Annual Update on Adequate Disclosure of Return Positions Issued

The IRS 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. 2012-15).

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. According to the IRS, Rev. Proc. 2012-15 has been updated to correct a reference in Section 4.01(4) of Rev. Proc. 2011-13 (last year’s update) to the incorrect line in Part III of Schedule M-3 (Form 1120), Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More. The correct reference is to “line 37, Other expense/deduction items with differences.”

The second change is that the language in Section 4.02(2)(d), “the employee-remuneration deduction limitations under the amended” Sec. 162(m), is changed to “the employee-remuneration limitations under the amended” Sec. 162(m) (that is, the word “deduction” is removed).

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), which applies to tax return preparers. 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 2011 tax form for a tax year beginning in 2011 and to any income tax return filed on a 2011 tax form for short tax years beginning in 2012.

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. (Different rules apply to corporations.) The amount of an understatement is reduced by any portion of the understatement attributable to items, other than tax-shelter items, 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 or reportable transaction positions, 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.