IRS releases 2005 guidelines for "adequate disclosure".

• Author: O'Driscoll, David

In general, Rev. Proc. 200575 provides guidance in determining when disclosure is adequate for purposes of reducing a tax understatement under Secs. 6662(d)(2) and 6694(a)(3). It does not apply to any other penalty provisions, such as the disregard provision, which are subject to an adequate disclosure exception. Taxpayers must furnish all required information in accordance with the applicable forms and instructions, and the amounts entered on the forms must be verifiable.

Law

If Sec. 6662 applies to any portion of a tax underpayment required to be shown on a return, 20% of the portion of the underpayment to which the section applies is added to the tax. The penalty rate is 40% for certain gross valuation misstatements. Under Sec. 6662(b)(2), Sec. 6662 applies to the portion of an underpayment attributable to a substantial income tax understatement.

Under Sec. 6662(d)(1), an income tax understatement is substantial if it exceeds the greater of 10% of the tax required to be shown on the return for the tax year, or $5,000. Under Sec. 6662(d)(1)(B), a corporation's (other than an S corporation or a personal holding company) understatement is substantial if the understatement exceeds the lesser of 10% of the tax required to be shown on the return (or $10,000, if greater) or $10 million.

Sec. 6662(d)(2) defines an understatement as the excess of the tax required to be shown on the return for the tax year, over the tax shown on the return, reduced by any rebate (within the meaning of Sec. 621l(b)(2)).

For an item not attributable to a tax shelter, Sec. 6662(d) (2) (B) (ii) provides that the understatement is reduced by the portion attributable to any item if the relevant facts affecting the item's tax treatment are adequately disclosed on the return or on a statement attached to the return, and a reasonable basis exists for the item's tax treatment.

Sec. 6694 imposes a $250 penalty on a return preparer for filing a return or refund claim that results in an understatement of liability due to a position for which the preparer knew, or should have known, that there was not a realistic possibility of being sustained on the merits, and did not disclose the position in accordance with Sec. 6662(d)(2) (B) (ii).

Fiscal-and short-tax year returns: In general, Rev. Proc. 2005-75 could apply to a return for a fiscal tax year that begins in 2005 and ends in 2006. It could also apply to a short-year return for a period beginning in 2006 when the return is to be filed before the 2006 forms are available. (Individuals are generally not in this position. For example, a decedent's final return for a fractional part of a year is...