Taxpayers that discover after filing their returns that they indirectly participated in a reportable transaction through a passthrough entity may be able to rely on Prop. Regs. Sec. 1.6011-4(e)(1) to avoid reportable transaction penalties. The preamble to the proposed regulations (REG-103038-05, 11/2/06) provided that this relief was effective immediately.
Reportable Transaction Basics
Currently, under Regs. Sec. 1.6011-4(b), there are five categories of reportable transactions: listed transactions, confidential transactions, transactions with contractual protection, Sec. 165 loss transactions and transactions with a brief asset-holding period. Taxpayers that have participated in one of these are required to disclose it on Form 8886, Reportable Transaction Disclosure Statement, attached to their Federal income tax return. The first time a taxpayer discloses the transaction, a copy of Form 8886 must also be sent to the Office of Tax Shelter Analysis (OTSA); see Regs. Sec. 1.6011-4(d).
For partnerships, S corporations and trusts, the entity and the interest holder must each separately determine whether the taxpayer has participated in a reportable transaction and, thus, whether the taxpayer is required to disclose it on Form 8886. Instructions for Schedule K-1 require passthrough entities to provide interest holders with information so that the latter can determine if they have a disclosure obligation (see, e.g., p. 13 of the Instructions to Form 1065, U.S. Return of Partnership Income, Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., under the heading "Code Q, Other Information"). Based on these rules, it is possible for a partner to have a disclosure obligation even though the partnership does not or, alternatively, for a partnership to have a disclosure obligation even though its partners do not.
Example: In 2007, Partnership X has a $10 million Sec. 165 loss that is not a Sec. 988 loss. Partners A (a corporation) and B (an individual) each have a 50% allocable share of the loss. Under the reportable transaction regulations, X has a disclosure obligation, because the loss exceeds the $2 million reporting threshold for Sec. 165 losses for partnerships under Regs. Sec. 1.6011-4(b)(5)(i)(C). In addition, B has a disclosure obligation, because his allocable share of the loss, $5 million, exceeds the $2 million reporting threshold for individuals under Regs. Sec. 1.6011-4(b)(5)(i)(C). However, A does not have a disclosure...