6694 - alimony

In a case just released, a series of payments under a divorce decree (the "settlement payments") were not deductible alimony under Code Sec. 215 because the decree clearly distinguished between the settlement payments and alimony; the absence of the specific disqualifying language of Code Sec. 71(b)(1)(B) was insufficient to make the settlement payments alimony; and the settlement payments were secured in the event of the death of the payor spouse with an insurance policy while the formal alimony payment were extinguished if the payor spouse died. Moreover, the vague linkage in the decree between the formal alimony payments and the settlement payments was not enough to qualify the settlement payments as alimony.Code Secs. 6662 and 6664]. The accuracy-related penalty was imposed under Code Sec. 6662 because the deduction caused the taxpayer to have an underpayment greater than 10 percent of the tax required to be shown on the relevant return. The taxpayer provided no evidence that the exceptions to the penalty under Code Sec. 6662(d)(2)(B) were available; and, the taxpayer presented no evidence that he reasonably and in good faith relied on professional advice in taking the deduction, thus the exception under Code Sec. 6664(c)(1) was not available. Note also the discussion of the "reasonabl basis" standard that is used in the 6694 statute for disclosed positions.

The alimony/settlement issue is a highly factual and legal issue that is a trap for the unwary tax return preparer. Although the 6694 penalty was not an issue in this case, it could have been made an issue. Knowing the IRS as I do, the IRS will be motivated by the large size of the 6694 penalties. The best defense to the 6694 penalty in this type of case is to get the opinion of a tax attorney in order to trigger the "reasonable cause" exception to the penalties (6694 and 6662).



Richard W. Fields v. Commissioner. Richard W. Fields and Ekaterina Fields v. Commissioner.

Dkt. Nos. 22132-06 ; 4256-07 , TC Memo. 2008-207, August 28, 2008.


MEMORANDUM OPINION


The issues for decision are: (1) Whether certain "Deferred Payments" Richard Fields made in 2000, 2001, and 2003 to Karen Fields, his former spouse, are deductible as alimony; and (2) if not, whether Richard Fields and Ekaterina Fields (petitioners) are liable for the accuracy-related penalty under section 6662(a) as a result of their claiming an alimony deduction for that payment in 2003.


Richard Fields filed his tax returns for 2000 and 2001 as a married taxpayer filing separately. He and Ekaterina Fields filed a joint tax return for 2003.



The deferred payments at issue herein arose as a consequence of Richard Fields's obligations to Karen Fields pursuant to a Separation, Support and Property Settlement Agreement (agreement) executed on October 7, 1999. Mr. Fields is an attorney; however, both he and Karen Fields had the advice of independent counsel in the negotiation and preparation of the agreement.



The agreement contains 19 headings and 42 numbered paragraphs. Paragraphs 3 and 4 of the agreement appear under the heading "Alimony". Paragraph 3 contains mutual waivers of claims each party might have against the other for alimony or spousal support except as specifically provided in paragraph 4.



Paragraph 4(a) provides:



So long as any portion of the Deferred Payments referred to in Paragraph 15(b) remains unpaid, the Husband shall pay to the Wife alimony at the rate of Seventy Five Thousand Dollars ($75,000) per year, in equal monthly installments of Six Thousand Two Hundred Fifty Dollars ($6,250), until December 31, 2001. * * * Commencing January 1, 2002, and on the first day of each month thereafter until December 31, 2002, so long as any portion of the Deferred Payments referred to in Paragraph 15(b) remains unpaid, the Husband shall pay the Wife alimony at the rate of Fifty Thousand Dollars ($50,000) per year, in twelve equal monthly installments of Four Thousand One Hundred Sixty-Seven Dollars ($4,167).



Paragraph 4(b)provides:



Alimony payments pursuant to this Paragraph 4 shall be taxable to the Wife and deductible by the Husband, and shall terminate forever on the first to occur of the death of either Party or full satisfaction of the Note (as defined in Paragraph 15(b) below); provided however, in the event the Husband fails to pay timely any of the Deferred Payments (as defined in Paragraph 15(b) below), the alimony payments to the Wife shall increase by twenty percent (20%) if, after expiration of the ten (10) day cure period, the Husband has not become current on the Note. Alimony shall remain at the increased level until the Husband becomes current on the note.



Paragraph 4(c) of the agreement provides: "Payments made pursuant to this paragraph shall not terminate in the event of the Wife's remarriage", and paragraph 4(d) of the agreement provides: "Except as provided in paragraph 4(a) and (b), alimony is non-modifiable."



Paragraph 15 of the agreement appears under the heading "Personalty"1 and provides, in pertinent part:



15. Lump Sum:



(a) At Closing, the Husband will pay the Wife Two Million Dollars ($2,000,000) in immediately available funds. * * *



(b) Thereafter, the Husband shall pay to the Wife the following amounts in immediately available funds ("Deferred Payments"):



- Two Hundred Seventy Five Thousand Dollars ($275,000) on or before December 31, 1999; and



- Five Hundred Thousand Dollars ($500,000) on or before December 31, 2000; and



- Five Hundred Thousand Dollars ($500,000) on or before December 31, 2001; and



- Five Hundred Twenty Five Thousand Dollars ($525,000) on or before December 31, 2002.



(c) The Deferred Payments shall be evidenced by a Promissory Note (the "Note"), and delivered to the Wife at Closing. The Deferred Payments shall be secured by an Irrevocable Letter of Instruction (the "Instruction Letter") from the Husband to the Firm [the law firm of which Mr. Fields was a partner at that time], requiring the Firm in the event of the Husband's default in payment under the Note, to pay directly to the Wife any funds or assets due the Husband including without limitation salary, draws, bonuses, return of capital or other forms of compensation otherwise owed to the Husband by the [F]irm * * *.



(d) The Promissory Note shall not bear interest and the Husband shall have the right to prepay it without penalty. * * *



(e) All payments to the Wife under this paragraph are tax free to her and are not modifiable. The Husband expressly agrees that for the purpose of incorporation into a court order, the obligations set forth in Paragraph 15(b) above arise out of and are in the nature of support obligations and thus shall not be dischargeable in bankruptcy. The Husband expressly agrees that he shall not seek to discharge or release any of these obligations in bankruptcy or any other similar proceeding. The Husband further agrees that in the event he files for bankruptcy and is relieved of any of his obligations under Paragraph 15(b), then the Wife shall have the right to petition a court of competent jurisdiction to receive an award of spousal support in an amount not to exceed the amount of the discharged Deferred Payments referred to in Paragraph 15(b).



(f) Except as provided in this agreement, upon delivery of the Two Million Dollar ($2,000,000) lump sum payment to the Wife at Closing, all assets, accounts, and interests of the parties in joint names or in the Husband's Separate name or in the Husband's possession shall become the Husband's sole and separate property. In addition to the assets and funds identified above as the Wife's sole and separate property, all assets, accounts and interests in the Wife's sole name shall become her sole and separate property.



Paragraph 25 provides:



25. The Parties intend, understand and agree that all transfers of property and Deferred Payments pursuant to Paragraph 15 above (excluding alimony payments) made to the Wife pursuant to this Agreement are intended to be tax-free to the Wife, pursuant to Section 1041 of the Internal Revenue Code, or under any other sections of the Internal Revenue Code which may pertain to said transfers or payments; provided, however, that the Wife shall be solely responsible for any taxes she may incur if she subsequently sells, transfers, or otherwise disposes of the property and payments she receives pursuant to this Agreement.



Paragraph 19 of the agreement requires Mr. Fields to maintain a decreasing term life insurance policy on his life designating Karen Fields as the beneficiary and owner, with the initial face amount of the policy being equal to the unpaid balance of the deferred payments. That policy is required to remain in effect until Mr. Fields satisfies the promissory note that evidences his obligation pursuant to paragraph 15 of the agreement, and the death benefits payable thereunder to be "commensurate with the unpaid balance of the Deferred Payments."



Some of the terms of the agreement were incorporated into the Circuit Court of Fairfax County, Virginia's divorce decree dated November 5, 1999 (divorce decree). The exact language of paragraph 3 of the agreement (relating to waivers of support other than as provided in paragraph 4 of the agreement), paragraph 4(a) of the agreement (relating to monthly installments of alimony during 2001 and 2002), paragraph 4(b) of the agreement (relating to the characterization of the payments from Richard Fields to Karen Fields as alimony for tax purposes), paragraph 4(c) of the agreement (relating to nontermination of the alimony payments upon Karen Fields's remarriage), and paragraph 4(d) of the agreement (relating to nonmodification of the alimony payments) was incorporated and reproduced in the divorce decree as paragraph 17 thereof. Paragraph 17 of the divorce decree is captioned "Support" and is the only provision in the divorce decree pertaining to spousal support. The divorce decree contains no reference to paragraph 15 of the agreement (other than the reference to paragraph 15 found in paragraph 4 of the agreement, which was incorporated and reproduced in the divorce decree).



Mr. Fields timely filed his tax return for the year 2000 with the assistance of American Express Tax & Business Services (American Express) of Rockville, Maryland, on October 15, 2001.2 The return reported total income of $1,848,795 and reflected, among other items, a $76,250 claimed deduction for alimony. The tax shown on the return was $693,313. On December 31, 2002, Mr. Fields, with the assistance of American Express, prepared and filed an amended return for 2000 in which he reduced by $500,000 the amount of adjusted gross income he had previously reported. The explanation for the change was: "The total alimony paid * * * was understated by $500,000 on the original tax return." The revised tax, according to the amended return, was $489,373.



Mr. Fields timely filed his tax return for the year 2001 with the assistance of Coppergate Associates International of London, England, on January 27, 2003 (pursuant to an extension of time in which to file until January 30, 2003, inasmuch as petitioner was living abroad). The return reported total income of $2,133,971 and reflected, among other items, a $568,750 claimed deduction for alimony. The tax shown on the return was $423,994.



Mr. Fields failed to make the final deferred payment of $525,000 to Karen Fields by December 31, 2002, as contemplated in the agreement. Instead, that payment was made in March 2003. Contemporaneously with the March 2003 payment, Richard and Karen Fields executed an "Agreement and Limited Mutual Release" in which, among other things, Karen Fields released Richard Fields from his obligations pursuant to "Paragraphs 15a-d (entitled Lump Sum), and Paragraphs 3-4 (entitled Alimony)" of the agreement.



Mr. Fields and Ekaterina Fields timely filed their tax return for the year 2003 with the assistance of Meridian Services, Ltd., of Charleston, South Carolina, on October 15, 2004. The return reported total income of $924,867 and reflected, among other items, a $525,000 claimed deduction for alimony. The tax shown on the return was $89,507.



After examining the 2000, 2001, and 2003 tax returns, respondent determined deficiencies in tax of $203,940, $195,500, and $170,797 respectively for those years. Respondent issued a notice of deficiency to Mr. Fields for years 2000 and 2001 on July 31, 2006, and a notice of deficiency to petitioners for the year 2003 on January 4, 2007. The deficiencies respondent determined were attributable entirely to disallowance of $500,000 of the claimed deductions for alimony in 2000 and 2001 and the $525,000 claimed deduction for alimony in 2003 (i.e., deductions attributable to payments made pursuant to paragraph 15(b) of the agreement). In addition, in his notice of deficiency, respondent determined that for 2003 petitioners were liable for a $34,159.40 penalty under section 6662(a).3 Respondent did not challenge the $76,250 alimony deduction claimed in 2000 or the $68,750 alimony deduction claimed in 2001 (i.e., deductions attributable to payments made pursuant to paragraph 4(a) of the agreement).



Petitioners timely petitioned this Court for a redetermination of the deficiencies. Petitioners claim that all amounts Mr. Fields paid to Karen Fields (and not just the amounts paid pursuant to paragraph 4(a) of the agreement) were deductible as alimony under section 215, noting: (1) Paragraph 15 of the agreement does not specifically state that those payments are not allowable as deductions under section 215; and (2) Mr. Fields was not obligated to make payments pursuant to paragraph 15(b) in the event of Karen Fields's death. Moreover, petitioners posit that even though the first sentence of paragraph 15(e) states that "All payments to the Wife under this paragraph are tax free to her", the deferred payments under paragraph 15(b) are in the nature of spousal support and would be tax free only in the event Mr. Fields filed for bankruptcy.



Petitioners did not address the issue of their liability for the section 6662(a) penalty for 2003 in their petition, but both they and respondent addressed that issue on brief.4





Discussion



As stated in Estate of Goldman v. Commissioner, 112 T.C. 317, 322 (1999), affd. without published opinion sub nom. Schutter v. Commissioner, 242 F.3d 390 (10th Cir. 2000):



Generally, property settlements (or transfers of property between spouses) incident to a divorce neither are taxable events nor give rise to deductions or recognizable income. See sec. 1041. On the other hand, amounts received as alimony or separate maintenance payments are taxable to the recipient (pursuant to sections 61(a)(8) and 71(a)) and deductible by the payor (pursuant to section 215(a)) in the year paid. For tax purposes, the phrase "alimony or separate maintenance payments" is defined in section 71(b)(1) as any cash payments meeting the following four criteria:



"(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,



(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under this section and not allowable as a deduction under section 215,



(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and



(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse."



The parties agree that Mr. Fields's payments to Karen Fields of $76,250 in 2000 and $68,750 in 2001 made pursuant to paragraph 4(a) of the agreement constitute deductible alimony. The parties further agree that Mr. Fields's payments to Karen Fields made pursuant to paragraph 15 of the agreement satisfy the first and third criteria of section 71(b)(1). They disagree as to whether Mr. Fields's payments to Karen Fields pursuant to paragraph 15 of the agreement satisfy the second and fourth criteria of section 71(b)(1). For the reasons set forth below, we hold those payments do not and thus sustain respondent's determination that the payments Mr. Fields made to Karen Fields of $500,000 in 2000, $500,000 in 2001, and $525,000 in 2003 are not alimony.



With respect to the second criterion of section 71(b)(1), petitioners posit that in order for payments from one spouse to the other to be disqualified as alimony payments made pursuant to a separation agreement or divorce decree, the separation agreement or divorce decree must specifically provide that the payments are not includable in the recipient's income and are not deductible by the payor. Because the agreement does not contain such a specific provision, petitioners maintain that Mr. Fields's payments to Karen Fields are not disqualified as deductible alimony under section 71(b)(1)(B).



We have already stated, in Estate of Goldman v. Commissioner, supra at 323, that the divorce or separation instrument need not mimic the language of section 71(b)(1)(B). Rather, we have stated that a nonalimony designation will be found "if the substance of such a designation is reflected in the instrument." Id.



In our view, the payments to be made pursuant to paragraph 15(b) of the agreement were designed to accomplish a purpose different from that of the payments made pursuant to paragraph 4. We believe the payments made pursuant to paragraph 4 were intended to be for the support of Karen Fields, whereas the payments made pursuant to paragraph 15 were intended to be a property settlement. The basis of this belief is as follows.



Paragraph 15 of the agreement is concerned with the division of property between Mr. Fields and Karen Fields. Tellingly, paragraph 15 appears under the heading "Personalty", whereas paragraph 4 appears under the heading "Alimony". And paragraph 4 is the only paragraph of the agreement referred to in the divorce decree as requiring Mr. Fields to pay Karen Fields alimony.



Paragraph 15(e) of the agreement provides that payments under paragraph 15 are to be tax free to the Wife (i.e., Karen Fields), whereas paragraph 4(b) designates the payments under paragraph 4 from the Husband (i.e., Mr. Fields) to the Wife as alimony "taxable to the Wife and deductible by the Husband". If all the payments to be made under both paragraphs 4 and 15 were intended to be alimony, we believe the agreement: (1) Would not have denominated the payments differently by means of placement in separate paragraphs and under different headings, and (2) would not have contained contradictory instructions as to the inclusion (or not) of the payments in Karen Fields's income.



Moreover, the amounts payable pursuant to paragraph 15(b) of the agreement are substantially larger than those required by paragraph 4 of the agreement. The payments made pursuant to paragraph 15(b) of the agreement, referred to as "Deferred Payments", are, in our opinion, a series of discrete amounts in the nature of installment payments, evidenced by a promissory note and secured by an irrevocable letter of instruction to Mr. Fields's law firm. Tellingly, as further security Mr. Fields was required to maintain a decreasing term life insurance policy on his life of which Karen Fields was to be the beneficiary and owner until the promissory note evidencing Mr. Fields's obligations under paragraph 15 was satisfied. Providing such security is inconsistent with the provision in paragraph 4(b) that such an obligation was to be extinguished upon Mr. Fields's death.



Petitioners point to some provisions of the agreement which give rise to a colorable claim that the payments made pursuant to paragraph 15 were deductible alimony. For example, paragraph 25, in describing the agreed tax treatment of the payments under paragraph 15 as tax free to Karen Fields, contains a parenthetical reference to alimony payments. Paragraph 15(e) first specifies that payments made under that paragraph are tax free to Karen Fields but then characterizes the payments to be made pursuant to paragraph 15(b) as support obligations "and thus not dischargeable in bankruptcy". It further provides that Karen Fields "shall have the right to petition a court of competent jurisdiction to receive an award of spousal support in an amount not to exceed the amount of the discharged deferred payments referred to in Paragraph 15(b)." Moreover, we are mindful that the agreement provides for an increase in the amount and duration of alimony payments under paragraph 4(a) and 4(b) in the event Mr. Fields does not timely make the payments required by paragraph 15, suggesting a linkage or interchangeability between the two types of payments.



Notwithstanding the aforesaid, we are persuaded that the agreement, when read in its entirety from a "reasonable, commonsense perspective," reflects a clear and express intent of the parties that the amounts which Mr. Fields was required to pay pursuant to paragraph 15 of the agreement constitute a division of marital assets, as opposed to spousal support, and are not to be included in the gross income of Karen Fields nor allowed as deductions to Mr. Fields. See Estate of Goldman v. Commissioner, 112 T.C. at 323. Consequently, the second criterion of section 71(b)(1), which the payments must satisfy if they are to qualify as alimony, has not been met.



With respect to the fourth criterion of section 71(b)(1), petitioners contend that the payments Mr. Fields was required to make pursuant to paragraph 15 would not continue upon Karen Fields's death, and consequently the requirement of subparagraph (D) of section 71(b)(1) is met. We disagree with petitioners' contention.



Whether a postdeath obligation exists may be determined by the terms of the divorce or separation instrument, or, if the instrument is silent on that matter, by State law. Morgan v. Commissioner, 309 U.S. 78, 80-81 (1940); see also Kean v. Commissioner, 407 F.3d 186, 191 (3d Cir. 2005), affg. T.C. Memo. 2003-163. But there is no need to resort to State law to determine the character of the payments at issue.5 Paragraph 4(b) of the agreement provides that the payments to be made thereunder shall terminate on the death of either party or upon the payment of all amounts due pursuant to paragraph 15, whichever occurs first. Such language is conspicuously lacking in paragraph 15. The agreement requires Mr. Fields to make payments pursuant to paragraph 15 until fixed amounts ($500,000 in 2000, $500,000 in 2001, and $525,000 in 2002) are paid. It does not state that the obligation to make those payments terminates upon the death of Karen Fields. Therefore, the amounts Mr. Fields paid pursuant to paragraph 15 of the agreement do not satisfy the requirement of subparagraph (D) of section 71(b)(1).



Having sustained respondent's determination that the payments Mr. Fields made to Karen Fields of $500,000 in 2000, $500,000 in 2001, and $525,000 in 2003 are not alimony, we now turn our attention to respondent's determination with respect to the accuracy-related penalty under section 6662(a).



Respondent determined that petitioners' 2003 underpayment was attributable to negligence or disregard of rules or regulations under section 6662(b)(1) and/or to a substantial understatement of income tax under section 6662(b)(2). We address only respondent's claim that petitioners' underpayment for 2001 was attributable to a substantial understatement of income tax under section 6662(b)(2). We do so because a finding that there was a substantial understatement of income tax alone would be determinative that petitioners are liable for the section 6662(a) penalty.



Under section 7491(c), the Commissioner has the burden of production with respect to any penalty. Once the Commissioner meets the burden of production, the taxpayer continues to have the burden of proof with respect to whether the Commissioner's determination of the penalty is correct. Rule 142(a); Higbee v. Commissioner, 116 T.C. 438 (2001). The submission of a case without trial under Rule 122(a) does not alter the requirements otherwise applicable to adducing proof. Rule 122(b).



For purposes of section 6662(b)(2), an understatement is equal to the excess of the amount of tax required to be shown in the tax return over the amount of tax shown. Sec. 6662(d)(2)(A). The difference is considered "substantial" in the case of an individual if the amount of the understatement for the taxable year exceeds the greater of 10 percent of the tax required to be shown in the return for that taxable year or $5,000 Sec. 6662(d)(1)(A). The amount of the understatement must be reduced by that portion of the understatement which is attributable to (1) "the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment", sec. 6662(d)(2)(B)(i),6 or (2) any item if (a) "the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return", sec. 6662(d)(2)(B)(ii)(I), and (b) "there is a reasonable basis for the tax treatment of such item by the taxpayer", sec. 6662(d)(2)(B)(ii)(II). Disclosure of an item is not effective to remove the item from the understatement to which the tax is attributable where the treatment of the item for tax purposes does not have a reasonable basis as defined in section 1.6662-3(b)(3), Income Tax Regs. Sec. 1.6662-4(e)(2)(i), Income Tax Regs.



Section 1.6662-3(b)(3), Income Tax Regs., provides that the reasonable basis standard "is not satisfied by a return position that is merely arguable or that is merely a colorable claim." If a return position is reasonably based on one or more of the authorities set forth in section 1.6662-4(d)(3)(iii), Income Tax Regs. (taking into account the relevance and persuasiveness of the authorities, and subsequent developments), the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial authority standard as defined in section 1.6662-4(d)(2), Income Tax Regs. See section 1.6662-4(d)(3)(ii), Income Tax Regs., for rules with respect to relevance, persuasiveness, subsequent developments, and use of a well-reasoned construction of an applicable statutory provision for purposes of the substantial understatement penalty.


Petitioners' 2003 return reported tax of $89,507. Respondent determined, and we agree, that the tax required to be shown on the return was $259,476. Thus, the understatement was $169,969. This amount exceeds 10 percent of the tax required to be shown in the return and obviously is greater than $5,000.



The record does not disclose on what basis petitioners claimed that Mr. Fields's payments under paragraph 15(b) to Karen Fields were alimony. Because Mr. Fields did not originally claim the 2000 payment of $500,000 as alimony, it is apparent that at one time Mr. Fields did not consider that payment to be deductible. Other than petitioners' uncorroborated claim (first set forth in their posttrial brief) that Mr. Fields changed the tax treatment of the payments made under paragraph 15(b) of the agreement on the advice of his tax return preparers, a claim discussed infra, nothing in the record indicates that petitioners relied on one or more of the authorities set forth in section 1.6662-4(d)(3)(iii), Income Tax Regs., or otherwise had a reasonable basis for deducting the payments made under paragraph 15(b) of the agreement on their 2003 return. Thus, petitioners have failed to carry their burden of showing that they had a reasonable basis for their tax treatment of the 2003 payment to Karen Fields, and accordingly the exception to the section 6662(a) penalty found in section 6662(d)(2)(B)(ii) is not applicable.



Pursuant to section 6664(c)(1), no penalty under section 6662 shall be imposed "with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion." The determination of whether the taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including the taxpayer's efforts to assess the taxpayer's proper tax liability, the knowledge and experience of the taxpayer, and the reliance on the advice of a professional, such as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Reliance on the advice of a professional, such as an accountant, does not necessarily demonstrate reasonable cause and good faith unless, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith. Id. In this connection, a taxpayer must demonstrate that his/her reliance on the advice of a professional concerning substantive tax law was objectively reasonable. Goldman v. Commissioner, 39 F.3d 402, 408 (2d Cir. 1994), affg. T.C. Memo. 1993-480. In the case of claimed reliance on an accountant who prepared the taxpayer's tax return, the taxpayer must establish that correct information was provided to the accountant and that the item incorrectly omitted, claimed, or reported in the return was the result of the accountant's error. Westbrook v. Commissioner, 68 F.3d 868, 881 (5th Cir. 1995), affg. T.C. Memo. 1993-634; Weis v. Commissioner, 94 T.C. 473, 487 (1990); Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173 (1978).



In their posttrial brief, petitioners claim that Mr. Fields's tax preparer, American Express, realized that it had erred in not deducting as alimony the $500,000 deferred payment Mr. Fields made in 2000 and therefore advised Mr. Fields to file an amended return to correct its error, which Mr. Fields did on December 31, 2002. Petitioners also assert on brief that their claiming deductions for the deferred payments made in 2001 and 2003 was approved by their return preparers for those years. Further, petitioners assert, because the Internal Revenue Service did not challenge the tax treatment of the deferred payments for 2000 and 2001, they had no reason to believe that respondent might disallow the claimed alimony deduction for 2003.



Although it appears that Mr. Fields had assistance from accountants in preparing his returns for each of the years in issue, no evidence was submitted as to what Mr. Fields told the preparers and what the preparers told him. See Garfield v. Commissioner, ___ Fed. Appx. ___ (2d Cir., Aug. 18, 2008), affg. T.C. Memo. 2006-67. There is nothing in the record to substantiate petitioners' uncorroborated and first-time assertions made in their posttrial brief that American Express admitted error in preparing Mr Fields's tax return for 2000 filed on October 15, 2001. We have no way of knowing whether the filing of the amended 2000 tax return on August 31, 2002, was to correct an "error" made by American Express, as asserted by petitioners, or resulted from Mr. Fields's desire to claim and/or insistence on claiming the benefit of a greater alimony deduction. Nor do we have any way of knowing what information the other tax preparers (Coppergate Associates International and Meridian Services, Ltd.) had in preparing petitioners' 2001 and 2003 tax returns. Moreover, the lack of a previous challenge by respondent of Mr. Fields's claimed alimony deductions for the deferred payments made in 2000 and 2001 pursuant to paragraph 15 of the agreement does not show that petitioners had reasonable cause for the erroneous position taken for 2003.



On the limited stipulated facts before us, we cannot find that Mr. Fields, apparently a knowledgeable attorney, had reasonable cause for, or acted in good faith with respect to, changing his original position with respect to the characterization of the $500,000 payment to Karen Fields in 2000 and, adhering to an erroneous position, with respect to the $525,000 payment in 2003.



Because petitioners have failed to prove that they are entitled to relief under section 6664(c)(1), we reject their arguments that they should be relieved of the section 6662 penalty.



To reflect the foregoing,



Decisions will be entered for respondent.


1 The heading that precedes the heading "Personalty" in the agreement is "Real Property". Two paragraphs are set forth thereunder (par. 7 and par. 8). Par. 7 provides for the release by Karen Fields of any interest in Mr. Fields's leasehold of a residence in London. Par. 8 provides for the release by Karen Fields of any interest in Mr. Fields's residence in Washington, D.C.

In addition to par. 15, various other paragraphs appear under the "Personalty" heading, most of which have subheadings: "Furniture, Home Furnishings, Fine Art and Other Tangible Personal Property" (par. 9), "Automobiles" (par. 10), "Pets" (par. 11), "Boat and Jet Skis" (par. 12), "Swidler Berlin Shereff Friedman, LLP" (par. 13), "Retirement Assets" (par. 14), and par. 16 relating to mutual indemnifications from third-party claims.

2 Mr. Fields's tax years 1999 and 2002 are not at issue, and the record does not reveal how he reported, for tax purposes, any payments he made to Karen Fields during those years.

3 On Jan. 16, 2007, respondent transmitted to petitioners an examination report for 2003 which reduced the alternative minimum tax and corresponding deficiency in tax for 2003 to $169,969 and reduced the penalty for 2003 to $33,993.80.

4 Petitioners claimed, for the first time on brief, that interest on any underpayment should be suspended pursuant to sec. 6404(g). Petitioners do not assert, and the record does not indicate, that the Secretary made a determination not to abate such interest, which would be reviewable by this Court pursuant to sec. 6404(h). Hence, we deem petitioners' claim for the suspension of interest to be premature.

5 Petitioners rely on Va. Code Ann. sec. 20-109.1 (2004), which provides that upon the death or remarriage of the spouse receiving support, spousal support shall terminate unless otherwise provided by stipulation or contract. We already found that payments Mr. Fields made pursuant to par. 15 were not spousal support payments but instead were part of a division of marital assets.

6 Following submission of this case, by means of an attachment to their brief petitioners attempted to introduce into evidence a written opinion by a law professor in support of a claim that there was substantial authority as provided in sec. 6662(d)(2)(B)(i) for their treatment of Mr. Fields's payments to Karen Fields. The written opinion, which does not cite any legal authorities, was not included in the stipulation of facts and exhibits submitted pursuant to Rule 122. Consequently, the Court returned the attachment. See Rules 143(b), 151.

Petitioners later sought, by means of a motion, to amend the stipulation of facts to include the written opinion. Respondent objected to petitioners' motion, and we denied petitioners' motion to amend.

We are mindful that the material petitioners wish the Court to consider is dated Apr. 28, 2006, whereas petitioners' 2003 return was filed on Oct. 14, 2004. Substantial authority for purposes of sec. 6662(d)(2)(B)(i) must exist at the time the return containing the item is filed or on the last day of the taxable year to which the return relates. See sec. 1.6662-4(d)(3)(iv)(C), Income Tax Regs. Accordingly, even if the material constituted "authority" as contemplated by sec. 6662(d)(2)(B)(i), which is doubtful, see sec. 1.6662-4(d)(3)(iii), Income Tax Regs., the material would not constitute substantial authority for purposes of sec. 6662(d)(2)(B)(i).

American Bar Association comment on 6694 regs

American Bar Association (ABA) Comments on Proposed Regulations Under Sections 6694 and 6695

September 2, 2008

American Bar Association (ABA) comments : Tax return preparer penalties : Proposed regulations .



Section of Taxation



10th Floor



740 15th Street, N.W.



Washington, DC 20005-1022



202-662-8670



FAX: 202-662-8682



E-mail: tax@abanet.org

August 26, 2008



Hon. Douglas Shulman



Commissioner



Internal Revenue Service



1111 Constitution Avenue, N.W.



Washington, DC 20224

Re: Comments on Proposed Regulations Under Section 6694 and 6695

Dear Commissioner Shulman:

Enclosed are comments on proposed regulations under section 6694 and 6695. These comments represent the views of the American Bar Association Section of Taxation. They have not been approved by the Board of Governors or the House of Delegates of the American Bar Association, and should not be construed as representing the policy of the American Bar Association.

Sincerely,

William J. Wilkins

Chair-Elect, Section of Taxation

Enclosure

cc: Hon. Donald L. Korb, Chief Counsel, Internal Revenue Service

Hon. Eric Solomon, Assistant Secretary (Tax Policy), Department of the Treasury

Karen Gilbreath Sowell, Deputy Assistant Secretary (Tax Policy)

Eric San Juan , Tax Legislative Counsel (Acting), Department of the Treasury

Deborah Butler, Associate Chief Counsel, Internal Revenue Service




AMERICAN BAR ASSOCIATION SECTION OF TAXATION COMMENTS ON PROPOSED REGULATIONS UNDER SECTION 6694 AND 6695


The following comments ("Comments") are submitted on behalf of the American Bar Association Section on Taxation (the "Section") and have not been approved by the House of Delegates or the Board of Governors of the American Bar Association. Accordingly, the Comments should not be construed as representing the position of the American Bar Association.

Principal responsibility for preparing these Comments was exercised by John Colvin. Substantive contributions were made by David Casten, Seth Cohen, Rochelle L. Hodes, Michael Lang, Alexandra Minkovich, David Moise, Fred Murray, Phillip Pillar, Ronald Wiener and Mark Wilensky. The Comments were reviewed by Bryan C. Skarlatos, Chair of the Section's Committee on Civil and Criminal Penalties. These Comments were further reviewed by Gersham Goldstein of the Section's Committee on Government Submissions and by Kathryn Keneally, the Council Director for the Section's Committee on Civil and Criminal Penalties.

Although members of the Section who participated in preparing these Comments have clients who might be affected by the federal income tax principles addressed in the Comments or may have advised clients in the application of such principles, and all could be affected to the extent they are treated as preparers, no such member or the firm or organization to which such member belongs has been engaged by a client to make, or has a specific individual interest in making, a submission to the government, or otherwise to influence the outcome, with respect to the specific subject matter of these Comments.

Contacts: John Colvin

(206) 223-0800

jcolvin@chicoine-hallett.com

Bryan C. Skarlatos

(212) 808-8100

bskarlatos@kflaw.com

Date August 26, 2008




EXECUTIVE SUMMARY


These Comments address proposed regulations (the "Proposed Regulations") implementing amendments to the tax return preparer penalties under sections 6694 and 66951 - and related provisions under sections 6060, 6107, 6109, 6696 and 7701(a)(36) - made by the Small Business and Work Opportunity Tax Act of 2007. The Proposed Regulations were issued published in the Federal Register on June 17, 2008.2

We believe the Department of the Treasury ("Treasury") and the Internal Revenue Service (the "Service") have done an excellent job of reconciling the amendments to the tax return preparer penalties with the practical problems that arise in every-day practice. We generally support the approach in the Proposed Regulations and we make the following recommendations:


1. Definition of Return . The Proposed Regulations, when finalized, should more narrowly define the types of information returns or other documents that the Service may treat as a "substantial portion" of a taxpayer's return, excluding certain information returns subject to penalties pursuant to sections 6721 et seq ., and certain other forms unrelated to the computation of tax liability.



2. Preparer's Obligation to Sign a Return . The Service should clarify that a preparer who is responsible for the overall substantive accuracy of the preparation of a return or claim for refund is required to sign the return or claim.



3. Penalty Arising from Pass-Through Returns . The Proposed Regulations, when finalized, should limit the amount of penalty that may be collected against the preparer of a pass-through return to the greater of $1,000 or one half of the fees collected for the return preparation services.



4. Person with Supervisory Responsibility . Application of the penalty against a person with "overall supervisory responsibility"3 for a position within a firm should be limited to cases in which some degree of fault can be attributed to the person with overall supervisory responsibility.



5. Reliance on Taxpayers for Legal Conclusion . We suggest that the language in Proposed Regulation section 1.6694-1(e)(1) providing that, while a preparer can rely on factual information furnished by a taxpayer, a preparer "may not rely on information provided by a taxpayer with respect to legal conclusions on federal tax issues" be eliminated. The principle that preparers cannot rely on legal conclusions provided by taxpayers is clear from other portions of the Proposed Regulations,4 and its restatement in the portion of the Proposed Regulations dealing with the preparer's ability to rely on information provided by taxpayers introduces ambiguity with respect to information provided by a taxpayer which may (unknown to the preparer) contain mixed questions of fact and law.



6. Reliance on Advice from Other Preparers . The Proposed Regulations, when finalized, should permit preparers to rely on advice received from other preparers in determining whether the preparer had "a reasonable belief that the position would more likely than not be sustained on the merits."5



7. Computation of the Penalty in Cases Involving Firm and Individual Liability . We suggest that the Proposed Regulations, when finalized, provide an example illustrating how the 50% of gross income standard will work in cases involving both firm and individual liability.



8. Standard Approach to Adequate Disclosure . We recommend that the Proposed Regulations, when finalized, clarify that a firm does not violate the prohibition against having a "boilerplate disclaimer"6 simply because it has adopted a standard approach to disclosure issues.



9. Disclosure of Taxpayer Return Information . There should be a mechanism to allow disclosure of taxpayer return information to preparers in the course of preparer penalty audits.



10. Reasonable Cause and Good Faith - Due Diligence . We believe that the amount of factual and legal due diligence required of a preparer to qualify for the "reasonable cause and good faith" defense should not be disproportionate to the amount of potential tax liability at issue with respect to the position.



11. Reasonable Cause and Good Faith - Changes in the Law . The Proposed Regulations, when finalized, should clarify that a preparer who becomes aware (or should become aware) of developments in the tax law only has a duty to determine whether previous advice is no longer reliable in cases where there has been either a statutory change or a change in controlling precedent.



12. Reasonable Cause and Good Faith - Generally Accepted Administrative or Industry Practice . The Proposed Regulations, when finalized, should provide that "generally accepted industry practices" include practice guidelines adopted by industry, as well as positions accepted by the Service with respect to industry-wide issues.



13. Burden of Proof . We suggest that the rules regarding "burden of proof"7 in preparer penalty litigation either be eliminated or be substantially revised to comport with section 7491.



14. No Single Position is MLTN . Where there are more than two potential tax treatments, none of which is "more likely than not," the Proposed Regulations, when finalized, should not penalize the preparer if the preparer reasonably concludes that one of the alternatives is more likely than the other to be sustained by the courts.





DISCUSSION


1. Definition of Return - Potential Inclusion of Information Returns.

Proposed Regulation section 301.7701-15(b)(4) provides a very broad definition of return that includes "any information return or other document identified in published guidance in the Internal Revenue Bulletin, and that reports information that is or may be reported on another taxpayer's return under the Code if the information reported on the information return or other document constitutes a substantial portion of the taxpayer's return."

This proposed definition of return potentially includes documents that would not be treated as a return of income tax under existing case law.8 In addition, this definition could include Form W-2,9 Form 1099, Forms 2210 and 2220 (computation of underpayment of estimated taxes), and Forms 1139 and 1045 (tentative refund applications),10 all of which are currently are excluded from the definition of income tax return under Regulation section 301.7701-15(b). We recognize that Treasury and the Service have not identified any of the forms identified in this comment as an information return which will be treated as a return if the information contained therein constitutes a substantial portion of a taxpayer's return. However, we believe that the Proposed Regulations, when finalized, should adopt a principled approach with respect to what types of forms may be identified in the future.

Forms W-2 and 1099 are often prepared by persons working for employers or service recipients, who have no obligation to the workers and service providers who receive such forms, and may have contrary interests. Many preparers of these returns are payroll services. As a policy matter, because the preparer of a Form W-2 or 1099 has no obligation running to the recipient of such forms, it would be anomalous to treat them as being responsible for a "substantial portion of the taxpayer's return." If improper positions are taken by a preparer working for an employer, such positions may also be reflected on the employment tax returns or the income tax return of the employer/service recipient, and subject to penalty with respect to such other return.

To prevent stacking of penalties, the current penalty structure that has been in place since 1989, treats preparer penalties and information return penalties (sections 6721-6725) as mutually exclusive categories.

Accordingly, we recommend that the definition of the term "return" for purposes of sections 6694 and 6695 exclude information returns that are subject to the information return penalties,11 as well as forms that are unrelated the computation of a liability on a tax return.12

2. Preparer's Obligation to Sign a Return.

The Proposed Regulations under section 6695 would penalize a "signing tax return preparer"13 for failing to satisfy a number of statutory duties imposed on signing preparers, including failing to sign the return. The Proposed Regulations define a "signing tax return preparer" as any preparer who signs the return or claim for refund as well as preparers required to sign pursuant to Proposed Regulation section 1.6695-1(b). Proposed Regulation section 1.6695-1(b)(3) provides a rule for determining who among multiple tax return preparers involved in preparing a return is to be considered the preparer required to sign the return. However, no rule is provided to indicate when either one preparer individually or several preparers together have been sufficiently involved in the preparation of the return that either the individual preparer or one among the group is actually required to sign the return.

We recommend that this issue be clarified by modifying Proposed Regulation section 1.6695-1(b)(1) to read as follows:


An individual who is a tax return preparer as described in §301.7701-15 of this chapter with respect to a return of tax or claim for refund of tax under the Code and who is responsible for the overall substantive accuracy of the preparation of the return or claim for refund that is not signed electronically shall sign the return or claim. . ..


A conforming change should be made to the regulations governing electronically signed returns.

3. Maximum Penalty Limit for Pass-Through Returns.

Section 6694(a) provides for a penalty equal to the greater of $1,000 or 50% of income derived by the preparer. A nonsigning preparer is any tax return preparer who is not a signing tax return preparer who prepares a "substantial portion" of a return or claim for refund, with respect to events that have occurred at the time that the advice is rendered. With respect to nonsigning preparers, if the schedule, entry or other portion of the return prepared by the nonsigning preparer involves amounts of gross income or deduction that do not exceed $10,000 in income/deduction, then the schedule, entry or other portion of the return is not considered substantial.14 The Proposed Regulations provide that the preparer of a partnership return (or S corporation return) is treated as the preparer of the partners' (or shareholders') returns, provided the flowthrough amounts constitute a "substantial portion" of the partners' or shareholders' individual returns.15

In the case of partnership or other flow through entity returns, the penalty computation rules do not provide any guidance in the case where a preparer of the entity return is not engaged to provide any services to the entity's interest holders, but is nonetheless treated as a nonsigning preparer with respect to the interest holders` returns. We believe these rules should be clarified so that the 50% fee limit applies to all fees the preparer receives with respect to the preparation of the entity returns. If the preparer also receives fees to provide advice with respect to a particular interest holder's return, those fees should be taken into account for purposes of determining the fee limit.

The following example illustrates this concept. A lawyer prepares a Form 1065 for a non-public real estate investment partnership having 100 individuals as equal partners and is paid $5,000 for the preparation. The partnership engaged in a like-kind exchange and deferred $5,000,000 of gain. The lawyer knows that the deferral is a substantial portion of each partner's return, but the lawyer is not a paid preparer with respect to any partner's individual returns. The Service challenges the like-kind exchange and asserts the section 6694(a) penalty against the lawyer. The potential penalty would be $2,500 (50% of $5,000). However, the preparer is also a nonsigning preparer of the Forms 1040 for each partner. It is unclear whether there will be an additional penalty with respect to the returns of each of the partners, or whether the single penalty at the partnership level will be the entire penalty. Further, if there is an additional penalty for each partner's understatement, it is not clear how that amount would be determined (i.e. , is it based on the fee paid by the partnership? Is the fee deemed to be $0 so that the $1,000 penalty amount applies?). If there is a penalty amount attributable to the partnership return and each partner's return, is there a cap with respect to such penalty amount?

To address these uncertainties, we suggest that Treasury and the Service clarify the Proposed Regulations, when finalized, to limit the amount of the penalty to the greater of $1,000 or 50% of the fees earned by the preparer with respect to preparation of the pass-through return. Thus, in the example above, regardless of the number of partners, the entire penalty amount imposed on the preparer could be no more than 50% of the total fees or $2,500.16

4. Responsibility within Firm - Supervisory Responsibility.

In situations involving both signing and nonsigning tax return preparers within the same firm, the individual within the firm with overall supervisory responsibility for the position of the section 6694 penalty is the preparer if the Service cannot conclude which individual (as between the signing tax return preparer and other persons within the firm) is responsible for the position. The preamble indicates that this rule is intended to address situations where there is uncertainty regarding the identification of the primarily responsible preparer within the firm prior to the expiration of the statute of limitations. This default rule may be interpreted as imposing liability on a person with some level of "supervisory responsibility" for the position, but who is unaware of the position. For example, in a law firm, the head of the tax department may have "overall supervisory responsibility" for all tax legal opinions issued by the firm, but may be unaware of a critical factual error in a subordinate's analysis. Moreover, there may well be ambiguity within the firm about who has "overall supervisory responsibility" for the position.

We recommend that the Proposed Regulations, when finalized, provide that a person with "supervisory responsibility" for the position be limited to persons who either (1) had actual knowledge of the position, or (2) through willfulness, recklessness, or gross indifference, failed to exercise appropriate diligence in the review of the position for which the penalty is being imposed. This recommendation is based on the standard in Proposed Regulation section 1.6694-2(a)(2) for determining whether firm liability is appropriate, and would ensure that only culpable individuals are subject to punishment.

5. Signing Preparers - Reliance upon Taxpayers - Legal Conclusions.

Proposed Regulation section 1.6694-1(e)(1) provides that a preparer "generally may rely in good faith without verification upon information furnished by the taxpayer." However, the preparer "may not rely on information provided by a taxpayer with respect to legal conclusions on Federal tax issues."17 It is clear from the remainder of the Proposed Regulations that a preparer is only entitled to rely on another advisor (and not the taxpayer) for advice on federal tax law (i.e. , legal conclusions), and only then if the preparer believes such other advisor is competent to render such advice.18

Some information that is commonly considered factual in nature may, on closer inspection, turn out be a mixed question of fact and law. For example, suppose a taxpayer sold a piece of real property during the year. To determine gain or loss on the sale, the preparer needs to know the taxpayer's adjusted tax basis. A taxpayer's adjusted tax basis in real property sold during the year may depend only on the taxpayer's original cost. However, it may also depend on any number of other things, e.g ., whether the property was acquired in a prior like-kind exchange, whether the real property was acquired from a decedent, or what the "allowable depreciation" was with respect to the property. If the preparer simply obtained the adjusted tax basis in the property from the taxpayer's books and records or on basis information furnished directly by or on behalf of the taxpayer, the preparer would not know or have reason to know whether this information was significantly affected by a legal conclusion. We believe that this regulation could cause confusion in the case of mixed questions of fact and law, especially where the preparer does not actually know that the information may reflect legal conclusions.

While we agree that a preparer is not entitled to rely on legal conclusions provided by the taxpayer, we recommend that the Proposed Regulations, when finalized, eliminate the sentence stating that a preparer may not rely on information provided by a taxpayer with respect to legal conclusions on Federal tax issues. The restatement of this principle in the regulation providing that preparers generally can rely on taxpayers for factual information may engender confusion in the case where the factual information provided (unknown to the preparer) contains embedded legal conclusions. Alternatively, the Proposed Regulations, when finalized, should clarify that the bar against relying on taxpayers with respect to legal conclusions applies only to an express statement by a taxpayer as to a legal conclusion on a federal tax issue, e.g. , "Section xx of the Code justifies the position I would like to take on the return."

6. Signing Preparers - Reliance upon Advice from Other Preparers.

The Proposed Regulations appear to contain an oversight that may be construed to preclude reliance on advice provided by another tax advisor, except to establish "reasonable cause." The preamble to the Proposed Regulations states that a tax return preparer may meet the "reasonable belief that a position would more likely than not be sustained on the merits standard" if, among other things, the tax return preparer "relies on information or advice furnished by a taxpayer, advisor, another return preparer, or another party (even when the advisor or tax return preparer is within the tax return preparer's same firm), as provided in proposed §1.6694-1(e)." However, the only place in the text of the Proposed Regulations where a tax return preparer is permitted to rely on the "advice" of anyone is in Proposed Regulation section 1.6694-2(d), which defines "reasonable cause."

This language in the preamble suggests that any omission in the text of the Proposed Regulations regarding this issue was merely an oversight. We recommend correcting this omission by amending Proposed Regulation sections 1.6694-1(e), 1.6694-2(b), and 1.6694-2(c) to specifically permit reasonable reliance on the advice of other advisors for purposes of establishing the existence of "a reasonable belief that the position would more likely than not be sustained on the merits," as well as to establish "reasonable cause." Preparers should also be permitted to reasonably rely on advice received from other advisors in determining their obligations with respect to positions that do not meet the MLTN standard (e.g. , the reasonable basis standard).

7. Income Derived - Compensation - Individual and Firm Allocation.

We believe that the Proposed Regulations, when finalized, should contain an example illustrating how the penalty will be computed in cases involving employees and partners who spend a portion of their time on a particular position subject to the section 6694 penalty, for which the firm earns a specific amount. We suggest the inclusion of the following example:


A works for Firm F. A is an employee of Firm F, with a salary of $75,000/year. A performs tax preparation work for Client C. The Client C return contains a position that results in an understatement subject to the §6694 penalty. A spent 100 hours on this position (out of a total of 2,000 billed during the year). The total fees earned by Firm F with respect to the position reflected on Client C's return are $50,000.



If A is subject to the penalty, the penalty amount computed under the 50% of income standard is 0.5 X (100/2,000) X $75,000 = $1,875.



If Firm F is subject to the penalty, the penalty amount computed under the 50% of income standard is 0.5 X $50,000 = $25,000, less any penalty amount imposed against A. If a penalty of $1,875 were assessed against A, and Firm F were subject to the penalty, a penalty of $23,125 would be the amount of penalty to be assessed against Firm F.


8. Adequate Disclosure - Communicating Options to Taxpayers.

When a position does not satisfy the "reasonable belief that the position would more likely than not be sustained on the merits" standard, but does satisfy the "reasonable basis" standard, and if the position is not appropriately disclosed on the tax return, the preparer is required to provide certain advice to taxpayers, and to prepare contemporaneous documentation that such advice was provided.19 The proposed regulation provides that "no form of a general boilerplate disclaimer is sufficient to satisfy these standards."20 This provision appears to be aimed at stopping preparers who might attempt to opt out of penalty exposure entirely by telling clients, "Some items on your return may not meet the `more likely than not' (`MLTN') standard. If the items do not meet MLTN, and if there is not `substantial authority' supporting your position, you should disclose or face penalty exposure."

However, we expect that many responsible firms and their insurance carriers will want procedures in place for making sure that preparers point out to their clients any reservations with respect to any positions that do not meet the MLTN standard, as well as a script/template for advising clients of their options when a specific position does not reach MLTN, when the position has "substantial authority," and when the position only has a "reasonable basis." The options will be similar for situations in each different category.

Accordingly, we believe that the provision against having a "boilerplate disclaimer," should be clarified to state that having general procedures to follow in a situation where the preparer is unable to reach the "reasonable belief that the position would more likely than not be sustained on the merits" standard does not violate the provision providing that "no form of general boilerplate is sufficient," so long as the preparer specifies to the client which specific position or positions on the return do not meet the "more likely than not" standard," and provides specific advice regarding the standards applicable to preparers and/or taxpayers relative to those positions as set out in proposed regulation 1.6694-2(c).

9. Disclosure of Taxpayer Returns or Return Information in Preparer Penalty Audits.

Under current law, it is not clear whether a tax return preparer is able to obtain disclosure of taxpayer returns or return information (as defined in section 6103(b)) to the extent relevant and material to the examination of the tax return preparer with respect to a penalty under sections 6694(a) or (b). Section 6103, and the regulations thereunder, provide for limited disclosure of taxpayer returns and return information, with unauthorized disclosure potentially resulting in civil and/or criminal penalties.21 By enacting section 6103(l)(4)(A)(ii), Congress recognized the need for tax return preparers to have access to returns and return information in the context of disciplinary hearings before or proceedings instituted by the Director of the Office of Professional Responsibility.22 It is unclear, however, whether the Secretary may disclose returns or return information under section 6103(l)(4)(A)(ii) to tax return preparers prior to the examiner's filing of a report with the Director of the Office of Professional Responsibility.

The state of the law regarding the Service's ability to disclose taxpayer returns or return information to a preparers under section 6103(h)(4) is uncertain, insofar as the Circuit Courts of Appeals are divided as to whether that section permits disclosure only to Federal officials and employees or allows audit disclosures.23 It is also unclear whether information regarding taxpayer returns becomes "taxpayer return information," pursuant to section 6103(b), with respect to the preparer, when such information is used as a basis for computing a proposed preparer penalty liability.

We recommend that Treasury and the Service issue regulations providing that section 6103(l)(4)(A)(ii) permits the Secretary or its delegate to disclose taxpayer returns and return information to a tax return preparer at the tax return preparer's request upon initiation of an examination of the tax return preparer for tax return preparer penalties, to the extent that the Secretary or its delegate determines that the returns and return information are relevant and material to the examination. We believe that such disclosure is within the scope of section 6103(l)(4)(A)(ii) insofar as an examination of the tax return preparer may eventually result in an administrative action or proceeding under Circular 230.

10. Exception for Reasonable Cause and Good Faith.

Generally, we believe that the Proposed Regulations, when finalized, should specify that the amount of factual and legal due diligence required on the part of the preparer in order to qualify for the "reasonable cause and good faith" defense should not be disproportionate to the amount of the tax liability that would be affected by the position at issue.

11. Reliance Upon the Advice of Others .

Proposed Regulation section 1.6694-2(d)(5)(iii) provides that a preparer may not rely upon the advice of another advisor if,


[t]he tax return preparer knew or should have known (given the nature of the tax return preparer's practice) at the time that the return or claim for refund was prepared, that the advice or information was no longer reliable due to developments in the law since the time the advice was given.


This provision could be construed to impose a duty on a preparer who received advice from another preparer prior to the preparation of the return and who later learns (or has reason to learn) of legal developments, to conduct due diligence in order to determine whether the advice or information provided is still reliable in light of the developments in the law.

We believe that the phrase "reliable due to developments in the law" is inherently ambiguous, and difficult to apply even to relatively simple tax advice. Certainly, signing tax return preparers who become aware of the enactment of a federal tax statute or a Supreme Court decision that directly altered the treatment of a significant item on a return could determine that prior inconsistent advice is no longer reliable. For example, in Knight v. Commissioner , 128 S.Ct. 782 (2008), the Supreme Court ruled that a trust's investment advisory fees were subject to the two percent AGI floor of section 67. Preparers should be aware of this decision and be able to determine that prior inconsistent advice is no longer reliable.

However, other legal developments, although possibly important to the analysis of the issue, may not rise to the level that they make the prior analysis "unreliable." Suppose, at the time that the advice was initially given, there was a Tax Court decision in favor of the position advocated by the advisor, and a Court of Federal Claims decision contrary to the position advocated by the advisor. The advisor relied on the Tax Court decision (arguing that it was better reasoned) to opine that the position was "more likely than not." A post-advice decision by a federal district court agreeing with the Court of Federal Claims opinion outside the taxpayer's jurisdiction may well be a "development in the law." Depending on the analysis employed by the district court, the opinion may render the position objectively no longer "more likely than not." However, the existence of an additional court case contrary to the advisor's position does not necessarily render the position "unreliable," in the same way that a new statute or controlling precedent would. A preparer who is relying on another advisor should not be required to Shepardize cases and independently evaluate their impact.

Accordingly, we believe that the Proposed Regulations, when finalized, should state that, in determining whether advice given prior to the preparation of a return is "reliable," a preparer who relies upon another advisor need only determine that the position advocated by the advisor has not been overruled by subsequent legislation or adverse controlling precedent.

12. Reliance on Generally Accepted Administrative or Industry Practice .

We believe that guidance should be provided to explain how a practitioner should determine whether a practice is "generally accepted." For example, preparers should be able to rely on ethical and other practice guidelines published by the American Bar Association, the AICPA, or similar organizations in determining what "generally accepted" practices are. In addition, if the Service has permitted a specific technical position for an industry in the past, then such practice should be treated as "generally accepted" for purposes of qualifying for the exception, unless the Service has announced in published guidance that the practice is no longer accepted.

We believe that, in appropriate cases "industry practice" should be taken into account in determining both "reasonable belief that a position is MLTN," as well as whether the position has a "reasonable basis."

13. Burden of Proof in Preparer Penalty Litigation.

The Proposed Regulations have retained, substantially unchanged, the rules in the current regulations regarding the burden of proof in any proceeding with respect to the penalty imposed by sections 6694(a) and (b), respectively.24 The burden of proof rules may be relevant, for instance, in a refund suit filed by the tax return preparer pursuant to sections 6694(c) and 6696(c) - (d). The current regulations addressing the burden of proof were issued prior to the 1998 enactment of section 7491.

Under section 7491(a), the burden of proof in a court proceeding involving a tax liability (including a refund suit) is shifted to the government if the taxpayer introduces credible evidence with respect to a factual issue relevant to ascertaining the taxpayer's liability for any tax and if certain other requirements are met. Moreover, under section 7491(c), the Secretary has the burden of production in a court proceeding with respect to an individual's liability for any penalty, which would also appear to include a tax return preparer penalty.25 Under section 7491(c), for instance, we believe that the Service would have the burden of production for its case in chief, including demonstrating that the tax return preparer "knew or reasonably should have known that the questioned position was taken on the return" and that "the position was not adequately disclosed."26 Insofar as "reasonable cause and good faith" are an affirmative defense to penalty liability, the taxpayer should have the burden of production regarding those issues.27 Accordingly, we recommend that the provisions regarding burden of proof be removed or revised to comport with section 7491.

14. Preparer's Alternatives When There Is No Position That is "More Likely Than Not."

Given the complexity of the Internal Revenue Code, and the different potential tax treatment available for certain items, there may be situations in which no single position is "more likely than not." For example, the sole shareholder of a corporation takes funds from his or her corporation during the year, but dies before the end of the year. Do the funds constitute compensation, a dividend distribution, or the repayment of a loan? The facts about the intended characterization may be ambiguous. When the facts are uncertain, the three different positions (which have radically different tax consequences) may be equally plausible. Thus, there is no one position that is "more likely than not."

We recommend that the Proposed Regulations, when finalized, provide that when there is no single position that is "more likely than not" to be the correct position, the preparer will not be penalized if he or she reasonably concludes that one of the alternative positions is the most likely to be sustained by a court (vis-à-vis the other positions) and takes that position on the return.

1 All references to "section" herein are to sections of the Internal Revenue Code of 1986, as amended (the "Code" ), unless otherwise expressly stated herein, and references to regulations are to the Treasury Regulations promulgated under the Code.

2 73 Fed. Reg. 34,560 (June 17, 2008).

3 Prop. Reg. §§1.6694-1(b)(1) and (b)(3).

4 E.g. , Prop. Reg. §1.6694-2(d)(5)

5 73 Fed. Reg. 34,560 (June 17, 2008).

6 Prop. Reg. §1.6694-3(c)(3)(iii)

7 Prop. Reg. §§1.6694-2(e) and 1.6694-3(g).

8 See , Beard v. Commissioner , 82 T.C. 766, 777 (1984), affd. per curiam 793 F.2d 139 (6th Cir. 1986) (providing a four-part test including calculating a liability). Nothing in the amendments made by the Small Business and Work Opportunity Act of 2007 demonstrates a Congressional intent to change the long established definition of a return. Rather, the 2007 amendments merely extend the preparer penalties to all types of tax (estate and gift, excise, etc.).

9 Form W-2 was excluded from the definition of an income tax return under PLR 8034159 (June 2, 1980); PLR 8035069 (June 6, 1980); and GCM 38648 (March 3, 1981).

10 Forms 1139 and 1045 (tentative refund applications) were excluded from the definition of a return in PLR 7846077 (August 21, 1978) and GCM 38071 (August 29, 1979), relying on the flush language of section 6411(a).

11 I.e. , section 6721 et seq .

12 E.g. , computations of underpayment of estimated taxes (i.e ., Forms 2210 and 2220) and tentative refund applications (i.e , Forms 1139 and 1045).

13 Prop. Reg. §301.7701-15(b)(1).

14 Prop. Reg. §301.7701-15(b)(3)(ii)(A).

15 Prop. Reg. §301.7701-15(b)(3)(iii).

16 A preparer who made the same mistake (for the same fees) regarding the replacement period with respect to a section 1031 exchange on an individual return would be subject to a $2,500 penalty.

17 Prop. Reg. §1.6694-1(e)(1).

18 Prop. Reg. §1.6694-2(d)(5).

19 Prop. Reg. §1.6694-2(c)(3)(iii).

20 Id.

21 See, e.g. , sections 7213(a)(1) and 7431.

22 See also , Circular 230, section 10.72(d)(3) - (4), providing for disclosure of returns or return information to any practitioner or appraiser "whose rights are or may be affected by an administrative proceeding under this subpart D."

23 See, e.g. , Chamberlain v. Kurtz , 589 F.2d 827 (5th Cir. 1979); First Western Government Securities, Inc. v. United States , 796 F.2d 356 (10th Cir. 1986); Mallas v. United States , 993 F.2d 1111 (4th Cir. 1993).

24 See Prop. Reg. §§1.6694-2(e) and 1.6694-3(g).

25 See , section 6671(a) and Revenue Ruling 78-245, 1978-1 C.B. 435, treating tax return preparer penalties as a "tax."

26 Prop. Reg. §§1.6694-2(e)(1) and (3).

27 Prop. Reg. §1.6694-2(e)(2).




https://www.abanet.org/tax/pubpolicy/2008/080826commentsonregsundersec6694and6695.pdf

reasonable cause - 6662 - 6694

It is expected that the judicial precedent for "reasonable cause" exception to the 6662 penalty will apply to establish "reasonable cause" for the section 6694 penalty.
The following case makes the point that if (assume the context of 6694)a return preparer relies on another "tax advisor," CPA, or tax attorney for an opinion, the return preparer would need to provide full information to the applicable professional. Without question, the easiest way to duck the "analysis" and "authority" requirements under the 6694 regulations is to rely on a tax professional for a written opinion to be filed with the tax return for disclosed positions or retained in the client file for undisclosed positions. The fact is that the "reasonable cause" standard is a virtual "lock" on avoiding the 6694 penalty if the preparer gets a professional opinion from an outside professional. The return preparer, in turn, assumes the responsibility for supplying the relevant "analysis" and technical "authority" to avoid the 6694 penalty.

Dkt. No. 17593-06 , TC Memo. 2008-200, August 27, 2008.


[Code Sec. 6662]


A taxpayer who could show neither that she provided adequate materials to her tax return preparer nor that she adequately examined her return could not qualify for the reasonable cause and good faith exception to the accuracy-related penalty imposed under Code Sec. 6662. While the taxpayer showed that she had relied on a competent tax professional, in her case a certified public accountant, to prepare her tax return, she did not show that the return preparer was supplied with necessary and accurate information. She also did not show that she had relied in good faith on the adviser's judgment because she did not examine her return after he had prepared it to insure that all income items had been included.


R determined a deficiency in P's Federal income tax for 2004. R also determined an accuracy-related penalty pursuant to sec. 6662, I.R.C. After concessions, P and R dispute only whether P is liable for the penalty.

Held: P is liable for the sec. 6662, I.R.C., penalty.





MEMORANDUM OPINION



WHERRY, Judge: This case is before the Court on a petition for redetermination of a Federal income tax deficiency and penalty under section 6662 that respondent determined with respect to petitioner's 2004 tax year.1



The parties have resolved a number of issues and have filed a stipulation of facts and two stipulations of settled issues, all of which are hereby incorporated by reference into our findings. After concessions, the sole issue remaining for decision is whether petitioner is liable for the accuracy-related penalty pursuant to section 6662.2





Background



Petitioner and Yincang Wei (Mr. Wei), who was then her husband, filed a joint Federal income tax return for 2004. That return appears to have been prepared by a certified public accountant (C.P.A.) named John T. Tsai (Mr. Tsai).3 On June 26, 2006, respondent issued petitioner and Mr. Wei a notice of deficiency with respect to their 2004 tax year. The deficiency was attributable to issues including (1) unreported gambling income, (2) dividends, and (3) interest income. Respondent also determined an accuracy-related penalty pursuant to section 6662. Petitioner filed a timely petition with this Court.4 At the time she filed her petition, petitioner resided in California.



Before trial, respondent granted petitioner partial relief pursuant to section 6015(c). A trial was held on May 2, 2008, in Los Angeles, California.5 After trial, the parties filed a stipulation agreeing to the amount of gambling income, dividends, and interest income allocable to petitioner for 2004.





Discussion



Respondent bears the burden of production with respect to petitioner's liability for the section 6662(a) penalty. See sec. 7491(c). This means that respondent "must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." Higbee v. Commissioner, 116 T.C. 438, 446 (2001).



Subsection (a) of section 6662 imposes an accuracy-related penalty on an underpayment of tax that is equal to 20 percent of any underpayment that is attributable to one of the causes listed in subsection (b). Among those causes is negligence or disregard of rules or regulations. Sec. 6662(b)(1). Respondent contends that petitioner is liable for the section 6662 penalty "on the grounds of negligence."



Section 6662(c) defines negligence as "any failure to make a reasonable attempt to comply with the provisions of this title". "[D]isregard" is defined to include "any careless, reckless, or intentional disregard." Id. Under caselaw, "'Negligence is a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the circumstances.'" Freytag v. Commissioner, 89 T.C. 849, 887 (1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo. 1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).



There is an exception to the section 6662(a) penalty when a taxpayer can demonstrate (1) reasonable cause for the underpayment and (2) that the taxpayer acted in good faith with respect to the underpayment. Sec. 6664(c)(1). Regulations promulgated under section 6664(c) further provide that the determination of reasonable cause and good faith "is made on a case-by-case basis, taking into account all pertinent facts and circumstances." Sec. 1.6664-4(b)(1), Income Tax Regs.



Reliance upon the advice of a tax professional may establish reasonable cause and good faith for the purpose of avoiding a section 6662(a) penalty. See United States v. Boyle, 469 U.S. 241, 250 (1985) ("Courts have frequently held that 'reasonable cause' is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney".). Such reliance does not serve as an "absolute defense"; it is merely "a factor to be considered." Freytag v. Commissioner, supra at 888. The caselaw sets forth the following three requirements in order for a taxpayer to use reliance on a tax professional to avoid liability for a section 6662(a) penalty: "(1) The adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser's judgment." See Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002).



Petitioner argues in summary fashion that she is not liable for the penalty because she "was allowed to offset in excess of 90% of the gambling winnings with the losses." We are unpersuaded. To begin with, whether she has been allowed to offset most of her gambling income with gambling losses, although relevant to the amount of the section 6662 penalty, is irrelevant to the issue of whether she negligently underpaid tax because she failed to report gambling income.



As for her reliance on Mr. Tsai, petitioner has failed to demonstrate that she has satisfied the latter two prongs of the Neonatology test. As to the first Neonatology prong, we accept that Mr. Tsai, as a C.P.A., was a competent professional who had sufficient expertise to justify reliance. See supra note 3. As to the second Neonatology prong, petitioner has provided no evidence that she supplied Mr. Tsai with necessary and accurate information. Indeed, the only information of record as to what Mr. Tsai had in his possession when he prepared the return is petitioner's testimony that "my former husband got all this paperwork and presented it to the tax preparer."



As to the final Neonatology prong, petitioner has not demonstrated that her reliance on Mr. Tsai was in good faith. In that regard, petitioner had a duty to examine her return to ensure that all income items were included. Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981). She has conceded that she failed to do so. Specifically, at trial petitioner acknowledged that she reads arabic numerals and that she understood that she was signing the 2004 joint return under penalty of perjury. However, when asked by respondent's counsel "Did you take the time to look at the numbers on the return before you signed it?", she answered: "Well, I didn't look at the detail on that. Just signed it." When asked by the Court whether she had an opportunity to ask Mr. Tsai, who petitioner acknowledged spoke Chinese, questions about the return, petitioner answered: "Well, I didn't ask. I had [the] opportunity, but I didn't ask."



The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.



To reflect the foregoing,



Decision will be entered under Rule 155.


1 Unless otherwise indicated, section references are to the Internal Revenue Code of 1986, as amended and in effect for the tax year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

2 Respondent asserts on brief that "Petitioner intends to argue on brief that she is entitled to have the deficiency in tax for 2004 computed based on head of household rates." Respondent then argues that petitioner is not entitled to such treatment. In any event, petitioner did not raise that issue in her petition or at any other time. Thus, even if her deficiency could now be computed at the head of household tax rate, petitioner is deemed to have conceded that she does not qualify for head of household filing status for 2004. See Rule 34(b)(4). There is no evidence that suggests otherwise, were the matter preserved for consideration on the merits.

3 Records of the California Board of Accountancy, which this Court will take judicial notice of, indicate that Mr. John Tzung-Hsun Tsai has been a licensed certified public accountant since Sept. 27, 1991.

4 Petitioner listed herself and Mr. Wei as the taxpayers in her petition. On Mar. 15, 2007, the Court dismissed the case for lack of jurisdiction as to Mr. Wei.

5 Petitioner testified at trial through a translator.

301.6112-1(b)(1) reporting requirement

To the extent tax return preparers are involved in the reporting requirement on behalf of "material advisors," the following are the regulations under which the IRS is now requesting comment in connection with reportable transactions. Obviously, the 6694 penalty will be applied automatically for any "reportable transaction" that is not reported because the requirements are mandatory.

Proposed Amendments of Regulations (REG-103043-05) , published in the Federal Register on November 2, 2006.

[ Code Sec. 6112]



Amendments of Reg. §301.6112-1, providing the rules relating to the obligation of material advisors to prepare and maintain lists with respect to reportable transactions, are proposed. The text is at: ¶37,021A.




AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations under section 6112 of the Internal Revenue Code which provide the rules relating to the obligation of material advisors to prepare and maintain lists with respect to reportable transactions. These regulations affect material advisors responsible for keeping lists under section 6112.

DATES: Written or electronic comments and requests for a public hearing must be received by January 31, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-103043-05), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-103043-05), Courier's Desk, Internal Revenue Service, Crystal Mall 4 Building, 1901 S. Bell St., Arlington, VA., or sent electronically, via the IRS Internet site at www.irs.gov/regs or via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-103043-05).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Tara P. Volungis or Charles Wien, 202-622-3070; concerning the submissions of comments and requests for hearing, Kelly Banks, 202-622-0392 (not toll-free numbers).



SUPPLEMENTARY INFORMATION:



Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget , Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service , Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by January 2, 2007.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information (see below);

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collections of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of service to provide information.

The collection of information in this proposed regulation is in §301.6112-1(b) and (d). This information is required in order for a material advisor to comply with the list maintenance rules under section 6112. This information will be used to improve compliance with the tax laws by giving the IRS earlier notification of transactions that may not comport with the tax laws. The collection of information is mandatory. The likely respondents are business or other for-profit institutions or individuals.

Estimated total annual reporting burden: 50,000 hours.

Estimated average annual burden hours per respondent: 100 hours.

Estimated number of respondents: 500.

Estimated annual frequency of responses: on occasion.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.



Background

This document proposes to amend 26 CFR part 301 by amending the rules relating to the list maintenance requirements of material advisors with respect to reportable transactions under section 6112.

The American Jobs Creation Act of 2004, Public Law 108-357, 118 Stat. 1418, (AJCA) was enacted on October 22, 2004. Section 815 of the AJCA amended section 6112 to provide that each material advisor (as defined in section 6111, as amended by the AJCA) with respect to any reportable transaction is required to maintain a list (in such manner as the Secretary may by regulations prescribe) identifying each person with respect to whom the advisor acted as a material advisor with respect to the transaction, and containing other information as the Secretary may by regulations require. Section 815 of the AJCA is effective for transactions with respect to which material aid, assistance, or advice is provided after October 22, 2004. Prior to the amendments to section 6111 made by the AJCA, the definition of material advisor was in §301.6112-1 of the Procedure and Administration Regulations.

In response to the AJCA, the IRS and Treasury Department issued interim guidance affecting section 6112 in Notice 2004-80, 2004-2 C.B. 963; Notice 2005-17, 2005-1 C.B. 606; Notice 2005-22, 2005-1 C.B. 756; and Notice 2006-6, 2006-5 I.R.B. 385 (see §601.601(d)(2)). The IRS and Treasury Department have received various comments and questions regarding the application of section 6112 under the AJCA. Consequently, the IRS and Treasury Department propose amendments to the rules relating to the list maintenance obligation of material advisors under section 6112.



Explanation of Provisions



A. In General

These proposed regulations are being issued concurrently with proposed regulations under §1.6011-4 and §301.6111-3 published elsewhere in the Federal Register . The definition of material advisor is provided in the proposed regulations under §301.6111-3(b). The definition of reportable transaction is provided in the proposed regulations under §1.6011-4(b)(1). Under these proposed regulations, each material advisor for any reportable transaction must maintain a list identifying each person with respect to whom the advisor acted as a material advisor and containing other information described in the regulations.



B. The List

The information that must be contained in the list under these proposed regulations is similar to the information required to be included on the list under the current §301.6112-1 regulations, with some additions or clarifications, such as, the name of each other material advisor to the transaction, if known by the material advisor, and any designation agreement to which the material advisor is a party. The IRS and Treasury Department believe that this information is required to be provided under the current regulations. However, due to questions raised by material advisors under the current regulations, these proposed amendments clarify that the name of other material advisors and designation agreements are required to be maintained.

To date, the IRS has received lists under the current regulations that are not in a form that enables the IRS to determine without undue delay or difficulty the information required under the regulation. Some material advisors have merely produced boxes of documents rather than a list as required under §301.6112-1. Under section 6708 as amended by the AJCA, any person who is required to maintain a list under section 6112(a) who fails to make the list available to the Secretary upon written request within 20 business days after the date of the request, must pay a penalty of $10,000 for each day of such failure. Failure to maintain the list in accordance with these regulations also subjects a person to the penalty under section 6708. The proposed regulations specifically clarify that the list to be maintained by the material advisor and furnished to the IRS upon request consists of three separate components: (1) an itemized statement of information, (2) a detailed description of the transaction, and (3) copies of documents relating to the transaction. The itemized statement of information must contain all of the requested information in a form that is easy to understand (for example, in a format such as a list, spreadsheet, or table). In order for the material advisor to be in compliance with its obligations under section 6112, the material advisor must maintain and furnish in the time prescribed the itemized statement of information, the description of the transaction, and the copies of documents. Under the proposed regulations, the Secretary, in published guidance, may provide a form or method for maintaining and/or furnishing a list.



C. Other Clarifications and Modifications

The proposed regulations remove the provision detailing how a privilege is claimed with regard to certain information on the list. The regulations continue to require that if a claim of privilege is made, the material advisor must continue to maintain the list in accordance with these regulations.

Similar to provisions in the current §301.6112-1 regulations, material advisors under the proposed regulations may have a designation agreement authorizing one material advisor to maintain and furnish the list. However, the designation agreement does not relieve the other material advisors of their obligation to furnish the list if the designated material advisor fails to furnish the list in a timely manner. Thus, parties to a designation agreement may still be liable for the penalty under section 6708.

Contrary to the provisions in the current regulations under §301.6112-1, these proposed regulations contain no provision to toll the requirement for maintaining the list when a potential material advisor requests a private letter ruling on a specific transaction. The IRS and Treasury Department believe that removing the tolling provision will promote effective tax administration. Consequently, potential material advisors may request a ruling on a transaction, as provided in the temporary regulations under §301.6111-3T(h), under the regular procedures for requesting a ruling, provided the ruling request is not factual or hypothetical, but the requirement for disclosing the transaction under section 6111 and maintaining the list under section 6112 will not be tolled. Final regulations removing the tolling provision are being issued concurrently with these proposed regulations. The removal of the tolling provision is effective for all ruling requests received on or after November 1, 2006.



D. Effective Date

Generally, when these proposed regulations become final, they will apply to transactions with respect to which a material advisor makes a tax statement on or after the date the regulations are published as final regulations in the Federal Register . However, upon publication the final regulations will apply to transactions of interest entered into on or after November 2, 2006 with respect to which a material advisor makes a tax statement under §301.6111-3 on or after November 2, 2006.



Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that most of the information is already required to be reported under the current regulations; the clarifications and new information required by the proposed regulations add little or no new burden to the existing requirements. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.



Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and Treasury Department request comments on the clarity of the proposed rules, how they can be made easier to understand, and the administrability of the rules in the proposed regulations. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that submits timely written or electronic comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register .



Drafting Information

The principal authors of these regulations are Tara P. Volungis and Charles Wien, Office of the Associate Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.



List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.



Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301 is proposed to be amended as follows:



PART 301 --PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 301.6112-1 is revised to read as follows:

§301.6112-1 Material advisors of reportable transactions must keep lists of advisees, etc.

(a) In general. Each material advisor, as defined in §301.6111-3(b), with respect to any reportable transaction, as defined in §1.6011-4(b) of this chapter, shall prepare and maintain a list in accordance with paragraph (b) of this section and shall furnish such list to the Internal Revenue Service (IRS) in accordance with paragraph (e) of this section.

(b) Preparation and maintenance of lists --(1) In general. A separate list must be prepared and maintained for each reportable transaction. However, one list must be maintained for substantially similar transactions. A list must be maintained in a form that enables the IRS to determine without undue delay or difficulty the information required in paragraph (b)(3) of this section. The Secretary may, by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter), provide a form or method for maintaining and/or furnishing a list.

(2) Persons required to be included on lists. A material advisor is required to maintain a list identifying each person with respect to whom the advisor acted as a material advisor with respect to the reportable transaction. However, a material advisor is not required to identify a person on the list if the person entered into a listed transaction or a transaction of interest more than 6 years before the transaction was identified in published guidance as a listed transaction or a transaction of interest.

(3) Contents. Each list must include the three components described in paragraph (b)(3)(i), (ii), and (iii) of this section.

(i) Statement. An itemized statement containing the following information --

(A) The name of each reportable transaction, the citation to the published guidance number identifying the transaction if the transaction is a listed transaction or a transaction of interest, and the reportable transaction number obtained under section 6111;

(B) The name, address, and TIN of each person required to be included on the list;

(C) The date on which each person required to be included on the list entered into each reportable transaction, if known by the material advisor;

(D) The amount invested in each reportable transaction by each person required to be included on the list, if known by the material advisor;

(E) A summary or schedule of the tax treatment that each person is intended or expected to derive from participation in each reportable transaction; and

(F) The name of each other material advisor to the transaction, if known by the material advisor.

(ii) Description of the transaction. A detailed description of each reportable transaction that describes both the tax structure of the transaction and the purported tax treatment of the transaction.

(iii) Documents. The following documents --

(A) A copy of any designation agreement (as described in paragraph (f) of this section) to which the material advisor is a party; and

(B) Copies of any additional written materials, including tax analyses or opinions, relating to each reportable transaction that are material to an understanding of the purported tax treatment or tax structure of the transaction that have been shown or provided to any person who acquired or may acquire an interest in the transactions, or to their representatives, tax advisors, or agents, by the material advisor or any related party or agent of the material advisor. However, a material advisor is not required to retain earlier drafts of a document provided the material advisor retains a copy of the final document (or, if there is no final document, the most recent draft of the document) and the final document (or most recent draft) contains all the information in the earlier drafts of such document that is material to an understanding of the purported tax treatment or the tax structure of the transaction.

(c) Definitions. For purposes of this section, the following terms are defined as:

(1) Material advisor. The term material advisor is defined in §301.6111-3(b).

(2) Reportable transaction. The term reportable transaction is defined in §1.6011-4(b)(1) of this chapter.

(3) Listed transaction. The term listed transaction is defined in §1.6011-4(b)(2) of this chapter. See also §§20.6011-4(a), 25.6011-4(a), 31.6011-4(a), 53.6011-4(a), 54.6011-4(a), or 56.6011-4(a) of this chapter.

(4) Substantially similar. The term substantially similar is defined in §1.6011-4(c)(4) of this chapter.

(5) Person. The term person is defined in §301.6111-3(c)(4).

(6) Related party. A person is a related party with respect to another person if such person bears a relationship to such other person described in section 267(b) or 707(b).

(7) Tax. The term tax is defined in §301.6111-3(c)(6).

(8) Tax benefit. The term tax benefit is defined in §301.6111-3(c)(7).

(9) Tax return. The term tax return is defined in §301.6111-3(c)(8).

(10) Tax structure. The term tax structure is defined in §301.6111-3(c)(9).

(11) Tax treatment. The term tax treatment is defined in §301.6111-3(c)(10).

(12) Transaction of interest. The term transaction of interest is defined in §1.6011-4(b)(6) of this chapter. See also §§20.6011-4(a), 25.6011-4(a), 31.6011-4(a), 53.6011-4(a), 54.6011-4(a), or 56.6011-4(a) of this chapter.

(d) Retention of lists. Each material advisor must maintain each component of the list described in paragraph (b)(3) of this section in a readily accessible form for seven 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, if known. If the material advisor required to prepare, maintain, and furnish the list is a corporation, partnership, or other entity (entity) that has dissolved or liquidated before completion of the seven-year period, the person responsible under state law for winding up the affairs of the entity must prepare, maintain and furnish each component of the list on behalf of the entity, unless the entity submits the list to the Office of Tax Shelter Analysis (OTSA) within 60 days after the dissolution or liquidation. If state law does not specify any person as responsible for winding up the affairs, then each of the directors of the corporation, the general partners of the partnership, or the trustees, owners, or members of the entity are responsible for preparing, maintaining and furnishing each component of the list on behalf of the entity, unless the entity submits the list to the OTSA within 60 days after the dissolution or liquidation. The responsible person must also provide notice to OTSA of such dissolution or liquidation within 60 days after the dissolution or liquidation. The list and the notice provided to OTSA must be sent to: Internal Revenue Service, OTSA Mail Stop 4915, 1973 North Rulon White Blvd., Ogden, Utah 84404, or to such other address as provided by the Commissioner.

(e) Furnishing of lists --(1) In general. Each material advisor responsible for maintaining a list must, upon written request by the IRS, make each component of the list described in paragraph (b)(3) of this section available to the IRS by furnishing each component of the list to the IRS within 20 business days from the day on which the request is provided. The 20 business-day period shall begin on the first business day following the earlier of the date that the IRS mails a request for the list by certified or registered mail to the last known address of the material advisor required to maintain the list, or hand-delivers the written request in person. Business days include every calendar day other than Saturdays, Sundays, or legal holidays. For purposes of this paragraph (e), legal holiday shall have the same meaning provided in section 7503. The request is not required to be in the form of an administrative summons. Each component of the list must be furnished to the IRS in a form that enables the IRS to determine without undue delay or difficulty the information required in paragraph (b)(3) of this section. If any component of the list is not in a form that enables the IRS to determine without undue delay or difficulty the information required in paragraph (b)(3) of this section, the material advisor will not be considered to have complied with the list maintenance provisions in section 6112 and this section.

(2) Claims of privilege. Each material advisor who is required to maintain a list with respect to a reportable transaction, must still maintain the list pursuant to the requirements of this section even if a person asserts a claim of privilege with respect to the information specified in paragraph (b)(3)(iii)(B) of this section.

(f) Designation agreements. If more than one material advisor is required to maintain a list of persons for a reportable transaction, in accordance with paragraph (b) of this section, the material advisors may designate by written agreement a single material advisor to maintain the list or a portion of the list. The designation of one material advisor to maintain the list does not relieve the other material advisors from their obligation to furnish the list to the IRS in accordance with paragraph (e)(1) of this section, if the designated material advisor fails to furnish the list to the IRS in a timely manner. A material advisor is not relieved from the requirement of this section because a material advisor is unable to obtain the list from any designated material advisor, any designated material advisor did not maintain a list, or the list maintained by any designated material advisor is not complete.

(g) Effective date. In general, this section applies to transactions with respect to which a material advisor makes a tax statement under §301.6111-3 on or after the date these regulations are published as final regulations in the Federal Register . However, upon the publication of final regulations, this section will apply to transactions of interest entered into on or after November 2, 2006 with respect to which a material advisor makes a tax statement under §301.6111-3 on or after November 2, 2006.

Mark E. Matthews

Deputy Commissioner for Services and Enforcement.



Notice and Request for Comments Regarding NPRM REG-103043-05

August 28, 2008

DEPARTMENT OF THE TREASURY

Internal Revenue Service

[REG-103043-05 ]

Proposed Collection; Comment Request for Regulation Project

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice and request for comments.

SUMMARY: The Department of the Treasury, as part of its continuing effort to reduce paperwork and respondent burden, invites the general public and other Federal agencies to take this opportunity to comment on proposed and/or continuing information collections, as required by the Paperwork Reduction Act of 1995, Public Law 104-13(44 U.S.C. 3506(c)(2)(A)). Currently, the IRS is soliciting comments concerning an existing final regulation, REG-103043-05 , Material Advisor of Reportable Transaction Must Keep List of Advisees, etc. (previously REG-103736-00 , Requirement to Maintain List of Investors in Potentially Abusive Tax Shelters).

DATES: Written comments should be received on or before [INSERT DATE 60 DAYS AFTER DATE OF PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER ] to be assured of consideration.

ADDRESSES: Direct all written comments to Glenn P. Kirkland, Internal Revenue Service, room 6129, 1111 Constitution Avenue NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Requests for additional information or copies of the regulation should be directed to Carolyn N. Brown, at (202) 622-6688, or at Internal Revenue Service, room 6129, 1111 Constitution Avenue NW., Washington, DC 20224, or through the internet at Carolyn.N.Brown@irs.gov.

SUPPLEMENTARY INFORMATION:

Title: Material Advisor of Reportable Transaction Must Keep List of Advisees, etc.

OMB Number: 1545-1686.

Regulation Project Number: REG-103043-05 .

Abstract: These final regulations provide guidance on the requirement under section 6112 to maintain a list of investors in potentially abusive tax shelters. As per Regulations section 301.6112-1(b)(1), Form 13976 (Itemized Statement Component of Advisee List) provides material advisors a format for preparing and maintaining the itemized statement component of the list with respect to a reportable transaction. This form contains space for all of the elements required by Regulations section 301.6112-1(b)(3)(i). Material advisors may use this form as a template for creating a similar form on a software program used by the material advisor. If a material advisor is required to maintain a list under a prior version of the regulations, this form may be modified or a similar form containing all the information required under the prior version o the regulations may be created and used.

Current Actions: There is no change to this existing regulation.

Type of Review: Extension of a currently approved collection.

Affected Public: Business or other for-profit organizations, individuals or households.

Estimated Number of Respondents: 500.

Estimated Time per Respondent: 100 hours.

Estimated Total Annual Burden Hours: 50,000.

The following paragraph applies to all of the collections of information covered by this notice:

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number. Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

REQUEST FOR COMMENTS: Comments submitted in response to this notice will be summarized and/or included in the request for OMB approval. All comments will become a matter of public record. Comments are invited on: (a) Whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility; (b) the accuracy of the agency's estimate of the burden of the collection of information; (c) ways to enhance the quality, utility, and clarity of the information to be collected; (d) ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and (e) estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

Approved: August 21, 2008

Allan M. Hopkins,

IRS Reports Clearance Officer