IRS treats protective disclosures inconsistently.

• Author: Simmens, Todd

In shaping the reportable transaction disclosure rules, Treasury provided a way for taxpayers who are uncertain about whether to report a particular transaction to file a "protective" disclosure. In this way (or so it seems), taxpayers can lodge their uncertainty on Form 8886, Reportable Transaction Disclosure Statement. Regs. Sec. 1.6011-4(f)(2) expressly provides:

Protective disclosures. If a taxpayer is uncertain whether a transaction must be disclosed under this section, the taxpayer may disclose the transaction in accordance with the requirements of this section, and indicate on the disclosure statement that the taxpayer is uncertain whether the transaction is required to be disclosed under this section and that the disclosure statement is being filed on a protective basis.

Until December 2005, taxpayers used to indicate in writing at the top of Form 8886 that they were filing a protective disclosure. Now they check a box that was added to the form. As a matter of tax administration, the new procedure assists the IRS in easily identifying protective disclosures, particularly if the underlying tax return is e-filed. Yet, even when a taxpayer identifies a disclosure as protective, what is the practical effect of a protective filing? Are these disclosures treated any differently from nonprotective disclosures?

Revised Form 8886

In December 2005, the IRS revised Form 8886 and its instructions. It now asks taxpayers for more detailed information than it had apparently been receiving with prior versions of the form. Perhaps the most significant change is a prohibition banning taxpayers from stating on Form 8886 that further information will be "available upon request." Rather, taxpayers must now provide all required information with the original form. The instructions to the new form expressly specify that stating "available upon request" will subject taxpayers to penalties for failing to disclose (taxpayers must also now answer all questions on the face of the form, and only use additional sheets of paper as continuation sheets).

For protective disclosures, taxpayers must give as much detailed information as they would for nonprotective disclosures. Indeed, the only difference between a protective filing and a nonprotective filing is the checkbox. Yet, a protective disclosure covers those scenarios which the taxpayer is uncertain about whether to disclose a transaction altogether. By definition, a protective disclosure filing requires...