IRS has updated its adequate disclosure procedure. The procedure identifies when disclosure of an item or position is adequate for purposes of reducing the accuracy-related penalty under Code Sec. 6662(d) and to avoid the tax return preparer penalty under Code Sec. 6694(a).
Background—accuracy-related penalty
If Code Sec. 6662 applies to any portion of an underpayment of tax required to be shown on a return, an amount equal to 20% of the portion of the underpayment is added to the tax.
The penalty increases to 40% in the case of gross valuation misstatements under Code Sec. 6662(h), nondisclosed noneconomic substance transactions under Code Sec. 6662(i), or undisclosed foreign financial asset understatements under Code Sec. 6662(i).
Except as provided in the next paragraph, there is a substantial understatement of income tax if the amount of the understatement exceeds the greater of
- 10% of the amount of tax required to be shown on the return for the tax year or
- $5,000. (Code Sec. 6662(d)(1)(A))
For corporations (other than S corporations or a personal holding companies), a substantial understatement of income tax exists when the amount of the understatement exceeds the lesser of
- 10% of the tax required to be shown on the return for a tax year (or, if greater, $10,000) or
- 10,000,000. (Code Sec. 6662(d)(1)(B))
An understatement is the excess of the amount of tax required to be shown on the return for the tax year over the amount of the tax that is shown on the return reduced by any rebate. (Code Sec. 6662(d)(2)(A)) Generally, the amount of the understatement is reduced when a taxpayer has a reasonable basis for the tax treatment of the item causing the understatement (except when the item is attributable to a tax shelter) and the relevant facts about the item’s tax treatment are adequately disclosed on the return or in a statement attached to the return. (Code Sec. 6662(d)(2)(B)(ii))
Background—return preparer penalty
Code Sec. 6694(a) imposes a penalty on a tax return preparer who prepares a return or claim for refund reflecting an understatement of tax liability due to an “unreasonable position” if the tax return preparer knew (or reasonably should have known) of the position.
A position (other than a position with respect to a tax shelter or a reportable transaction to which Code Sec. 6662A applies) is unreasonable unless
- There is or was substantial authority for the position, or
- The position was properly disclosed under Code Sec. 6662(d)(2)(B)(ii)(l) and had a reasonable basis.
A position taken with respect to a tax shelter or a reportable transaction is unreasonable unless it is reasonable for the return preparer to believe that the position would more likely than not be sustained on the merits.
In Rev Proc 2019-9, 2019-2 IRB 292, IRS set out the adequate disclosure rules applicable to tax year 2018. See IRS sets out what must be disclosed to reduce or avoid penalties (12/21/2018).
Updated guidance
Rev Proc 2019-42 provides guidance on how to adequately disclose an item or position on a return for purposes of reducing accuracy-related and avoiding preparer penalties. Generally, a taxpayer must furnish all required information in accordance with the applicable forms and instructions, and the amounts entered on these forms must be verifiable to comply with the Revenue Procedure.
In the Revenue Procedure, IRS has updated the tax years and tax forms to which the procedure applies, but has not made any substantive changes to the previously release guidance in Rev Proc 2019-9.
The Revenue Procedure applies to any income tax return filed on a 2019 tax form for a tax year beginning in 2019 and in to any income tax return filed on a tax form in 2020 for a short tax year beginning in 2020.
To continue your research on disclosure on a return as defense against penalty, see FTC 2d/FIN ¶V-2168; United States Tax Reporter ¶66,624, United States Tax Reporter ¶66,944.
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