*Venable llp, Washington, D. C. Tax Management Memorandum Vol. 46 No. 9 May 2, 2005 [Editor’s Note

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Editor’s Note: T.D. 9201, 70 Fed. Reg. 28824 (5/19/05), revised § 10.35(b)(8) to read: “An item is prominently disclosed if it is readily apparent to a reader of the written advice. Whether an item is readily apparent will depend on the facts and circumstances surrounding the written advice including, but not limited to, the sophistication of the taxpayer and the length of the written advice. At a minimum, to be prominently disclosed an item must be set forth in a separate section (and not in a footnote) in a typeface that is the same size or larger than the typeface of any discussion of the facts or law in the written advice.”]

31 The New York State Bar Association Tax Section's Report on Circular 230 Regulations (3/3/05), among many recommendations, has suggested replacing the "opt-out" system with a bifurcated regime: (a) an "opt-out" approach limited to Marketed Opinions and written advice with respect to Listed Transactions; and (b) an "opt-in" approach for all Other Written Advice, whereby written advice could elect to be subject to the Covered Opinion requirements by stating that the tax opinion is intended to be relied upon for penalty protection purposes.

32 Circular 230 §10.35(d).

33 Id. §10.35(f).

34 Id. §10.35(c)(1)(i)-(iii).

35 Id. §10.35(e).

36 Whether a taxpayer has "participated" in a particular reportable transaction depends upon the type of transaction. The regulations provide specific rules for each type of reportable transaction, as well as for certain types of taxpayers. Regs. §1.6011-4(c)(3).

37 A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and identified by notice, regulations, or other form of published guidance as a listed transaction. Regs. §1.6011-4(b)(2).

38 This category includes a transaction offered to a taxpayer under conditions of confidentiality and for which the taxpayer has paid an advisor a minimum fee. Regs. §1.6011-4(b)(3)(i). The regulations state that a transaction will be considered offered under conditions of confidentially if (i) the advisor who is to be paid the minimum fee limits the taxpayer's ability, whether legally binding or not, to disclose the tax treatment or tax structure of the contemplated transaction and (ii) the limitation on disclosure serves to protect the confidentiality of the advisor's tax strategies. Regs. §1.6011-4(b)(3)(ii). The minimum fee criteria are $250,000 for corporate taxpayers and $50,000 for all other taxpayers. Regs. §1.6011-4(b)(3)(iii).

39 A transaction has contractual protection if the taxpayer or a related party has the right to a full or partial refund of fees if all or part of the intended tax consequences from the transaction are not sustained. Regs. §1.6011-4(b)(4)(i). Transactions with contractual protection also include transactions in which the advisor's fees are contingent on the taxpayer's realization of the desired tax benefits from the transaction. The IRS has published a list of certain transactions with contractual protection that are not reportable transactions for purposes of the disclosure rules under Regs. §1.6011-4(b)(4). See Rev. Proc. 2004-65, 2004-50 I.R.B. 965.

40 A loss transaction is any transaction resulting in the taxpayer claiming a loss under §165 of (a) at least $10 million in a single taxable year or $20 million in any combination of taxable years for corporations (or partnerships with only corporations as partners); (b) at least $2 million in any single taxable year or $4 million in any combination of taxable years for partnerships, individuals, S corporations, and trusts; or (c) at least $50,000 in any single taxable year for individuals or trusts if the loss is attributable to §988. Regs. §1.6011-4(b)(5). See Rev. Proc. 2004-66, 2004-50 I.R.B. 966 (listing certain losses that not taken into account in determining whether a transaction is a loss transaction).

41 A transaction has a significant book-tax difference if any item or items of income, gain, expense, or loss from the transaction differs by more than $10 million on a gross basis from the amount of the item or items for book purposes in any taxable year. Regs. §1.6011-4(b)(6)(i). This category of reportable transactions is limited to entities with required to make filings with the SEC or other business entities with at least $250 million in gross assets at the end of the entity's taxable year. Regs. §1.6011-4(b)(6)(ii). For a list of specific items not taken into account in determining whether a transaction has a significant book-tax difference, see Rev. Proc. 2004-67, 2004-50 I.R.B. 967.

42 A transaction involving a brief asset holding period is any transaction resulting from in the taxpayer claiming a tax credit greater than $250,000, including a foreign tax credit, if the underlying asset giving rise to the credit is held by the taxpayer for 45 days or less. Regs. §1.6011-4(b)(7). In Rev. Proc. 2004-68, 2004-50 I.R.B. 969, the IRS listed a handful of transactions with brief asset holding periods that do not constitute reportable transactions under Regs. §1.6011-4(b)(7).

43 Regs. §1.6011-4(a).

44 Regs. §1.6011-4(a), (e). A regulated investment company (RIC), as defined in §851, or an investment vehicle that is at least 95% owned by one or more RICs at all times during the course of an otherwise reportable transaction is not required to file Form 8886 for any transaction other than a Listed Transaction. Regs. §1.6011-4(b)(8)(ii).

45 Regs. §1.6011-4(e)(1).

46 Rev. Proc. 2004-45, 2004-31 I.R.B. 140. Effective for taxable years ending on or after Dec. 31, 2004, any domestic corporation (including a U.S. consolidated tax group consisting of a U.S. parent corporation and additional includible corporations listed on Form 851, Affiliations Schedule) required to file Form 1120 that reports on Schedule L of Form 1120 total consolidated assets at year-end of $10,000,000 or more must complete Schedule M-3 in lieu of Schedule M-1, Reconciliation of Income (Loss) per Books with Income per Return. Corporations that are not required to file Schedule M-3, nevertheless, may elect to file Schedule M-3.

47 P.L. 108-357, §811 (codified at 26 USC §6707A).

48 §6707A(b)(1).

49 §6707A(b)(2).

50 §6707A(e)(2)(A).

51 §6707A(e).

52 Notice 2005-11, 2005-7 I.R.B. 493.

53 H.R. Rep. No. 755, 108th Cong., 2d Sess. 599 (2004). The Conference Report states that in assessing whether to waive an §6707A penalty, the IRS should consider whether—(a) the taxpayer has a good compliance history, (b) the violation was due to an unintentional mistake of fact, and (c) imposing the penalty would be against equity and good conscience. Id.; see also Notice 2005-11, 2005-7 I.R.B. 493 (noting these same factors).

54 §6707A(d)(1).

55 §6707A(d)(2).

56 Regs. §1.6011-4(e)(2)(i) (requiring disclosure of any transaction that becomes a reportable transaction by reason of becoming a Listed Transaction in a subsequent tax year). As discussed below, new §6501(c)(10) extends the statute of limitations for undisclosed Listed Transactions.

57 A reporting position that has a "reasonable basis" (as defined in Regs. §1.6662-3(b)(3)) is not considered negligent. "Negligence" includes (a) any failure to make a reasonable attempt to comply with the Code provisions or to exercise ordinary and reasonable care in the preparation of a tax return; (b) any failure to keep adequate books and records; and (c) any failure to substantiate items properly. Regs. §1.6662-3(b)(1).

The penalty for disregarding a rule or regulation applies if (i) the taxpayer's position is contrary to a rule or regulation; and (ii) the taxpayer carelessly, recklessly, or intentionally disregards the rule or regulation. Regs. §1.6662-3(a). The penalty for disregarding a rule or regulation can be avoided under two circumstances in addition to the §6664(c) "reasonable cause and good faith" exception. First, the penalty for disregarding a rule or regulation does not apply if the reporting position has a "reasonable basis" and is adequately disclosed (including contrary authority disclosure on Form 8275 (or Form 8275-R)) and, in the case of a position contrary to a regulation, the position represents a good faith challenge to the validity of the regulation. Regs. §1.6662-3(c). Second, a taxpayer who takes a reporting position contrary to a revenue ruling or a notice has not disregarded the ruling or notice if the contrary position has a "realistic possibility" of being sustained on the merits. Regs. §1.6662-3(b)(2). Regs. §1.6662-3(a) refers to Regs. §1.6694-2(b) for a description of the "realistic possibility" standard.

58 §6662(d)(2)(C)(ii). The AJCA did not change the definition of a "tax shelter" within the meaning of §6662.

59 §6662(d)(2).

60 §6662(d)(1)(B), as amended by §819(a) of the AJCA.

61 The substantial authority standard is an objective standard based on an analysis of the law and an application of the law to the relevant facts. See generallyRegs. §1.6662-4(d)(2) and (3). The confidence level is less stringent than the "more likely than not" standard, but more stringent than the "reasonable basis" standard. The taxpayer's subjective belief is not relevant. Substantial authority for the tax treatment of an item exists only if, taking into account all relevant authorities, the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. There may be substantial authority for more than one position with respect to the same item. Whether a position has substantial authority is determined when the return is filed or on the last day of the taxable year. The published list of positions that constitute substantial authority pursuant to §6662(d)(2)(D) is contained in the regulations. For the nature of the analysis, types of authorities and special rules, see Regs. §1.6662-4(d)(3)(ii), (iii), and (iv).

62 §6662(d)(2)(B)(i), (ii). The penalty for a substantial understatement can be avoided if the reporting position has a "reasonable basis" and the return includes contrary authority disclosure on Form 8275 (or Form 8275-R) and, in the case of a position contrary to a regulation, the position represents a good faith challenge to the validity of the regulation. Regs. §1.6662-4(e), (f). This exception will not apply if the substantial understatement is attributable to a tax shelter item, the position is not properly substantiated, or the taxpayer failed to keep adequate books and records with respect to the item or the position.

63 Pre-2004 AJCA §6662(d)(2)(C)(i)(II).

64 §6662(d)(2)(C)(i).

65 Regs. §1.6664-4(f)(2)(i)(B).

66 Reliance by a taxpayer on professional tax advice constitutes "reasonable cause and good faith" if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith. Regs. §1.6664-4(b)(1). "Tax advice" is defined broadly to include any communication from a professional tax advisor or another person (other than the taxpayer) and does not have to be in any particular form. Regs. §1.6664-(c)(2). The minimum requirements for taxpayer reliance on a tax opinion or advice are two-fold, although satisfying these minimum requirements will not necessarily establish the exception. First, the advice must be based upon all pertinent facts and circumstances and the law as it related to those facts and circumstances. Second, the advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the taxpayer or any other person. Regs. §1.6664-4(c)(1).

67 The Preamble to T.D. 9165 (final regulations under Circular 230) states that the IRS will amend Regs. §1.6664-4 to clarify that a taxpayer cannot rely upon written advice that contains the "opt-out" disclosure for avoiding treatment as a Reliance Opinion or Marketed Opinion in order to establish the "reasonable cause and good faith" defense to the accuracy-related penalties.

68 Regs. §1.6664-4(c)(1)(iii) (referencing the adequate disclosure rules in Regs. §1.6662-3(c)(2)).

69 Regs. §1.6664-4(d) refers to Regs. §1.6011-4(b) (or Regs. §1.6011-4T(b), as applicable) for the definition of "reportable transaction," and the disclosure requirements of Regs. §1.6011-4 (or Regs. §1.6011-4T, as applicable).

70 P.L. 108-357, §812 (codified at 26 USC §6662A).

71 §6662A(b)(2). Section 6662A(d) incorporates by reference the definitions of Listed Transaction and reportable transaction set forth in §6707A(c).

One commentator, albeit perhaps a bit "tongue-in-cheek", referred to Reportable Avoidance Transactions as "RATs." See Beller, "The New Penalty Regime: Proceed With Caution," 106 Tax Notes 311 (1/17/05).

72 §6662A(e)(1).

73 §6662A(a), (c). In Notice 2005-12, 2005-7 I.R.B. 494, the IRS provided that a taxpayer will be considered to have adequately disclosed the relevant facts for purposes of §§6662A and 6664(d)(2)(A) (the reasonable cause exception) if the taxpayer filed Form 8886 or Schedule M-3.

74 §6707A(e)(2)(B).

75 §6707A(e).

76 §6662A(b).

77 P.L. 108-357, §812(c) (codified at 26 USC §6664(d)).

78 A taxpayer failing to adequately disclose a reportable transaction will be treated as satisfying this threshold requirement for the reasonable cause exception if the IRS rescinds the §6707A penalty for failing to disclose the taxpayer's participation in the transaction. §6664(d)(2) (flush language).

79 §6664(d)(2).

80 §6664(d)(3)(A).

81 P.L. 108-357, §815 (codified at 26 USC §6111).

82 §6111(a).

83 §6111(b)(1). For purposes of determining the applicable minimum fee threshold, a partnership or a trust with only corporate partners or beneficiaries is deemed to be a corporation. Regs. §301.6112-1(c)(3) (also applying a look-through rule to any partners or beneficiaries that are themselves a partnership or trust).

84 Notice 2004-80, 2004-50 I.R.B. 963 (restating the applicability of the threshold amounts specified in Regs. §301.6112-1(c)(3)); see also Notice 2005-22, 2005-12 I.R.B. 756 (providing that one of the tests for determining when a person will be treated as becoming a material advisor under §6111 is when that person receives (or expects to receive) the minimum fee).

85 Notice 2005-22, 2005-12 I.R.B. 756 (clarifying and modifying Notice 2004-80, 2004-50 I.R.B. 963 (announcing that pending issuance of regulations under new §§6111, 6112, and 6708, the current regulations, in part, will apply as interim guidance)).

86 2005-12 I.R.B. 756.

87 Notice 2005-22, 2005-12 I.R.B. 756. The IRS issued Notice 2005-22 in response to critical comments from the tax bar regarding the requirement set forth in Notice 2004-80, which had required an advisor to file Form 8264 within 30 days of becoming a material advisor. See Comments Concerning Notice 2004-80, ABA Tax Sec. (2/7/05), reprinted in Daily Tax Rep. (2/9/05), at TaxCore-IRS Documents; "NYSBA Suggests Clarifications For Interim Material Advisor Rules," Daily Tax Rep. (2/24/05) at G-6.

88 Notice 2004-80, 2004-50 I.R.B. 963.

89 P.L. 108-357, §816 (codified at 26 USC §6707).

90 §6707(a).

91 §6707(b).

92 §6707(c).

93 P.L. 108-357, §815 (codified at 26 USC §6112).

94 §6112(b)(1).

95 P.L. 108-357, §816 (codified at 26 USC §6708).

96 §6708(a).

97 H.R. Rep. No. 755, 108th Cong., 2d Sess. 599 (2004).

98 As announced in the Preamble to T.D. 9165, the regulations will be amended to clarify that, for purposes of establishing the "reasonable cause and good faith" defense to the accuracy-related penalties, a taxpayer may not rely upon written advice that contains the disclosure that the advice was not written to be used and cannot be used for the purpose of avoiding penalties.

99 Long Term Capital Holdings v. U.S., 330 F. Supp. 2d 122 (D. Conn. 2004). For a discussion of the accuracy-related penalty aspects of this decision, see Fisher, "Long Term Capital Holdings v. U.S.: The End of Penalty Protection?," 46 Tax Mgmt. Memo. 19 (2005).

100 See, e.g.,Lipton, "Reliance on Tax Opinions: The World Changes Due to Long Term Capital Holdings and the AJCA," J. Tax'n344 (Dec. 2004).

101 See generallyCummings, Jr., "The Range of Legal Tax Opinions, with Emphasis on the 'Should Opinion,'" 98 Tax Notes1125 (2/17/03).

102 Id.Regs. §1.6662-3(b)(3) defines "reasonable basis" as a relatively high standard of tax reporting, which is significantly higher than the "not frivolous" standard and which is not satisfied by a return position that is merely arguable or a colorable claim. A return position that is reasonably based on one or more of the enumerated authorities (taking into account the relevance and persuasiveness of the authorities and subsequent developments) will generally satisfy the "reasonable basis" standard, even though it may not satisfy the higher "substantial authority standard as defined in Regs. §1.6662-4(d)(2)."

103 Circular 230 §10.34(d)(1). See also Regs. §1.6694-2(b), which describes the "realistic possibility" standard as a one in three, or greater, likelihood of being sustained on the merits.

104 See alsoIRM 535.1(20).

105 Circular 230 §10.35(b)(4)(i). See alsoRegs. §1.6662-4(d)(2).

106 A tax shelter item of a non-corporate taxpayer can invoke the "reasonable cause and good faith" exception of §6664(c) without the modification of Regs. §1.6662-4(f) applicable to corporate Tax Shelters requiring the higher, "more likely than not" confidence level.

107 §6664(d)(3)(B)(i).

108 See supra note 83 and accompanying text (defining material advisor).

109 §6664(d)(3)(B)(ii). See Notice 2005-12, 2005-7 I.R.B. 494 (setting forth detailed interim guidance regarding (1) the level of activities that constitute participation in the "organization, management, promotion or sale" of a transaction, and (2) disqualifying compensation arrangements).

110 SeeCircular 230 §10.35(e).

111 See supranote 5 and accompanying text (PCAOB Proposed Rule 3521 on contingent fee arrangements).

112 §6664(d)(3)(B)(iii).

113 Regs. §1.6664-4(c)(3).


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