Tax shelter temp. regs.

• Author: Mendelson, Dan L.
• Position: Part 1

EXECUTIVE SUMMARY

* Temporary regulations modify the regulatory scheme established in February 2000 to identify potentially abusive tax shelters.

* The same reportable transactions trigger both tax return disclosure statements and the investor-list-maintenance requirements.

* Taxpayers may obtain an IRS ruling as to whether a transaction or group of transactions are reportable.

On Oct. 22, 2002, Treasury released temporary Regulations (1) on tax return disclosure statements and maintenance of investor lists for "reportable transactions" and "potentially abusive tax shelters." The temporary regulations are the fourth modification to the temporary tax shelter reporting regulations promulgated in February 2000. (2)

The February 2000 temporary regulations established three sets of rules, including (1) disclosure of tax avoidance transactions by corporate taxpayers, (3) (2) list maintenance of investors in potentially abusive tax shelters by promoters (organizers and sellers) (4) and (3) registration of confidential corporate tax shelters by promoters. (5) However, the asymmetrical nature of the rules caused confusion, because promoters of potentially abusive tax shelters might be required to maintain a list of participants in a transaction, even though return disclosure was not required of the corporate taxpayer. (6)

The IRS previously modified the temporary regulations on Aug. 16, 2000, (7) Aug. 2, 2001 (8) and June 14, 2002. (9) The June 2002 temporary regulations extended the Sec. 6011 disclosure requirements to individuals, partnerships, trusts and S corporations that participate, directly or indirectly, in listed transactions and repealed for all taxpayers the projected-tax-effect test for listed transactions.

In addition, the definition of "indirect participants" was extended to those who know or have reason to know that the tax benefits claimed from the taxpayer's transaction are derived from a reportable transaction. Most importantly, the June 2002 temporary regulations broadened the definition of "substantially similar" transactions to include transactions expected to obtain the same, or similar, types of tax benefits and are either factually similar or based on the same, or a similar, tax strategy. Finally, the time frame for providing return disclosure was clarified.

Based on the meager number of return disclosures, Treasury conceded that the existing regulatory scheme was not working as intended and proposed a major overhaul. A Sept. 16, 2002 IRS news release (10) indicated that 1,664 disclosure statements had been filed under an amnesty program offered to taxpayers for the voluntary disclosure of any tax shelter if filed by April 23, 2002.

New Regime

The new temporary regulation substantially replace the prior return disclosure and advisor list-maintenance rules for transactions entered into after 2002. They contain two key changes from the prior regime. First, the new temporary regulations trigger both tax return disclosure and list maintenance from the same event (i.e., engaging in a "reportable transaction"). Also, Temp. Regs. Sec. 301.6112-1T(c)(2) places the obligation to maintain lists of reportable transactions on so-called "material advisors."

The desired result of these changes is to promote a high degree of consistency between transactions disclosed in tax returns and those required to be maintained on potentially abusive tax shelter lists. Material advisors are obligated to maintain names of taxpayers entering into transactions. However, at times, the advisor will not be required to maintain a taxpayer's name on a list even though the taxpayer has disclosed the transaction due to the minimum-fee rules.

Proposed legislation would require material advisors to register reportable transactions (not just confidential corporate tax shelters) with the IRS; Treasury indicated that it will amend the temporary registration regulations when such legislation is enacted. (11)

In the interim, there is no consistency between registerable tax shelter transactions and reportable transactions for return disclosure and list-maintenance purposes. See Exhibit 1 on p. 88 for a "quick" reference guide identifying the similarities and differences among the registration, list-maintenance and disclosure regulations. The disclosure and list-maintenance columns are based on the October 2002 modifications; the registration column is based on the June 2002 modifications.

Reportable Transactions

Prior to the October 2002 temporary regulations, different definitions, but similar exceptions, applied to the three reporting requirements for taxpayers and promoters, resulting in significant uncertainty and complexity. (12) Temp. Regs. Sec. 1.6011-4T(b) now defines a transaction that must be disclosed and listed to include the following six categories of "reportable transactions":

* Listed transactions (transactions that have been specifically identified by the IRs as tax avoidance transactions and substantially similar transactions).

* Transactions marketed under "conditions of confidentiality."

* Transactions with contractual protection (e.g., an indemnity if the claimed tax benefits are not sustained or a fee contingent on the claimed tax benefits being sustained).

* Transactions generating a Sec. 165 tax loss exceeding specified amounts.

* Transactions resulting in a book-tax difference exceeding $10 million. * Transactions generating a tax credit exceeding $250,000 when the underlying asset is held for less than 45 days.

While three of the six categories described above contain dollar thresholds, there is no longer an across-the-board minimum tax benefit threshold that must be met before disclosure is required. In addition, the six categories are more objective than the prior regime, but broader in scope. The October 2002 temporary regulations treat all taxpayers (including individuals and S corporations) equally; the prior regime focused primarily on corporations, as to disclosure.

Other important distinctions from the prior rules include disclosure of listed transactions affecting estate, gift, employment, pension and exempt organization excise taxes, as well as Federal income tax. (13) In addition, certain U.S. shareholders of foreign corporations subject to certain income inclusion rules (e.g., subpart F) are required to disclose reportable transactions of such corporations. (14)

Listed Transactions

The IRS and Treasury were concerned that some taxpayers and their advisors have applied the "substantially similar" standard in a narrow manner to avoid disclosure. (15) Consistent with earlier modifications to the tax shelter regulations, Temp. Regs. Sec. 1.6011-4T(c) (4) defines "substantially similar" (to a listed transaction) to include any transaction (1) expected to obtain the same or similar types of tax consequences and (2) either factually similar or based on the same or a similar tax strategy. Treasury suggests that the term should be broadly construed in favor of disclosure.

AICPA comments on the June 14, 2002 tax shelter regulations recommended that the listed transactions be subject to a formal review process. (16) The temporary regulations, however, do not incorporate such a process. In view of the absence of criteria and standards for determining whether a transaction should be listed, a formal advance notice procedure that enables taxpayers and their advisors to submit comments on the fact...