By Arthur V. Pearson and Kristen McCulloch
The Treasury Department acting under the authority of Internal Revenue Code §§ 6011(a) and 6111(f) has over the past several years promulgated a series of temporary and proposed regulations, each one amending or modifying the previous ones, to deal with abusive tax shelters.1 All of these decisions have made changes to Treasury Regulation § 1.6011-4T. While this article focuses on Regulation § 1.6011-4T, the reader should be aware of related, temporary regulations under Internal Revenue Code §§ 6111 and 6112.2
Treasury Decision (TD) 9000 made a very significant change. Prior to TD 9000 only C corporations were required to make the required disclosures. TD 9000 expanded the required disclosures to partnerships, S corporations, trusts, and individuals, whether directly or indirectly involved in the transaction. It is effective for federal income tax returns filed after February 28, 2000.³ It should be noted that the new regulations will apply to transactions entered into on or after January 1, 2003. These will be addressed at the end of this article.
As mentioned above, prior to TD 9000, Regulation § 1.6011-4T, required disclosure of a potential Tax Shelter transaction only by certain corporate taxpayers4 that were directly engaged in the "reportable transaction". However, TD 9000 changed the regulation to also require disclosure by anyone who directly or indirectly benefits from the "reportable transaction." Put differently, third party beneficiaries, such as partners of partnerships and shareholders of S-Corporations, where the entities, not the owners, are engaged in the potential tax shelter transactions, must now also disclose the transaction in addition to the entities themselves.
Regulation 1.6011-4T, which TD 9000 modifies, now refers to two categories of transactions, which are considered to be reportable tax shelters.
The first category to which TD 9000 applies are those transactions, which are deemed "listed transactions" because they have been specifically identified as such in either an IRS notice, Revenue Ruling, or Tax Court Case. In Notice 2000-15 the IRS identified certain "listed transactions" which it deems to be potentially abusive tax sheltered transactions and thus subject to disclosure and reporting. Notice 2000-15 identifies 10 categories of transactions as "listed transactions" pursuant to § 301.6112-1T:
(1) Rev. Rul. 90-105, 1990-2 C.B. 69 (transactions in which taxpayers claim deductions for contributions to a qualified cash or deferred arrangement or matching contributions to a defined contribution plan where the contributions are attributable to compensation earned by plan participants after the end of the taxable year);
(2) Notice 95-34, 1995-1 C.B. 309 (certain trust arrangements purported to qualify as multiple employer welfare benefit funds exempt from the limits of §§ 419 and 419A of the Internal Revenue Code);
(3) Notice 95-53, 1995-2 C.B 334 (certain multiple-party transactions intended to allow one party to realize rental or other income from property or service contracts and to allow another party to report deductions related to that income (often referred to as "lease strips"));
(4) Transactions described in Part II of Notice 98-5, 1998-1 C.B. 334 (transactions in which the reasonably expected economic profit is insubstantial in comparison to the value of the expected foreign tax credits);
(5) Transactions substantially similar to those at issue in ASA Investerings Partnership v. Commissioner, No. 98-1583 (D.C. Cir. Feb. 1, 2000) and ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998) (transactions involving contingent installment sales of securities by partnerships in order to accelerate and allocate income to a tax-indifferent partner, such as a tax exempt entity or foreign person, and to allocate later losses to another partner);
(6) Prop. Treas. Reg. § 1.643(a)-8 (transactions involving distributions described in § 1.643(a)-8 from charitable remainder trusts);
(7) Rev. Rul. 99-14, 1999-13 I.R.B. 3 (transactions in which a taxpayer purports to lease property and then purports to immediately sublease it back to the lessor (that is, lease-in/lease out or LILO transactions));
(8) Notice 99-59, 1999-52 I.R.B. 761 (transactions involving the distribution of encumbered property in which taxpayers claim tax losses for capital outlays that they have in fact recovered);
(9) Treas. Reg. § 1.7701(l)-3 (transactions involving fast-pay arrangements as defined in §1.7701(l)-3(b)); and
(10) Rev. Rul. 2000-12, 2000-11 I.R.B. 826, dated March 13, 2000 (certain transactions involving the acquisition of two debt instruments the values of which are expected to change significantly at about the same time in opposite directions).
In addition to those transactions described in Notice 2000-15, the IRS website also identifies the following as "listed transactions"
The second category of transactions are those which are deemed tax shelters because they meet 2 out of 5 criteria as set forth in Treas. Reg.§1.6011-4T(b)(3). These are:
(A) The taxpayer has participated in the transaction under conditions of confidentiality (as defined in Sec. 301.6111-2T(c)).
(B) The taxpayer has obtained or been provided with contractual protection against the possibility that part or all of the intended tax benefits from the transaction will not be sustained, including, but not limited to, rescission rights, the right to a full or partial refund of fees paid to any person, fees that are contingent on the taxpayer's realization of tax benefits from the transaction, insurance protection with respect to the tax treatment of the transaction, or a tax indemnity or similar agreement (other than a customary indemnity provided by a principal to the transaction that did not participate in the promotion of the transaction to the taxpayer).
(C) The taxpayer's participation in the transaction was promoted, solicited, or recommended by one or more persons who have received or are expected to receive fees or other consideration with an aggregate value in excess of $100,000, and such person or persons' entitlement to such fees or other consideration was contingent on the taxpayer's participation in the transaction.
(D) The expected treatment of the transaction for Federal income tax purposes in any taxable year differs or is expected to differ by more than $5 million from the treatment of the transaction for purposes of determining book income as taken into account on the schedule M-1 (or comparable schedule) on the taxpayer's Federal corporate income tax return for the same period.
(E) The transaction involves the participation of a person that the taxpayer knows or has reason to know is in a federal income tax position that differs from that of the taxpayer (such as a tax exempt entity or a foreign person), and the taxpayer knows or has reason to know that such difference in tax position has permitted the transaction to be structured on terms that are intended to provide the taxpayer with more favorable Federal income tax treatment than it could have obtained without the participation of such person (or another person in a similar tax position).
TD 9000 clarified the term "indirect participants" and redefined the term "substantially similar." A taxpayer will have indirectly participated in a transaction if the taxpayer knows, or has reason to know, that the tax benefits claimed are derived from a reportable transaction. TD 9000 defined "substantially similar" as including "any transaction that is expected to obtain the same or similar types of tax benefits and that is factually similar or based on the same or similar tax strategy."5 It further required that "the term substantially similar must be broadly construed in favor of disclosure."
Once it is determined that disclosure must be made, the reportable transactions must be reported on Form 8886, "Reportable Transaction Disclosure Statement." That disclosure statement for the reportable transaction is required to be attached to the taxpayer's federal income tax return for each taxable year that the taxpayer's federal income tax liability is affected by participation in the transaction. A partnership or S corporation must attach a disclosure statement to its return for each taxable year ending with or within the taxable year of a partner or shareholder whose federal income tax liability will be affected by the transaction. Additionally, this entity tax return must also be filed with the IRS Office of Tax Shelter Analysis.6
An interesting quirk is that that if the transaction becomes a reportable transaction (due to a change of facts or IRS listing) AFTER the date the taxpayer has filed the return for the first year the transaction affected the taxpayer's federal income tax liability, the disclosure statement must be attached to next filed federal income return whether or not the transaction affects the taxpayer's federal income tax liability for that year.7
For situations that have arisen in 2002 another special rule applies. If a disclosure is required as an attachment to a federal income tax return filed between June 14, 2002 and 180 days thereafter, the taxpayer must either attach the statement to the return or file the statement "as an amendment" to the return no later than 180 days after June 14, 2002.8
The above rules apply to federal income tax returns filed on or after February 28, 2000. However, certain portions of these rules will not apply9 if the transaction was entered into on or before January 2001 and the return was filed on or before June 14, 2002.
For transactions that were entered into on or after January 1, 2003 a new set of regulations have been promulgated10 which vary significantly from the above Regulations created by TD 9000.
For transactions entered into after January 1, 2003, TD 9017 amends the two out of five test for reportable transactions. As set forth above, prior to TD 9017, the second category of transactions are those which are deemed tax shelters because they meet 2 out of 5 criteria as set forth in Treas. Reg.§1.6011-4T(b)(3). However, the IRS and Treasury have determined that taxpayers are interpreting the five characteristics in an overly narrow manner and are interpreting the exceptions in an overly broad manner. Accordingly, TD 9017 eliminates the projected tax effect test and the general exceptions and redefines a reportable transaction as a transaction that satisfies any one of six identified categories of transactions. The six identified categories of reportable transactions are: (1) listed transactions, (2) confidential transactions, (3) transactions with contractual protection, (4) loss transactions, (5) transactions with a significant book-tax difference, and (6) transactions involving a brief asset holding period.11
TD 9018 amends IRC § 6112 to also require organizers and sellers (i.e., material advisors) to maintain a list of investors in potentially abusive tax shelters (transactions required to be registered under 6111 and for reportable transactions under Treas. Reg.§ 1.6011-4T(b)). In general, a material advisor is any person who (i) receives, or expects to receive, at least a minimum fee12in connection with a transaction that is a potentially abusive tax shelter, and (ii) who makes or provides any statement, oral or written, to any person as to the potential tax consequences of that transaction. TD 9018. The required list must be maintained for a minimum of ten years after the date that the material advisor provided advise for the potentially abusive tax shelter transaction.
Also effective January 1, 2003, pursuant to TD 9017, if a taxpayer is uncertain whether a certain transaction is subject to disclosure under Regulation § 1.6011-4T, the taxpayer may, on or before the date of the disclosure would otherwise be required, request a ruling determination from the Commissioner. Provided all relevant information required for the Commissioner to make such determination has been included in the ruling request, the time period for making the disclosure is tolled for a period of 60 days after the determination is made. A transaction will not be a reportable transaction if the commissioner makes a determination, by published guidance, that the transaction is not subject to disclosure requirement. If the transaction is determined to be a reportable transaction, disclosure is required within 60 days of the determination.
1. Beginning with Treasury Decision (TD) TD 8877 (March 2, 2000), and followed by TD 8896 (August 7, 2000), TD 8961 (August 7, 2001), TD 9000 (June 14, 2002), TD 9017 (October 22, 2002) and TD 9018 (October 22, 2002), the Treasury has expanded the scope of persons and transactions that fall under their influence. Note that TD 9017 and 9018 are only effective for transactions entered into on or after 1-1-03.
2. IRC 6112 defines potentially abusive tax shelters and generally requires organizers and sellers (material advisors) to maintain lists of person for transactions required to be registered under IRC 6111. IRC 6111 requires registration of certain tax shelters. These sections along with 6011 constitute the Treasury's statutory scheme of dealing with abusive tax shelters. The focus of this article is the regulations under 6011. See Treasury press release (PO-2018). 3. Treasury Regulation 1.6011-4T(g) 4. C corporations.5. Treas. Reg.1.6011-4T(b)(1)(i) 6. Office of Tax Shelter Analysis (OTSA) at: Internal Revenue Service, Large & Mid Size Business Division, 1111 Constitution Avenue, N.W., Washington D.C. 202247. Treas. Reg. 1.6011-4T(d)8. Treas. Reg. 1.6011-4T(d)9. Treas. Reg. 1.6011-4T (a)(1)
Treas. Reg. (a)(2)
Treas. Reg. (a)(3)
Treas. Reg. (b)(1)
Treas. Reg. (b)(4)(i)
Treas. Reg. (b)(5)
Treas. Reg. Example 3
Treas. Reg. (c)(1)(iii)
Treas. Reg. (c)91)(v)
Treas. Reg. (c)(2)
Treas. Reg. Example (d)(1) & (3) 10. These new regulations are found in TD 9017 and 9018.11. TD 9017 also amends the rules to provide for the disclosure of listed transactions by certain taxpayers for estate, gift, employment, and pension and exempt organizations excise taxes requiring under section 6011.
12. The minimum fee is $250,000 where all person who have an interest, direct or indirect, in the transaction are regular C corporations. The minimum fee for all other transactions is $50,000.