Tax Shelter Penalties: Listed Transactions and Reportable Transactions

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
Jason@FreemanLaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

What are Tax Shelter Penalties?

The Internal Revenue Code imposes reporting obligations with respect to so-called “tax shelters.”  Most notably, if a taxpayer participates in a “reportable transaction,” the taxpayer must file a Form 8886 for each year in which the taxpayer participates in the reportable transaction.[1]  In addition, the taxpayer is required to send the form to the Office of Tax Shelter Analysis (the “OTSA”) when the taxpayer first files a Form 8886 for the reportable transaction.[2]  If a taxpayer fails to disclose participation in a reportable transaction, the taxpayer is subject to a penalty under Section 6707A.  That penalty is generally equal to 75 percent of the decrease in tax reflected on the return as a result of the transaction.

Treasury regulations mandate that certain tax shelters and other transactions be registered with the IRS.  Regulations also require that parties who organize or sell interests in the tax shelter(s) maintain lists of the investors in reportable transactions.  As noted above, investors in certain tax shelters and transactions are required to disclose their participation on their tax returns.

Types of Reportable Transactions:

The Reporting Obligation

Treas. Reg. § 1.6011-4(c)(3)(i)(A) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in IRS published guidance that lists the transaction. A taxpayer also has participated in a listed transaction if the taxpayer knows or has reason to know that the taxpayer’s tax benefits are derived directly or indirectly from tax consequences or a tax strategy described in published guidance that lists a transaction.

Treasury regulations provide that the disclosure statement for a reportable transaction, Form 8886 “Reportable Transaction Disclosure Statement” (or its successor form), must be attached to the taxpayer’s tax return for each taxable year for which a taxpayer participates in a reportable transaction. In addition, the disclosure statement for a reportable transaction must be attached to each amended return that reflects a taxpayer’s participation in a reportable transaction. A copy of the disclosure statement must be sent to the OTSA at the same time that any disclosure statement is first filed by the taxpayer.

Treasury regulations also provide that if a transaction becomes a listed transaction after the filing of a taxpayer’s tax return (including an amended return) reflecting either tax consequences or a tax strategy described in the published guidance listing the transaction (or a tax benefit derived from tax consequences or a tax strategy described in the published guidance listing the transaction) and before the end of the period of limitations for the final return (whether or not already filed) reflecting the tax consequences, tax strategy, or tax benefit, then a disclosure statement must be filed as an attachment to the taxpayer’s tax return next filed after the date the transaction is listed regardless of whether the taxpayer participated in the transaction in that year.  This discloses obligation arises even if the taxpayer is not aware that the transaction became a listed transaction or a transaction of interest.

The Statute of Limitations

Section 6501(c) contains a number of exceptions to the general three-year statute of limitations set forth in section 6501(a).  Notably, section 6501(c)(10) extends the limitations period when a taxpayer fails to properly disclose a listed transaction.  Where a taxpayer fails to disclose a listed transaction in compliance with the applicable treasury regulations, the statute of limitations is extended to one year after (i) the taxpayer makes the disclosure in Treas. Reg. sec. 301.6501(c)-1(g)(5) or (ii) a material advisor makes a disclosure described in Treas. Reg. sec. 301.6501(c)-1(g)(6).

Material Advisors

A “Material Advisor” may be required to file a Form 8918, Material Advisor Disclosure Statement.  Generally, a Material Advisor must maintain a list identifying each entity or individual with respect to whom the advisor acted as a Material Advisor with respect to a reportable transaction.[3]  A separate list must be prepared and maintained for each transaction or group of substantially similar transactions. This list must be maintained for 7 years following the earlier of the date on which the Material Advisor last made a tax statement relating to the transaction or the date the transaction was last entered into.[4]

Revenue Procedure 2008-20 provides guidance relating to the obligation of Material Advisors to prepare and maintain lists with respect to reportable transactions under § 6112 and provides that Material Advisors may use the Form 13976, “Itemized Statement Component of Advisee List” (or successor form) to maintain the itemized statement component of the list.  A material advisor may be required to provide a required list to the IRS with 20 business days of the request or be subject to a penalty of $10,000 for each day that the response is late.

A Material Advisor is defined as:

Penalties Associated with Reportable Transactions

In addition to potential criminal penalties, the following civil penalties may apply:

Criminal penalties may apply as well.

Listed Transactions

The following is a summary of the IRS’s “Listed Transactions” in chronological order:

Revenue Ruling 90-105 – Certain Accelerated Deductions for Contributions to a Qualified Cash or Deferred Arrangement or Matching Contributions to a Defined Contribution Plan (transactions in which taxpayers claim deductions for contributions to 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 (identified as “listed transactions” on February 28, 2000)). See also Rev. Rul. 2002-46, 2002-2 C.B. 117 (result is the same, and transactions are substantially similar, even though the contributions are designated as satisfying a liability established before the end of the taxable year), modified by Rev. Rul. 2002-73, 2002-2 C.B. 805

Voluntary Employee Beneficiary Association

Notice 95-34 – Certain Trusts Purported to be Multiple Employer Welfare Funds Exempted from the Lists of §§ 419 and 419A (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 (identified as “listed transactions” on February 28, 2000)). See also § 1.419A(f)(6)-1 of the Income Tax Regulations (10 or more employer plans)).

ASA Investerings Partnership v. Commissioner -Transactions similar to that described in the ASA Investerings litigation and in ACM Partnership v. Commissioner, 157 F.3d 231 (3rd 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 (identified as “listed transactions” on February 28, 2000)).

Treasury Regulation § 1.643(a)-8 – Certain Distributions from Charitable Remainder Trusts (transactions involving distributions described in § 1.643(a)-8 from charitable remainder trusts (identified as “listed transactions” on February 28, 2000)).

Corporate Distributions of Encumbered Property (BOSS)

Notice 99-59 – Transactions involving the distributions of encumbered property in which losses claimed for capital outlays have been recovered (aka BOSS transactions) (transactions involving the distribution of encumbered property in which taxpayers claim tax losses for capital outlays that they have in fact recovered (identified as “listed transactions” on February 28, 2000)). See also § 1.301-1(g) of the Income Tax Regulations;

Step Down Preferred/Fast Pay Stock §1.7701(1)-3

Treasury Regulation § 1.7701(I)-3 – Fast Pay or Step-Down Preferred Transactions (transactions involving fast-pay arrangements as defined in § 1.7701(l)-3(b) (identified as “listed transactions” on February 28, 2000))

Revenue Ruling 2000-12 – Debt Straddles (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 (identified as “listed transactions” on February 28, 2000))

Notice 2000-44 – Inflated Partnership Basis Transactions (Son of Boss) (transactions generating losses resulting from artificially inflating the basis of partnership interests (identified as “listed transactions” on August 11, 2000)). See also § 1.752-6T of the temporary Income Tax Regulations and §§ 1.752-1(a) and 1.752-7 of the proposed Income Tax Regulations;

Son of Boss Settlement Initiative

Stock Compensation Transactions

Notice 2000-60 – Stock Compensation Transactions (transactions involving the purchase of a parent corporation’s stock by a subsidiary, a subsequent transfer of the purchased parent stock from the subsidiary to the parent’s employees, and the eventual liquidation or sale of the subsidiary (identified as “listed transactions” on November 16, 2000));

Notice 2000-61 – Guam Trust (transactions purporting to apply § 935 to Guamanian trusts (identified as “listed transactions” on November 21, 2000));

Notice 2001-16 – Intermediary Transactions (transactions involving the use of an intermediary to sell the assets of a corporation (identified as “listed transactions” on January 18, 2001));

Notice 2001-17 – §351 Contingent Liability (transactions involving a loss on the sale of stock acquired in a purported § 351 transfer of a high basis asset to a corporation and the corporation’s assumption of a liability that the transferor has not yet taken into account for federal income tax purposes (identified as “listed transactions” on January 18, 2001));

Notice 2001- 45 – §302 Basis-Shifting Transactions (certain redemptions of stock in transactions not subject to U.S. tax in which the basis of the redeemed stock is purported to shift to a U.S. taxpayer (identified as “listed transactions” on July 26, 2001));

Notice 2002-21 – Inflated Basis “CARDS” Transactions (transactions involving the use of a loan assumption agreement to inflate basis in assets acquired from another party to claim losses (identified as “listed transactions” on March 18, 2002));

Notice 2002-35 – Notional Principal Contracts (transactions involving the use of a notional principal contract to claim current deductions for periodic payments made by a taxpayer while disregarding the accrual of a right to receive offsetting payments in the future (identified as “listed transactions” on May 6, 2002));

Common Trust Fund Straddles, Pass-Through Entity Straddle, and S Corporation Tax Shelter transaction

Notice 2002-50– Partnership Straddle Tax Shelter (transactions involving the use of a straddle, a tiered partnership structure, a transitory partner, and the absence of a § 754 election to claim a permanent noneconomic loss (identified as “listed transactions” on June 25, 2002)); Notice 2002-65, 2002-2 C.B. 690 (transactions involving the use of a straddle, an S corporation or a partnership, and one or more transitory shareholders or partners to claim a loss while deferring an offsetting gain are substantially similar to transactions described in Notice 2002-50); and Notice 2003-54, 2003-33 I.R.B. 363 (transactions involving the use of economically offsetting positions, one or more tax indifferent parties, and the common trust fund accounting rules of § 584 to allow a taxpayer to claim a noneconomic loss are substantially similar to transactions described in Notice 2002-50 and Notice 2002-65);

Revenue Ruling 2002-69, Lease In / Lease Out or LILO Transactions (transactions in which a taxpayer purports to lease property and then purports to immediately sublease it back to the lessor (often referred to as lease-in/lease-out, or LILO transactions) (identified as listed transactions on February 28, 2000)

Revenue Ruling 2003-6, Abuses Associated with S Corp ESOPs (certain arrangements involving the transfer of employee stock ownership plans (ESOPs) that hold stock in an S corporation for the purpose of claiming eligibility for the delayed effective date of § 409(p) (identified as “listed transactions” on December 17, 2002));

Notice 2003-22 – Offshore Deferred Compensation Arrangements (certain arrangements involving leasing companies that have been used to avoid or evade federal income and employment taxes (identified as “listed transactions” on April 4, 2003));

Notice 2003-24 – Certain Trust Arrangements Seeking to Qualify for Exception for Collectively Bargained Welfare Benefit Funds under § 419A(f)(5) (certain arrangements that purportedly qualify as collectively-bargained welfare benefit funds excepted from the account limits of §§ 419 and 419A (identified as “listed transactions” on April 11, 2003));

Transfers of Compensatory Stock Options to Related Persons

Notice 2003-55 – Accounting for Lease Strips and Other Stripping Transactions (transactions in which one participant claims to realize rental or other income from property or service contracts and another participant claims the deductions related to that income (often referred to as “lease strips”)), modifying and superseding Notice 95-53, 1995-2 C.B. 334 (identified as “listed transactions” on February 28, 2000);

Notice 2003-77 – Improper use of contested liability trusts to attempt to accelerate deductions for contested liabilities under IRC 461(f) (certain transactions that use contested liability trusts improperly to accelerate deductions for contested liabilities under § 461(f) (identified as “listed transactions” on November 19, 2003)). See also § 1.461-2 of the Income Tax Regulations. See Rev. Proc. 2004-31, 2004-22 I.R.B. 986, for procedures which taxpayers must use to change their methods of accounting for deducting under § 461(f) amounts transferred to trusts in transactions described in Notice 2003-77.

Major/Minor Tax Avoidance Using Offsetting Foreign currency Option Contracts

Notice 2003-81 – Offsetting Foreign Currency Option Contracts (certain transactions in which a taxpayer claims a loss upon the assignment of a § 1256 contract to a charity but fails to report the recognition of gain when the taxpayer’s obligation under an offsetting non-section 1256 contract terminates (identified as “listed transactions” on December 4, 2003));

Notice 2004-8 – Abusive Roth IRA Transactions (certain transactions designed to avoid the limitations on contributions to Roth IRAs described in § 408A (identified as “listed transactions” on December 31, 2003));

S Corporations ESOP

Revenue Ruling 2004-04 – Prohibited Allocations of Securities in an S Corporation (transactions that involve segregating the business profits of an ESOP-owned S corporation in a qualified subchapter S subsidiary, so that rank-and-file employees do not benefit from participation in the ESOP (identified as “listed transactions” on January 23, 2004));

Revenue Ruling 2004-20 – Abusive Transactions Involving Insurance Policies in IRC 412(i) Retirement Plans (certain arrangements in which an employer deducts contributions to a qualified pension plan for premiums on life insurance contracts that provide for death benefits in excess of the participant’s death benefit, where under the terms of the plan, the balance of the death benefit proceeds revert to the plan as a return on investment) (identified as “listed transactions” on February 13, 2004)). See also Rev. Rul. 2004-21, 2004-10 I.R.B. 544, §§ 1.79-1(d)(3), 1.83-3(e) and 1.402(a)-1(a)(1) and (2) of the proposed Income Tax Regulations, and Rev. Proc. 2004-16, 2004-10 I.R.B. 559;

Notice 2004-20 – Abusive Foreign Tax Credit Transactions (transactions in which, pursuant to a prearranged plan, a domestic corporation purports to acquire stock in a foreign target corporation and to make an election under § 338 before selling all or substantially all of the target corporation’s assets in a preplanned transaction that generates a taxable gain for foreign tax purposes (but not for U.S. tax purposes) (identified as “listed transactions” on February 17, 2004));

Notice 2004-30 – S Corporation Tax Shelter Involving Shifting Income to Tax Exempt Organization (transactions in which S corporation shareholders attempt to transfer the incidence of taxation on S corporation income by purportedly donating S corporation nonvoting stock to an exempt organization while retaining the economic benefits associated with that stock (identified as “listed transactions” on April 1, 2004));

Notice 2004-31 – Intercompany Financing Through Partnerships (transactions in which corporations claim inappropriate deductions for payments made through a partnership (identified as “listed transactions” on April 1, 2004)).

Notice 2005-13, Sale-In Lease-Out transactions

Notice 2007-57 – Loss Importation Transaction (IRB 2007-29) (transactions in which a U.S. taxpayer uses offsetting positions with respect to foreign currency or other property for the purpose of importing a loss, but not the corresponding gain, in determining U.S. taxable income (identified as “listed transactions” on July 16, 2007)).

Notice 2007-83 – Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits – 2007-45 I.R.B. 1 (transactions in which certain trust arrangements claiming to be welfare benefit funds and involving cash value life insurance policies that are being promoted to and used by taxpayers to improperly claim federal income and employment tax benefits (identified as “listed transactions” on October 17, 2007)).

Notice 2008-34 – Distressed Asset Trust (DAT) Transaction – 2008-12 I.R.B. 1 (transactions in which a tax indifferent party, directly or indirectly, contributes one or more distressed assets (for example, a creditor’s interests in debt) with a high basis and low fair market value to a trust or series of trusts and sub-trusts, and a U.S. taxpayer acquires an interest in the trust (and/or series of trusts and/or sub-trusts) for the purpose of shifting a built-in loss from the tax indifferent party to the U.S. taxpayer that has not incurred the economic loss (identified as listed transactions on February 27, 2008)).

Notice 2015-73 – Basket Option Contracts – This notice describes certain transactions involving a contract that is denominated as an option referencing a basket of actively traded personal property.  The Basket Option Contract attempts to defer income recognition and convert short-term capital gain and ordinary income to long-term capital gain using a contract denominated as an option contract. This notice was published in the Internal Revenue Bulletin on November 16, 2015.  This notice was previously listed under Notice 2015-47 which was revoked.

Notice 2017-10 – Syndicated Conservation Easement Transactions – This notice describes certain transactions in which some promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested.  The promoters identify a pass-through entity that owns real property, or form a pass-through entity to acquire real property.  Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the pass-through entity or tiered entities that owns the real property, suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction that equals or exceeds two and one-half times the amount of the investor’s investment.  The promoters obtain an inflated appraisal of the conservation easement based on unreasonable conclusions about the development potential of the real property.  The entity then donates a conservation easement encumbering the property to a tax-exempt entity.  Investors then claim a charitable contribution relying upon the pass-through entity’s holding period.

“De-Listed” Transactions

[1] Treas. Reg. § 1.6011-4(e)(1) provides that the disclosure statement for a reportable transaction, Form 8886 “Reportable Transaction Disclosure Statement” (or successor form), must be attached to the taxpayer’s tax return for each taxable year for which a taxpayer participates in a reportable transaction. In addition, the disclosure statement for a reportable transaction must be attached to each amended return that reflects a taxpayer’s participation in a reportable transaction. A copy of the disclosure statement must be sent to OTSA at the same time that any disclosure statement is first filed by the taxpayer.

 

[2] The taxpayer must file a Form 8886 even if the taxpayer also discloses the transaction separately, such as on Form 8275 or 8275-R.

[3] A Material Advisor is not required to keep a list if the entity or individual entered into a listed transaction or Transaction of Interest more than 6 years before the transaction was identified in published guidance as a listed transaction or Transaction of Interest

[4] Form 13976, Itemized Statement Component of Advisee List (April 2008), may be used by Material Advisors for the purpose of preparing and maintaining lists with respect to reportable transactions under § 6112 of the Internal Revenue Code. However, this form is not required to be used under § 301.6112-1.

 

Representation in Tax Audits & Appeals

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