Service issues New Procedure On Adequate Disclosure for Accuracy Related Penalty Purposes
The Service has just issued Rev. Proc. 2011-13, 2011-3 I.R.B.1, which updates Rev. Proc. 2010-15) as to whether whether disclosure of a position taken on a tax return is adequate for purposes of the section 6662(d) accuracy-related penalty and the section 6694(a) tax return preparer penalty. The guidance updates the Service’s position to new section 6662(i) which provides an enhanced accuracy related penalty for non-disclosed noneconomic substance transactions; the section 6662(j) increased accuracy-related penalty for undisclosed foreign financial asset understatements; and the Schedule UTP that must be filed by some corporations. The revenue procedure applies to any income tax return filed on 2010 tax forms for a tax year beginning in 2010 and to any income tax return filed on 2010 tax forms in 2011 for short tax years beginning in 2011.
Background
This revenue procedure updates Rev. Proc. 2010-15, 2010-7 I.R.B. 404, and identifies circumstances under which the disclosure on a taxpayer's income tax return with respect to an item or a position is adequate for the purpose of reducing the understatement of income tax under section 6662(d) and for the purpose of avoiding the tax return preparer penalty under section 6694(a) (understatements due to unreasonable positions on any income tax returns). The new procedure does not apply with respect to any other penalty provisions (including the disregard provisions of the section 6662(b)(1) accuracy-related penalty, the section 6662(i) increased accuracy-related penalty in the case of nondisclosed noneconomic substance transactions, and the section 6662(j) increased accuracy-related penalty in the case of undisclosed foreign financial asset understatements). This revenue procedure has been updated to include reference to: (i) the section 6662(i) increased accuracy-related penalty in the case of nondisclosed noneconomic substance transactions; (ii) the section 6662(j) increased accuracy-related penalty in the case of undisclosed foreign financial asset understatements; and (iii) the Schedule UTP, Uncertain Tax Position Statement, a new schedule required of certain corporations.
Section 6662
Section 6662 imposes a 20% accuracy related penalty with respect to any portion of an underpayment of tax required to be shown on a return. The penalty is increased 100% to 40% of the underpayment of tax attributable to gross valuation misstatements under section 6662(h), nondisclosed noneconomic substance transactions under section 6662(i), or undisclosed foreign financial asset understatements under section 6662(j)). Section 6662(b)(2) applies to the portion of an underpayment of tax that is attributable to a substantial understatement of income tax. See §6662(d)(1) for definition of substantial understatement of income tax. See also §6662(d)(1)(B) for corporations. Understatement is defined in section 6662(d)(2), i.e., the excess of the amount of tax required to be shown on the return for the taxable year over the amount of the tax that is shown on the return reduced by any rebate (within the meaning of section 6211(b)(2)).
Section 6694
Section 6694(a) imposes return preparer penalty on a return or claim for refund which reflects an understatement of liability due to an "unreasonable position" if the tax return preparer knew (or reasonably should have known) of the position. A position (other than a position with respect to a tax shelter or a reportable transaction to which section 6662A applies) is generally treated as unreasonable unless (i) there is or was substantial authority for the position, or (ii) the position was properly disclosed in accordance with section 6662(d)(2)(B)(ii)(I) and had a reasonable basis. If the position is with respect to a tax shelter (per §6662(d)(2)(C)(ii)) or a reportable transaction (per §6662A), it is more difficult to have the penalty lifted for reasonable cause. See Notice 2009-5, 2009-3 I.R.B. 309.
The Notice announces that an accurate disclosure of a tax position on the appropriate year's Schedule UTP, Uncertain Tax Position Statement, will be treated as if the corporation filed a Form 8275 or Form 8275-R regarding the tax position. The filing of a Form 8275 or Form 8275-R, however, will not be treated as if the corporation filed a Schedule UTP.
Operative Provisions
The Procedures addresses the quality and quantity of information required to make an adequate disclosure For example, the Procedure addresses how much factual information is sufficient and requires that the money amounts entered on the forms must be verifiable, i.e., if on audit, the taxpayer can prove the origin of the amount (even if that number is not ultimately accepted by the Internal Revenue Service) and the taxpayer can show good faith in entering that number on the applicable form. Special scrutiny is given to understatements arising from transactions involving related parties. The relationship must be disclosed on Form 8275 or Form 8275-R. Parts of the Procedure are quite detailed as to what is required to be stated on the disclosure. As set forth in the regulations, a properly or adequately disclosed position still does not have a “reasonable basis” per Treas. Reg. §1.6662-3(b)(3) or is attributable to a tax shelter (per §§6662(d)(2) or (d)(3), or is not properly substantiated or the taxpayer failed to keep adequate books and records with respect to the item or position. The Procedure warns that disclosure will not avoid a tax return preparer penalty where the position is taken with respect to a tax shelter (per §6662(d)(2)(C)(ii)) or a reportable transaction to which section 6662A applies.
A separate section of the Procedure addresses the required information needed for taxpayers itemizing deductions, claiming charitable contributions, casualty and theft losses, certain expenses related to the ownership of rental property, the reasonableness of officers compensation claimed on Form 1120 and other specific items. The Procedure addresses information required to be shown on Forms M-1 or M-3, partnership returns and other return information. As to foreign tax items, the Procedure provides information related to international boycott transactions as well as treaty based return positions.
Effective Date
This revenue procedure applies to any income tax return filed on a 2010 tax form for a taxable year beginning in 2010, and to any income tax return filed on a 2010 tax form in 2011 for a short taxable year beginning in 2011.
