IRS Updates Rules on Adequate Disclosure

The IRS has updated its guidance on the rules governing when disclosure of an item or position on a tax return constitutes “adequate disclosure” for purposes of reducing an understatement of income tax or avoiding certain tax return preparer penalties (Rev. Proc. 2010-15). The guidance applies only to the substantial understatement aspect of the accuracy-related penalty under Sec. 6662(d) and the penalty for understatement due to an unreasonable position under Sec. 6694(a). It does not affect other penalty provisions in the Code.

The revenue procedure provides guidance for determining what disclosure on a return (and on which specific returns) is adequate for purposes of Secs. 6662(d) and 6694(a). It updates previous guidance (Rev. Proc. 2008-14) to take into account changes made by the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, P.L. 110-343.

The guidance lists specific forms and schedules for which additional disclosure is not necessary (providing the forms and attachments are completed clearly and in accordance with their instructions). All money amounts entered on the forms must be verifiable on audit.

The new rules are effective for the current filing season; they apply to any income tax return filed for tax years beginning in 2009 and to returns filed on 2009 tax forms for short tax years beginning in 2010.

Sec. 6662(d) provides (for nontaxshelter items) that if the amount of an understatement of tax on a return is more than 10% of the correct amount of tax or $5,000 (whichever is greater), it is a substantial understatement. (Slightly different rules apply to corporations.) The amount of an understatement can be reduced by portions attributable to positions that were adequately disclosed on the return if there is a reasonable basis for the taxpayer’s treatment of the item.

Sec. 6694(a) imposes a penalty on a tax return preparer who prepares a return or claim for refund that understates the amount of tax because of an unreasonable position, if the preparer knew or should have known of the position. Except for tax shelter items, a position is unreasonable if there was no substantial authority for it or it was not properly disclosed and there was no reasonable basis for the position. Positions relating to tax shelter items or reportable transactions are treated as unreasonable unless it is reasonable to believe that they more likely than not will be sustained on their merits.