IRS Updates Guidance on Adequate Disclosure of Positions

The IRS has released updated guidance identifying when a taxpayer’s disclosure of an item or position in an income tax return is adequate for purposes of reducing the understatement of tax penalty and the tax return preparer penalty for understatement due to unreasonable positions (Rev. Proc. 2011-13).

The IRS regularly releases guidance on what constitutes adequate disclosure of positions for purposes of avoiding the Sec. 6662 understatement penalty and the Sec. 6694 preparer penalty. Rev. Proc. 2011-13 include updates for:

• The Sec. 6662(i) increased accuracy-related penalty in the case of nondisclosed transactions that lack economic substance;
• The Sec. 6662(j) increased accuracy-related penalty for undisclosed foreign financial asset understatements; and
• New Schedule UTP, Uncertain Tax Position Statement, required of certain corporations.

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 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 any income tax return filed on a 2010 tax form for a tax year beginning in 2010 and to any income tax return filed on a 2010 tax form for short tax years beginning in 2011.

Sec. 6662(d) provides (for non-tax-shelter 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.