Penalty regulations address new reasonable basis disclosure standard.

• Author: Kedda, Lisa B.

Under pre-Revenue Reconciliation Act of 1993 (RRA) law, disclosure of a return position was considered adequate for purposes of avoiding (1) the negligence or disregard of rules or regulations component and (2) the substantial understatement of income tax component of the Sec. 6662 accuracy-related penalty, if the return position was not frivolous (i.e., not patently improper) and the position was disclosed in the manner provided by the Sec. 6662 regulations (e.g., disclosed on a Form 8275, Disclosure Statement); see Regs. Secs. 1.6662-3(c) and 1.6662-4(e).

The RRA raised the disclosure standard for taxpayers from not frivolous to reasonable basis. In the case of the substantial understatement of income tax component of the Sec. 6662 penalty, the disclosure standard was raised by Sec. 6662(d)(2)(B)(ii). In the case of the negligence or disregard of rules or regulations component of the Sec. 6662 penalty, the legislative history to the RRA states that the disclosure standard is similarly raised from nonfrivolous to reasonable basis; see H. Rep. No. 213, 103d Cong., 1st Sess. 669 (1993) (hereinafter, the Conference Report). Presumably, the disclosure standard for the negligence or disregard component was not raised by statute because there was no prior statutory adequate disclosure exception for the negligence or disregard component.

To provide guidance on the new reasonable basis disclosure standard, the IRS recently issued temporary (and proposed) regulations that address (1) the effect of the new reasonable basis disclosure standard on the negligence component of the Sec. 6662 penalty; (2) the definition of the reasonable basis standard; and (3) the effective dates of the RRA changes.

Effect of the new reasonable basis disclosure standard on negligence

Temp. Regs. Sec. 1.6662-7T(b) states that the penalty for negligence may no longer be avoided by disclosure. This follows from the fact that, by definition, a position that has a reasonable basis is not a negligent position; see Regs. Sec. 1.6662-3(b). Therefore, with the new reasonable basis disclosure standard, the adequate disclosure exception is no longer applicable to negligence (since a position that has a reasonable basis does not need to be disclosed). The adequate disclosure exception, however, continues to apply to the disregard of rules or regulations component of the Sec. 6662 penalty.

Definition of the reasonable basis standard

Prior to amendment by the temporary regulations...