In revising the annual Revenue Procedure (Revenue Procedure 2016-13) that contains the provisions that would provide for adequate disclosure for purposes of avoiding certain penalties under §6662 (accuracy related penalty imposed on taxpayers) and §6694 (paid preparer penalties), the IRS reduced the amount of information certain taxpayers must provide on Schedule M-3 to have adequate disclosure.
The annual procedure is meant to provide guidance as to what constitutes adequate disclosure of positions that do not have substantial authority but do have a reasonable basis. Adequate disclosure of such positions in most cases serves to eliminate the accuracy related penalty due on substantial understatements of tax or the paid preparer penalty for a tax deficiency related to an unreasonable position.
The taxpayer penalty under §6662 for substantial understatement of 20% for an individual applies to any understatement of tax that exceeds the greater of:
- 10% of the amount of tax that should have shown on the return or
For a corporation (other than a personal holding company or S corporation) the penalty (again set at 20%) applies to an understatement that exceeds the lesser of:
- 10% of the tax required to be shown on the return (or $10,000 if less) or
The protection provided by this revenue procedure does not apply to a position if it either the position is attributable to a tax shelter (as defined in IRC §6662(d)(2)(c)(ii)) or the taxpayer failed to keep adequate books and records to support the position or otherwise failed to keep required substantiation (such as the documentation requirements found in IRC §274(d) for listed property).
The §6694(a) preparer penalty imposes a penalty on a paid preparer of the greater of $1,000 or ½ of the fee received for the matter in question if there is an “unreasonable position” on the return that the the preparer was or should have been aware of that leads to a tax assessment. A position leading to an understatement is generally unreasonable unless:
- Substantial authority existed in support of the position or
- The position has a reasonable basis and was properly disclosed (in accordance with this revenue procedure) on the return.
This year’s changes are summarized by the IRS as follows:
Editorial changes have been made throughout this revenue procedure. In addition, section 4.02(3) has been updated to reflect that for tax years ending December 31, 2014, or later, filers that (a) are required to file Schedule M-3 (Form 1120), Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More, and have less than $50 million in total assets at the end of the tax year or (b) are not required to file Schedule M-3 and voluntarily file Schedule M-3, are not required to file Schedule B (Form 1120), Additional Information for Schedule M-3 Filers. Section 4.02(3) has also been updated to reflect that for tax years ending on December 31, 2014, or later, partnerships that (a) are required to file Schedule M-3 (Form 1065), Net Income (Loss) Reconciliation for Certain Partnerships, and have less than $50 million in total assets at the end of the tax year or (b) are not required to file Schedule M-3 and voluntarily file Schedule M-3, are not required to file Schedule C (Form 1065), Additional Information for Schedule M-3 Filers. No additional substantive changes have been made.
Section 4 of the Revenue Procedure contains the requirements that must be met to have adequate disclosure for penalty purposes. Generally a Form 8275 or Form 8275-R is used to make a disclosure along with providing all information requested by the IRS forms and instructions. As well, anytime an understatement arises from a transaction between related parties that presents a legal issue or controversy due to the related party transaction (such as issue arising under IRC §482 for allocation of income and deductions among taxpayers) a Form 8275 or Form 8275-R must be filed with the return to have adequate disclosure.
In addition to any Form 8275 and/or Form 8275-R filing requirements, the Revenue Procedure provides specific information and procedures to be followed for specific forms and return types.
This procedure is a very significant procedure for any professional involved in compliance work, since a failure to meet the requirements provided in this procedure may end up costing the taxpayer penalties that otherwise could have been avoided.