IRS Proposes Rule Updates and Clarifications to Penalty for Nondisclosure of Reportable Transactions

The IRS issued proposed regulations Thursday (REG-103033-11) that would update and clarify the rules regarding the penalty for failure to disclose reportable transaction information.

Sec. 6707A imposes a penalty for failing to include on any return or statement any information with respect to a reportable transaction that is required to be included with the return or statement. Reportable transactions are ones that the IRS has determined have a potential for tax avoidance or evasion. Sec. 6707A also prescribes a heightened penalty for listed transactions, which are reportable transactions that are the same as, or substantially similar to, certain transactions the IRS has identified as tax avoidance transactions.

In addition, Sec. 6707A(e) imposes a penalty for failure to disclose in required periodic reports to the SEC any penalty under Sec. 6707A a person is required to pay with respect to a listed transaction; any penalty a person is required to pay under Sec. 6662A (accuracy-related penalty on understatement of tax) with respect to a reportable transaction; and any penalty under Sec. 6662(h) (increase in accuracy-related penalty in case of gross-valuation misstatements) for a reportable transaction.

Before amendment by the Small Business Jobs Act, P.L. 111-240, Sec. 6707A(b) prescribed stated dollar amounts for penalties (for reportable transactions, $10,000 in the case of a natural person and $50,000 in any other case; for listed transactions, $100,000 for natural persons and $200,000 otherwise). Responding to concerns that those amounts could be disproportionate to the tax benefits derived from the transactions, Congress in the Small Business Jobs Act set a penalty of 75% of the decrease in tax shown on the return as a result of the transaction (or that would have resulted if the transaction were respected), with maximum amounts (for listed transactions, $100,000 for natural persons and $200,000 otherwise; for any other reportable transactions, $10,000 for natural persons and $50,000 otherwise) and minimum amounts (for any transaction, $5,000 for natural persons and $10,000 otherwise).

The proposed regulations issued Thursday clarify the phrase “decrease in tax” (1) as reflecting the difference between the amount of tax reported on the filed return and a hypothetical return without the reportable transaction, taking into account “adjustments that result mechanically from backing out the reportable transaction” and (2) as including “any other tax that results from participation in the reportable transaction but was not reported on the taxpayer’s return,” such as an excise tax on excess individual retirement account contributions.

Also, the proposed regulations address the situation where a taxpayer uses a single disclosure statement to disclose multiple years of participation in a reportable transaction, as allowed under Regs. Sec. 1.6011-4. The proposed rules state that in such instances the decrease in tax will nonetheless be determined separately for each such year of participation, and the amount of the penalty will be 75% of the aggregate decrease in tax for all years for which disclosure was required, subject to the minimum and maximum amount limitations.

In addition, because each separate failure to disclose a reportable transaction can give rise to a penalty under Sec. 6707A(a), the proposed regulations clarify that the minimum and maximum limits apply separately to each such penalty. Prop. Regs. Sec. 301.6707A-1(d)(iv)(2) provides that where no tax is required to be shown on a return, as in the case of passthrough entities, the minimum penalty amount will be imposed for a failure to disclose a reportable transaction.

Finally, the proposed regulations clarify that the 75% calculation applies to the penalty under Sec. 6707(e) for failure to report a penalty to the SEC.

The proposed regulations also provide several new examples of the application of the penalty.

The regulations will be effective after the date they are published as final in the Federal Register.

 —Paul Bonner (pbonner@aicpa.org) is a Tax Adviser senior editor.