The IRS has issued proposed regulations (REG-103033-11) that would provide guidance on the application of the failure to disclose a reportable transaction penalty found in IRC §6707A.
Generally a taxpayer who participates in a reportable transaction must disclose such participation on any return affected by the transaction in question under IRC §6011. A taxpayer who fails to make such a required disclosure (generally on a Form 8886) is subject to a penalty.
In 2010 the penalty rules were modified. Generally the penalty is equal to 75% of the decrease in tax that takes place on the return for which disclosure was not made, subject to a minimum and maximum amount. For a natural person the minimum penalty is $5,000, while the maximum penalty is $10,000 unless the transaction is a listed transaction in which case the maximum rises to $100,000.
For other taxpayers the minimum is set at $10,000, with the maximum penalty capped at $50,000 unless the transaction is a listed transaction in which case the maximum rises to $200,000.
The regulations that are currently in place do not address the 2010 law changes, so these regulations would update the regulations to reflect the law as it currently stands rather than as it was originally enacted in 2004.
The regulations first start by outlining the calculation of the difference in tax on which the 75% penalty is computed. As the preamble notes:
The proposed regulations define this decrease in tax generally as the difference between the amount of tax reported on the return as filed and the amount of tax that would be reported on a hypothetical return where the taxpayer did not participate in the reportable transaction. The amount of tax shown on the hypothetical return will reflect adjustments that result mechanically from backing out the reportable transaction, such as tax items affected by an increase in adjusted gross income resulting from non-participation in the reportable transaction.
The proposed regulations also have a provision to deal with a situation where a taxpayer, by entering into what is found to be a prohibited transaction, may be found to owe more tax than if the transaction had not entered into—specifically penalties for excess contributions to retirement accounts.
The preamble describes the proposed treatment as follows:
In some situations, a taxpayer's participation in a listed transaction creates a liability for a tax that would not exist absent participation in the transaction. For example, a taxpayer engaging in a listed abusive Roth IRA transaction may be subject to an excise tax on excess IRA contributions. If the taxpayer fails to report the excise tax on his excess IRA contributions, this amount of tax would not appear on the return filed by the taxpayer that reflected his participation in the reportable transaction. The excise tax would also not appear on a return filed by the taxpayer if he had not engaged in the transaction, because there would be no excess contribution on which excise tax would be imposed. Therefore, the difference between these two returns would result in no decrease in tax attributable to the unreported tax. To capture this tax, the proposed regulations include in the definition of the decrease in tax "any other tax that results from participation in the reportable transaction but was not reported on the taxpayer's return."
The proposed regulations contain the following example to illustrate the application of this provision:
Example 1. Taxpayer X, a natural person, filed a return reflecting participation in an abusive Roth IRA transaction listed in Notice 2004-8, 2004-1 I.R.B. 333 (Jan. 26, 2004). As described in the notice, X's Roth IRA acquired shares of a wholly owned corporation and then X sold assets to the corporation at less than fair market value, effectively transferring value to the corporation comparable to a contribution to the Roth IRA. X failed to disclose his participation in the listed transaction as required by the regulations under section 6011. As a result of the transaction, X was liable under section 4973 for a $10,000 excise tax for excess contributions to his Roth IRA. On his return, X correctly reported $25,000 of income tax, none of which was attributable to the listed transaction, but failed to report the excise tax. If X had not participated in the listed transaction, the excise tax under section 4973 would not have applied and his income tax would have remained $25,000. There would, therefore, be no difference between the tax on his return as filed and the tax on his return if it did not reflect participation in the transaction. The excise tax, however, is another tax that resulted from participation in the transaction but was not reported on X's return, as described in paragraph (d)(1)(i)(B) of this section. Therefore, the decrease in tax resulting from the listed transaction is $10,000, which amount is the sum of zero (the excess of the amount of tax that would be shown on X's return if the return did not reflect X's participation in the transaction over the tax X actually reported on the return reflecting X's participation in the transaction) and $10,000 (the amount of excise tax that resulted from participation in the transaction but was not reported on the return). The amount of the penalty will be $7,500, which amount is 75 percent of the $10,000 decrease in tax.
Special rules apply to disclosures when a transaction is identified as a listed transaction after the taxpayer has filed the return but before the statute of limitations has run. In such a case the taxpayer is allowed, pursuant to Reg. §1.6011-4, to file a single disclosure covering all of the years affected.
The proposed regulations look at how a penalty would be computed where a taxpayer fails to make the disclosure noted:
Under §1.6011-4, the taxpayer may use a single disclosure statement to disclose multiple years of participation in a reportable transaction. Because the taxpayer in these cases is permitted to disclose multiple years of participation on a single statement, the taxpayer's failure to complete and submit the disclosure statement properly will result in no more than one penalty under section 6707A. The proposed regulations provide, however, that the amount of that penalty will be determined by taking into account the aggregate decrease in tax shown on all of the returns for which disclosure was not provided. Accordingly, under the proposed regulations, the decrease in tax will be determined separately for each year of participation for which only a single disclosure statement was required and the amount of the penalty will be 75 percent of the aggregate decrease in tax in all years for which disclosure was required, subject to the minimum and maximum penalty amount limitations.
The proposed regulations also deal with what the IRS sees as an inadvertent failure of Congress to handle the related penalty for failure to disclose their liability for various penalties to the SEC. As the IRS notes in the preamble:
Section 6707A(e) generally requires certain taxpayers who must pay penalties under sections 6707A, 6662A(accuracy-related penalty on understatements with respect to reportable transactions), or 6662(h) (accuracy-related penalty on underpayments attributable to gross valuation misstatements) to disclose their liability for these penalties in filings with the SEC. The flush language of section 6707A(e) provides that "[f]ailure to make a disclosure in accordance with the preceding sentence shall be treated as a failure to which the penalty under subsection (b)(2) applies." However, as discussed in the Background section of this preamble, subsection (b)(2) was amended in 2010. Prior to enactment of the Jobs Act, section 6707A(b)(2) provided that the amount of the penalty for failure to disclose participation in a listed transaction was $100,000 for natural persons and $200,000 in any other case. After the 2010 amendments, section 6707A(b)(2) now provides that "[t]he amount of the penalty under subsection (a) with respect to any reportable transaction shall not exceed -- (A) in the case of a listed transaction, $200,000 ($100,000 in the case of a natural person), or (B) in the case of any other reportable transaction, $50,000 ($10,000 in the case of a natural person)."
Treasury and the Service do not believe that Congress intended its reference to subsection (b)(2) to impose the maximum penalty on violations of section 6707A(e). This would be contrary to the purpose of the 2010 amendments to section 6707A, which sought to make the penalty proportionate to the tax benefit derived by the transaction. A reference solely to subsection (b)(2) does not make sense in terms of describing the amount of the penalty, as subsection (b)(2) merely caps the amount of the penalty that can be imposed on a failure to disclose and does not provide a particular amount for the penalty. It seems likely that the intent was to reference the amount of the penalty generally under subsection (b). The proposed regulations clarify this point.
In each case giving rise to an obligation to disclose liability in filings with the SEC, there must be a reportable transaction for the relevant penalty to arise. The amount of the penalty for a violation of section 6707A(e), therefore, will be 75 percent of the decrease in tax, as provided in section 6707A(b). In addition to being consistent with the language of section 6707A(e), the proposed regulations are also consistent with the Congressional intent of the 2010 amendments to section 6707A to render proportionality between the amount of the penalty and the tax benefit derived from the reportable transaction. See JCS-2-11.
The proposed regulations also clarify how the minimum and maximum provisions apply when there are multiple failures to disclose. The preamble notes:
Pursuant to section 6707A(b)(2), "[t]he amount of the penalty under subsection (a) with respect to any reportable transaction shall not exceed" certain specified dollar values. Likewise, under section 6707A(b)(3), "[t]he amount of the penalty under subsection (a) with respect to any transaction shall not be less than" certain specified dollar values. Under the proposed regulations, these minimum and maximum limits on the amount of the penalty would be applied separately to each individual penalty under section 6707A(a). The limitations in sections 6707A(b)(2) and (3) apply expressly to "[t]he amount of the penalty under subsection (a)." Because, as provided in §301.6707A-1(c), each separate failure to disclose a reportable transaction gives rise to a new penalty under section 6707A(a), the minimum and maximum limits on the amount of the penalty apply separately to each failure to disclose.
The regulations would apply to penalties assessed after the day they are are published as final regulations. However, for portions where the current regulations no longer describe the law that exists today, advisers likely can assume these regulations reflect positions the IRS will be likely to assert when assessing such a penalty.