Tax shelter final regs.

• Author: Mendelson, Dan L.

Treasury and the IRS issued tax shelter final regulations on taxpayer disclosure and material advisor list maintenance for reportable transactions. This article focuses on certain differences between the final and temporary regulations and significant issues the former present.

On Feb. 28, 2003, Treasury and the IRS issued tax shelter final regulations (1) on the disclosure and list maintenance of reportable transactions. Although the final regulations addressed many of the shortcomings of the October 2002 temporary regulations (2) and received generally positive reviews, difficult interpretive and administrative issues remain for taxpayers and their advisors.

A two-part article in the February and March 2003 issues (3) summarized the history of Treasury's efforts to curb the proliferation of corporate tax shelters and analyzed the regime established by the temporary regulations. This follow-up article focuses on certain remaining issues taxpayers and their advisors may face when attempting to comply with the final regulations.

Revised Effective Date

The temporary regulations are effective for transactions entered into after 2002 and before Feb. 28, 2003; the final regulations are generally effective for transactions entered into after Feb. 27, 2003. However, under Regs. Sec. 1.6011-4(h), taxpayers may elect to apply the final regulations to all transactions entered into after 2002. Because the final regulations are generally narrower in scope of reporting than the temporary regulations, there is no benefit in applying the temporary regulations (rather than the final regulations) for transactions entered into after 2002 and before Feb. 28, 2003.

How does a taxpayer determine when a transaction is "entered into" for purposes of applying the correct set of regulations? Many situations could arise in which the initial steps of a transaction commence before 2003, but the final steps occur after 2002. Which regulations should the taxpayer apply in such situations? The answer is significant, because many transactions would not be reportable under the prior rules, but would be under the final regulations.

To rely solely on the step-transaction doctrine to determine which set of regulations to apply would be risky. Rather, taxpayers should evaluate the timing and significance of each transactional step and then ascertain the transactions reportability under the regulations in effect when the first "substantive" steps occur. In any event, both the prior and final regulations trigger disclosure in the first affected tax year.

Participation

The final regulations are helpful, because they provide that a taxpayer must disclose a transaction when the taxpayer has "participated" in a reportable transaction. Regs. Sec. 1.6011-4(c)(3) further establishes when a taxpayer has participated in each of the six categories of reportable transactions. (4) Like earlier regulations, there must be Federal tax benefits from the transaction. (5) Thus, if the initial steps do not affect the taxpayer's Federal tax liability, it is likely that the initial tax year is not the year of disclosure. The practical effect of this uncertainty, however, may be that conservative taxpayers will evaluate a transaction under the old regime when the first substantive steps occur prior to 2003 (and disclose if warranted), then evaluate the same transaction again under the new regime when substantive steps occur after 2002 (and possibly disclose a second time), to avoid the harsh proposed penalty regime. Exhibit 1 on p. 340 presents a quick reference guide highlighting the similarities and differences between the disclosure, list maintenance and registration requirements under the current regulations. Exhibit 2 on p. 342 is a decision tree for determining whether a transaction should be disclosed.

Exhibit 1: Final tax shelter regulations quick reference guide Disclosure Governs Taxpayer (TP) Code Sec. Sec. 6011 Required TP files disclosure statement with return for each action year TP "participates" in a reportable transaction (copy to Office of Tax Shelter Analysis (OTSA) for first year). Retain related documents until expiration of statute on final tax-year disclosure was required. Type "Reportable transactions" Definition After 2002, a transaction described in any of the six categories listed below. Transitional election: For transactions entered into between Jan. 1, 2003 and Feb. 28, 2003, TPs can elect to apply the final regulations in place of the October 2002 temporary regulations. As the final regulations are generally narrower in scope, TPs may benefit from the election. Participation: Participation is defined for each of the six categories. Generally, a TP has participated in a reportable transaction if the TP's return reflects tax consequences or a tax strategy from the transaction. Participation is expanded for listed transactions to include situations in which a TP knows or has reason to know that tax benefits are derived directly or indirectly from a listed transaction. Transaction: Includes all of the factual elements rele- vant to the expected tax treatment of any investment, entity, plan or arrangement, and includes any series of steps carried out as part of a plan. Category 1. Same or substantially similar to "listed transactions" 2. Confidential transactions 3. Transactions with contractual protection 4. Sec. 165 loss transactions * 5. Transactions with significant (exceeding $10 million) book-tax differences ** 6. Transactions involving a brief asset holding period *** Exceptions Category 1: No exceptions Category 2: * Securities law * Mergers and acquisitions Category 3: * Termination of transaction * Previously reported transactions Category 4: * Assets with a qualifying basis * 8 other exceptions listed Category 5: * 30 exceptions listed Category 6: No exceptions General: Published guidance or ruling exceptions. Penalties Sec. 6662: Accuracy penalty Sec. 6663: Fraud penalty Sec. 6664(c): Reasonable cause * Significant proposed penalties for nondisclosure List Maintenance Governs Material Advisor (MA) Code Sec. Sec. 6112 Required MA maintains lists of investors acquiring interests action and retains lists and related documents for seven years following the earlier of the date MA last made a tax statement, or the date the transaction was entered into, if known. Type "Potentially abusive tax shelters" Definition After Feb. 27, 2003, a transaction that: * Is a Sec...