Reportable transactions - what tax advisers need to know.

• Author: Schaefer, Rene C.

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, masts or all other partnerships; or (2) $50,000 in a single tax year for individuals or masts 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...