Sec. 6707 Material Adviser Penalty Applies on a Transaction-by-Transaction Basis

Regulations

On July 30, the IRS issued final regulations under Sec. 6707, which imposes a large penalty on any material adviser who fails to file a return required under Sec. 6111(a) disclosing a reportable transaction or who files a false or incomplete return (T.D. 9686). The regulations adopt the proposed regulations issued in 2008 (REG-160872-04) with some substantive changes and remove temporary regulations issued in 1984, when Sec. 6707 applied only to tax shelters (former Temp. Regs. Sec. 301.6707-1T).

A reportable transaction is defined as any transaction for which information is required to be included with a return or statement because the IRS has determined that the transaction is of a type that has a potential for tax avoidance or evasion (Sec. 6707A(c)(1)). The penalty for a material adviser failing to report a reportable transaction is $50,000 for each failure (Sec. 6707(b)(1)). A listed transaction is the same as a reportable transaction, except the IRS has specifically identified it as a tax avoidance transaction (Sec. 6707A(c)(2)). The penalty for a listed transaction is the greater of $200,000 or 50% of the material adviser’s gross income from the transaction (Sec. 6707(b)(2)). Sec. 6707(c) gives the IRS authority to rescind these penalties.

The 2008 proposed regulations set forth the rules for application of the penalty under Sec. 6707, including examples and relevant definitions such as the definition of incomplete information, false information, and when a failure is intentional so that the higher penalty with respect to listed transactions will apply. The 2008 proposed regulations also adopted the factors described in Rev. Proc. 2007-21 that the IRS will consider when determining whether a request for rescission of a Sec. 6707 penalty with respect to a nonlisted reportable transaction will be granted.

One change to the final regulations involves adding a new provision clarifying that when a penalty applies because a transaction is both a listed transaction and a reportable transaction, only one penalty, the higher one for listed transactions, will apply. The regulations also clarify that a material adviser will be liable for a separate penalty for each reportable or listed transaction with which he or she is involved. In addition, a section has been added to the description of gross income for purposes of the 50% penalty to exclude fees from a listed transaction for which the person is not a material adviser.

Finally, the regulations amend the provisions governing the IRS’s criteria for rescinding the penalty. Under Rev. Proc. 2007-21, a material adviser’s filing of Form 8918, Material Advisor Disclosure Statement, after the due date weighs strongly in favor of rescission unless the form is filed after the taxpayer files a Form 8886, Reportable Transaction Disclosure Statement, identifying the material adviser as an adviser for the transaction or after the IRS contacts the material adviser about the reportable transaction.

Because the IRS believes that merely filing Form 8918 before Form 8886 is filed is not sufficient to justify rescission, the final rules provide that filing Form 8918 will be a factor weighing in favor of rescinding the penalty if the facts suggest that the material adviser did not delay filing the form until after the IRS had taken steps to identify that person as a material adviser for that particular transaction. Furthermore, the late filing of Form 8918 will not weigh in favor of rescission if the facts and circumstances suggest that the material adviser delayed filing the form until after the material adviser’s client filed his or her Form 8886 disclosing the client’s participation in the reportable transaction.

These new rules apply to returns with due dates after July 31, 2014.