi. What if the information contained in my advisor’s list is incorrect?

A penalty is imposed for false statements related to the tax effect of a listed transaction. Any promoter who makes a false statement about the tax benefits of a reportable transaction knowing the statement is false or fraudulent is subject to a penalty of 50 percent of the gross income derived from promoting the activity.