How to Unwind Reportable Transactions & Tax Shelter Penalties

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Reportable Transactions, Tax Shelter Penalties & Voluntary Disclosure

Reportable Transactions, Tax Shelter Penalties & Voluntary Disclosure

Reportable Transactions & Tax Shelter Penalties

Reportable Transactions, Tax Shelter Penalty & Voluntary Disclosure: More often than not, tax shelters in general — and listed transactions in particular — are better left alone. A very common issue that impacts Taxpayers across the globe, is what happens when a Taxpayer claims a deduction that is required to be disclosed as a reportable transaction (Listed, Confidential, etc.) and either did not report the transaction to the IRS on Form 8886 — or they did report it, but now want to switch gears, kick-it in reverse and unwind the transaction(s). When it comes to international tax matters, a common reoccurring issue is with conservation easements located offshore. Taxpayers generally have an opportunity to unwind a reportable transaction position they have taken before and amend their tax returns to remove any deductions they included as a result of claiming deductions from a listed transaction or other reportable transaction.

What is a Prohibited Tax Shelter Transaction?

A prohibited tax shelter transaction is a transaction that the IRS deems to be it transaction which may be used for improper purposes in order to artificially reduce tax liability. As provided by the IRS:
      • Generally, the term “prohibited tax shelter transaction” means listed transactions, transactions with contractual protection, or confidential transactions. See the definitions of these categories below.
      • There may be additional disclosure requirements for tax-exempt entities with respect to these types of transactions. If you are a tax-exempt entity and you are a party to a prohibited tax shelter transaction, you may be required to file Form 8886-T, Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction, in addition to filing Form 8886. For more information, see the Instructions for Form 8886-T.

Offshore Syndicated Conservation Easements

The offshore syndicated conservation easement has become much more popular as of late. Here is a typical example: Taxpayer wants to invest overseas, and learns about an investment opportunity in which a foreign company can provide an incredibly generous charitable tax deduction by way of a syndicated conservation easement. Without getting into the technicalities of the investment, typically what happens is the Taxpayer invests in the company (or directly with the promoter) that purchases property. The property is then donated by way of a conservation easement — for a value that far exceeds the value of the property (buoyed by a false appraisal). The company is held through one or several pass through companies, and therefore the benefits of the donation pass through to the investors. Is this illegal? Technically, no but it is high on the IRS radar — and who wants to proactively be on the IRS radar, right?

What is a Listed Transaction?

A listed transaction is not necessarily an illegal transaction come but is a transaction in the IRS considers to presumably be non-kosher — and designed solely for tax avoidance purposes. As provided by the IRS:
      • 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. These transactions are identified by notice, regulation, or other form of published guidance as a listed transaction. For existing guidance, see Notice 2009-59, 2009-31 I.R.B. 170, available at gov/pub/irs-irbs/irb09-31.pdf PDF. For updates to this list, go to the IRS web page at IRS.gov/businesses/corporations/abusive-tax-shelters-and-transactions.
      • The listed transactions will also be periodically updated in future issues of the Internal Revenue Bulletin. You can find a notice or ruling in the Internal Revenue Bulletin at IRS.gov/pub/irs-irbs/irbXX-YY.pdf, where XX is the two-digit year and YY is the two-digit bulletin number. For example, you can find Notice 2009-59, 2009-31 I.R.B. 170, at IRS.gov/pub/irs-irbs/irb09-31.pdf PDF.
          • You have participated in a listed transaction if any of the following applies.
          • Your tax return reflects tax consequences or a tax strategy described in published guidance that lists the transaction.
          • You know or have reason to know that tax benefits reflected on your tax return are derived directly or indirectly from such tax consequences or tax strategy.
          • You are in a type or class of individuals or entities that published guidance treats as participants in a listed transaction.
          • The IRS publishes a list of recognized abusive and listed transactions. In fact, the syndicated conservation easement transaction is the most recent (the list is published in chronological order)

Reporting a Listed Transaction

When a taxpayer participates in a Confidential or Listed Transaction — or other certain reportable transactions — they are required to report the transaction on a reportable transaction disclosure statement, Form 8886. Form 8886 requires the Taxpayer to disclose whether or not they have participated in a listed transaction, confidential transaction or other types of reportable transactions.

Penalties for Noncompliance

As provided by the IRS:
      • There is a monetary penalty under section 6707A for the failure to include on any return or statement any information required to be disclosed under section 6011 with respect to a reportable transaction. Generally, the penalty for failure to include information with respect to a reportable transaction is 75% of the reduction in the tax reported on the income tax return as a result of participation in the transaction or that would result if the transaction were respected for federal tax purposes, but not less than $5,000 in the case of an individual and $10,000 in any other case.
      • The annual maximum penalty for failure to disclose a reportable transaction, other than a listed transaction, cannot exceed $10,000 in the case of an individual, and $50,000 in any other case. The maximum annual penalty for failure to include information with respect to a listed transaction is $100,000 in the case of an individual and $200,000 in any other case. This penalty is in addition to any other penalty that may be imposed. For information, see section 6707A and Regs. 301.6707-1.
      • If you have a reportable transaction understatement, an accuracy-related penalty may be imposed under section 6662A. This penalty applies to the amount of the understatement that is attributable to any listed transaction and any reportable transaction (other than a listed transaction) with a significant tax avoidance purpose. The penalty increases for transactions that are not disclosed on Form 8886 in accordance with these instructions.
      • If the transaction is not disclosed and a reportable transaction understatement exists, you may not have a reasonable cause and good faith defense under section 6664(d) with respect to the accuracy-related penalty under section 6662A. For more information, see section 6662A and Notice 2005-12, 2005-7 I.R.B. 494, available at IRS.gov/pub/irs-irbs/irb05-07.pdf PDF.
      • A penalty under section 6707A is assessed for each failure by any individual or entity required to file a Form 8886 if the individual or entity (a) fails to attach Form 8886 to the appropriate original, amended return, or application for tentative refund; (b) fails to file the form with OTSA, if required; or (c) files a form that fails to include all the information required (or includes incorrect information).
      • The Form 8886 must be completed in its entirety with all required attachments to be considered complete. Do not enter “Information provided upon request” or “Details available upon request,” or any similar statement in the space provided. Inclusion of any such statements subjects you to penalty under sections 6707A and 6662A.

New Office of Promoter Investigations Targets Reportable Transactions

 In recent years, the Internal Revenue Service has significantly increased scrutiny of matters involving promoters. The idea of the promoter, is that the promoter goes on the hunt to try to find US Persons who may invest in tax schemes which may not be considered legal or proper by the IRS. Sometimes these will involve Form 8886 Reportable Transactions — but sometimes these transactions are not listed as reportable yet, because they have not fully shown up on the IRS radar. Let’s take a brief look at the Office of Promoter Investigations:

Office of Promoter Investigations

As provided by the IRS:
      • WASHINGTON — As part of the continued focus on compliance issues, the Internal Revenue Service announced today the establishment of the IRS Office of Promoter Investigations. The new office will further expand on the efforts of the Promoter Investigations Coordinator that began last summer.
      • “By establishing the Office of Promoter Investigations, we are continuing our increased focus on promoters of abusive tax avoidance transactions, which we have demonstrated over the last year,” said IRS Commissioner Chuck Rettig. “This office will coordinate efforts across multiple business divisions to address abusive syndicated conservation easements and abusive micro-captive insurance arrangements, as well as other transactions.”

Unwinding a Reportable Transaction

Oftentimes, once a Taxpayer realizes that they are out of compliance for a reportable transaction and/or otherwise do not want to take the tax position any longer — they can unwind it. Depending on the facts and circumstances of their situation, they may qualify for one of the voluntary disclosure programs— or reasonable cause. Which direction the Taxpayer takes in order to unwind the reportable transaction disclosure will depend heavily on the facts and circumstances of their specific situation.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure. Contact our firm for assistance.