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Proposed regs explain amount of penalty for failure to report reportable transactions

Preamble to Prop Reg 08/27/2015, Prop Reg § 301.6707A-1

IRS has issued proposed regs that would provide guidance on the amount of the penalty under Code Sec. 6707A for failure to include on any return or statement any information required to be disclosed under Code Sec. 6011 with respect to a reportable transaction. The proposed regs would clarify the amount of the penalty under Code Sec. 6707A, as amended by the Small Business Jobs Act of 2010 (Jobs Act, P.L. 111-240, 9/27/2010).

Background. Code Sec. 6707A imposes a penalty on any person who fails to include on any return or statement any information regarding a “reportable transaction” which is required to be included with the return or statement. Reportable transactions are those identified by IRS as having a potential for tax avoidance or evasion. A listed transaction for Code Sec. 6707A purposes is a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by IRS as a tax avoidance transaction for Code Sec. 6111 purposes. The penalty applies regardless of whether the transaction results in a tax understatement. The penalty also applies in addition to any other penalty that may be imposed under the Code.

Under pre-Jobs Act law, the penalty for failure to report reportable transactions was $10,000 in the case of a natural person and $50,000 for others ($100,000 and $200,000, respectively, for listed transactions).

The Code Sec. 6707A penalty was widely criticized as a Draconian provision that unfairly penalizes small business and other taxpayers that unwittingly participate in a transaction that turns out to be a tax shelter. IRS announced, on July 6, 2009, a suspension of Code Sec. 6707A collection enforcement through Sept. 30, 2009, in cases where the annual tax benefit from the transaction was less than $100,000 for individuals or $200,000 for other taxpayers per year. This suspension was extended several times over. The last extension expired on June 30, 2010.

For penalties assessed after Dec. 31, 2006, the Jobs Act completely replaces the Code Sec. 6707A penalty structure. Except as provided below, the amount of the penalty with respect to any reportable transaction is 75% of the decrease in tax shown on the return as a result of the transaction (or which would have resulted from the transaction if it were respected for federal tax purposes). (Code Sec. 6707A(b)(1), as amended by Jobs Act Sec. 2041(a))

The amount of the penalty for any reportable transaction for any tax year can’t exceed:

1. for a listed transaction, $200,000 ($100,000 in the case of a natural person); and
2. for any other reportable transaction, $50,000 ($10,000 in the case of a natural person). (Code Sec. 6707A(b)(2))
RIA observation: The Act dramatically lowered the Code Sec. 6707A penalties. The previously applicable penalty amounts required to be imposed for listed transactions ($100,000 for natural persons and $200,000 for others) are now the maximum penalties for such persons for listed transactions. Similarly, the previously applicable penalty amounts required to be imposed for reportable transactions ($10,000 for natural persons and $50,000 for others) are now the maximum penalties for such persons for reportable transactions.

The Jobs Act also established a minimum penalty for a failure to disclose a reportable or listed transaction. The amount of the penalty for any transaction for any tax year can’t be less than $5,000 for a natural person and $10,000 for any other person. (Code Sec. 6707A(b)(3))

On Sept. 7, 2011, IRS issued final Code Sec. 6707A regs. However, the regs did not provide guidance on the amount of the penalty, as amended by the Jobs Act, beyond reciting the language of Code Sec. 6707A.

Proposed regs. For purposes of the Code Sec. 6707A penalty, the proposed regs would generally define the decrease in tax—i.e., the decrease in tax shown on the return as a result of the transaction (or which would have resulted from the transaction if it were respected for federal tax purposes)—as the difference between the amount of tax reported on the return as filed and the amount of tax that would be reported on a hypothetical return where the taxpayer did not participate in the reportable transaction. The amount of tax shown on the hypothetical return would reflect adjustments that result mechanically from backing out the reportable transaction, such as tax items affected by an increase in adjusted gross income resulting from non-participation in the reportable transaction. (Prop Reg § 301.6707A-1(d)(1)(i))

In some situations, a taxpayer’s participation in a listed transaction creates a liability for a tax that would not exist absent participation in the transaction. For example, a taxpayer engaging in a listed abusive Roth IRA transaction may be subject to an excise tax on excess IRA contributions. If the taxpayer fails to report the excise tax on his excess IRA contributions, this amount of tax would not appear on the return filed by the taxpayer that reflected his participation in the reportable transaction. The excise tax would also not appear on a return filed by the taxpayer if he had not engaged in the transaction, because there would be no excess contribution on which excise tax would be imposed. Thus, the difference between these two returns would result in no decrease in tax attributable to the unreported tax. To capture this tax, the proposed regs would include in the definition of the decrease in tax “any other tax that results from participation in the reportable transaction but was not reported on the taxpayer’s return.” (Prop Reg § 301.6707A-1(d)(1)(i), Prop Reg § 301.6707A-1(d)(2), Example 1)

Subsequently identified transactions. Once a listed transaction or a transaction of interest is identified by published guidance, a taxpayer has a reporting obligation if the taxpayer participated in the transaction prior to the issuance of the guidance and the statute of limitations for the year of the taxpayer’s participation remains open; under Reg. § 1.6011-4, the taxpayer may use a single disclosure statement to disclose multiple years of participation in a reportable transaction. Under the proposed regs, the decrease in tax would be determined separately for each year of participation for which only a single disclosure statement was required and the amount of the penalty would be 75% of the aggregate decrease in tax in all years for which disclosure was required, subject to the minimum and maximum penalty amount limitations. (Prop Reg § 301.6707A-1(d)(1)(ii))

Penalty for failure to report to the SEC. The proposed regs would clarify that, in the case of a penalty imposed under Code Sec. 6707A(e) for failure to disclose liability for certain penalties in reports to the Securities and Exchange Commission (SEC), the amount of the penalty would be determined under Code Sec. 6707A(b)—rather than under Code Sec. 6707A(b)(2) as the flush language in Code Sec. 6707A(e) actually provides—regardless of whether the penalty that the taxpayer failed to disclose was imposed under Code Sec. 6707A, Code Sec. 6662A (the accuracy-related penalty on understatements with respect to reportable transactions), or Code Sec. 6662(h) (the accuracy-related penalty on underpayments attributable to gross valuation misstatements). (Prop Reg § 301.6707A-1(d)(1)(iii))

IRS does not believe that Congress intended its reference to Code Sec. 6707A(b)(2) to impose the maximum penalty on violations of Code Sec. 6707A(e). In each case giving rise to an obligation to disclose liability in filings with the SEC, there must be a reportable transaction for the relevant penalty to arise. The amount of the penalty for a Code Sec. 6707A(e) violation, therefore, would be 75% of the decrease in tax, as provided in Code Sec. 6707A(b). The proposed regs would not only be consistent with the language of Code Sec. 6707A(e), but also with the Congressional intent of the Jobs Act to render proportionality between the amount of the penalty and the tax benefit derived from the reportable transaction. (Preamble to Prop Reg08/27/2015)

Minimum and maximum amount of the penalty. Under the proposed regs, the limitations on the minimum penalty amounts in Code Sec. 6707A(b)(3) and maximum penalty amounts in Code Sec. 6707A(b)(2) would apply separately to each failure to disclose that is subject to a penalty. (Prop Reg § 301.6707A-1(d)(1)(iii))

References: For the Code Sec. 6707A penalty, see FTC 2d/FIN ¶  V-2282  et seq.; United States Tax Reporter ¶  67,07A4; TaxDesk ¶  866,502; TG ¶  71811.