To Disclose Or Not To Disclose: Tax Shelters, Penalties, And Circular 230 In 2013

Linda Z. Swartz and Jean Marie Bertrand for Cadwalader, Wickersham & Taft LLP write: 

I. TAX SHELTER REGULATIONS  (To Read this entire 126 Page Document Click Here)

A. Overview

• Disclosure requirements for participants in "reportable transactions."
• List-maintenance requirements for "material advisors" with respect to reportable transactions.
• Disclosure requirements for "material advisors" with respect to reportable transactions.¹

II. TAX SHELTER DISCLOSURE REQUIREMENTS FOR PARTICIPANTS

A. Overview

• Categories of Reportable Transactions²
• Listed Transactions
  • Confidential Transactions
  • Loss Transactions
  • Contractual Protection Transactions
  • Transactions of Interest entered into on or after November 2, 2006
  • Patented Transactions would constitute a new category of reportable transaction under proposed regulations.³
• Participant Reporting Obligations
  • Every taxpayer "participating" in a reportable transaction that is required to file a U.S. tax return must:⁴
    • Mail IRS Form 8886 to the IRS Office of Tax Shelter Analysis for the first year the taxpayer participates in the transaction,
    • Attach IRS Form 8886 to its tax return (and any amended return) for each year in which the taxpayer participates in the transaction,⁵ and
    • Retain a copy of all documents and other records related to the reportable transaction that are material to an understanding of the tax treatment and tax structure of the transaction until the statute of limitations runs.⁶ However, taxpayers are not required to retain non-substantive emails and other documents that are not material to the tax treatment or tax structure of the transaction. Taxpayers are also not required to retain earlier drafts of a document if they retain a copy of the final document (or, absent a final document, the most recent draft of the document), and such final document (or most recent draft) contains all the information found in earlier drafts that is material to an understanding of the purported tax treatment or tax structure of the transaction.⁷
  • A taxpayer's failure to properly disclose a reportable transaction is a strong indication that the taxpayer did not act in good faith with respect to the transaction for purposes of the general reasonable cause and good faith exception to the accuracy related penalty.⁸ Moreover, a taxpayer that has not adequately disclosed a reportable transaction in accordance with the tax shelter regulations may not rely on the adequate disclosure exception to the accuracy related penalty for disregard of rules and regulations.⁹ Finally, the regulations deny the "realistic possibility" defense for a taxpayer that disregards a revenue ruling or notice with respect to a reportable transaction.¹⁰
  • If a taxpayer requests a ruling on the merits of a specific transaction on or before the date disclosure would otherwise be required, and receives a favorable ruling as to the transaction, the disclosure rules will be satisfied if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.¹¹
  • If a taxpayer requests a ruling as to whether a specific transaction is a reportable transaction on or before the date that disclosure would otherwise be required, the IRS commissioner in his discretion may determine that the request satisfies the disclosure rules if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.¹²
    • However, the taxpayer's potential disclosure obligation is not suspended while the ruling request is pending.¹³
  • A protective disclosure filed with respect to a potentially reportable transaction that complies with all disclosure requirements would satisfy a taxpayer's potential obligation to disclose the transaction.¹⁴
• In the case of a taxpayer who is a partner in a partnership, a shareholder in an S corporation, or a beneficiary of a trust, the disclosure statement must be attached to the entity's return for each taxable year in which the entity participates in a reportable transaction.¹⁵
  • If a taxpayer receives a timely Schedule K-1 less than 10 calendar days before the due date of the taxpayer's return (including extensions), the taxpayer must file the disclosure statement with the OTSA within 60 calendar days after the due date of the taxpayer's return (including extensions).¹⁶
• If a transaction becomes a listed transaction (discussed in Section II.B., below) or a transaction of interest (discussed in Section II.F., below) after the filing of a taxpayer's return (including an amended return), but before the end of the period of limitations for the taxpayer's final return reflecting the listed transaction, the taxpayer must file a disclosure statement with the OTSA within 90 calendar days after the date on which the transaction became a listed transaction or transaction of interest, whether or not the taxpayer participated in the transaction in that subsequent year.¹⁷
• If a transaction becomes a loss transaction (discussed in Section II.D., below) because the losses equal or exceed the threshold amounts, a disclosure statement must be filed as an attachment to the taxpayer's tax return for the first taxable year in which the threshold amount is reached and to any subsequent tax returns that reflect any amount of loss from the transaction.¹⁸

•  (To Read this entire 126 Page Document Click Here)