Part III. Administrative, Procedural, and Miscellaneous

New Penalty Section 6707A and Rescission Authority

Notice 2005–11

The purpose of this notice is to alert taxpayers to new section 6707A of the Internal Revenue Code. This notice announces that the Internal Revenue Service and the Treasury Department will issue regulations under section 6707A, which will apply to returns and statements the due date for which is after October 22, 2004, and provides guidance regarding the imposition and rescission of penalties under section 6707A. This notice also invites comments from the public regarding rules and standards relating to section 6707A.

BACKGROUND AND PRIOR LAW

Section 6011 and the regulations thereunder require a taxpayer that has participated in a reportable transaction to disclose certain information with respect to the reportable transaction with its tax return. Section 1.6011–4(b) of the Income Tax Regulations describes six categories of reportable transactions. One category of reportable transactions is a transaction that is the same as, or substantially similar to, one of the types of transactions that the Internal Revenue Service has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a “listed transaction.” Section 1.6011–4(b)(2).

Section 1.6011–4(d) requires that a taxpayer file a disclosure statement on Form 8886, Reportable Transaction Dis- closure Statement, for each reportable transaction in which the taxpayer participated. Section 1.6011–4(e)(1) provides that a reportable transaction disclosure statement is due when the taxpayer files an original or amended return that reflects the taxpayer’s participation in a reportable transaction. The taxpayer also must send a copy of the disclosure statement to the IRS Office of Tax Shelter Analysis (OTSA) at the same time that the taxpayer first files a disclosure statement with a return. In certain circumstances, a taxpayer may be deemed to have satisfied its disclosure obligations by filing Schedule M–3, Net Income (Loss) Reconciliation for Corpo-

rations With Total Assets of $10 Million or More, as provided by Rev. Proc. 2004–45, 2004–31 I.R.B. 140 (August 2, 2004). Section 6011 also requires the disclosure of listed transactions under section 20.6011–4 of the Estate Tax Regulations, section 25.6011–4 of the Gift Tax Regulations, section 31.6011–4 of the Employment Tax Regulations, section 53.6011–4 of the Foundation and Similar Excise Tax Regulations, section 54.6011–4 of the Pension Excise Tax Regulations, and section 56.6011–4 of the Public Charity Tax on Excess Lobbying Expenditure Regulations.

Prior to the enactment of section 6707A, there was no monetary penalty for the failure by a taxpayer to disclose a reportable transaction.

THE AMERICAN JOBS CREATION ACT OF 2004

The American Jobs Creation Act of 2004, P.L. 108–357, 118 Stat. 1418 (the Act) was enacted on October 22, 2004. Section 811 of the Act added section 6707A to the Code to provide a monetary penalty for the failure to include on any return or statement any information required to be disclosed under section 6011 with respect to a reportable transaction.

Section 6707A(b)(1) provides that the penalty for failure to include information with respect to a reportable transaction, other than a listed transaction, is $10,000 in the case of a natural person, and $50,000 in any other case. Section 6707A(b)(2) provides that the penalty for failure to include information with respect to a listed transaction is $100,000 in the case of a natural person, and $200,000 in any other case.

Section 6707A(d)(1) grants the Commissioner authority to rescind all or a portion of any penalty imposed by section 6707A if (1) the violation relates to a reportable transaction that is not a listed transaction and (2) rescission of the penalty would promote compliance with the requirements of the Code and effective tax administration. Section 6707A(d)(2) provides that the Commissioner’s determination whether to rescind the penalty may not be reviewed in any judicial proceeding. The legislative history to section

6707A provides that “the IRS Commissioner or his delegate can rescind (or abate) the penalty.” H.R. Conf. Rep. No. 755, 108 ^th Cong., 2d Sess. at 373 (2004). Section 6707A(e) also provides that a person that is required to file periodic reports under section 13 or 15(d) of the Securities Exchange Act of 1934, or required to be consolidated with another person for purposes of those reports, must disclose the requirement to pay the following penalties in the reports to the Securities and Exchange Commission for the periods specified by the Secretary: (1) the penalty under section 6707A for failure to disclose a listed transaction; (2) the 30 percent penalty under section 6662A for an understatement attributable to an undisclosed listed transaction or undisclosed reportable avoidance transaction; and (3) the 40 percent penalty under section 6662 for a gross valuation misstatement if the 30 percent penalty under section 6662A would have applied, but for the application of section 6662A(e)(2)(c)(ii). Section 6707A(e) also provides that the failure to make a disclosure on reports filed with the Securities and Exchange Commission as required by the Secretary shall be treated as a failure to include information with respect to a listed transaction for which the penalty under section 6707A applies.

The penalty under section 6707A is in addition to any other potentially applicable penalties, including accuracy-related penalties under sections 6662 and 6662A. The penalty under section 6707A will be imposed regardless of whether the transaction results in an underpayment of tax.

Section 6707A is effective for returns and statements the due date for which is after October 22, 2004.

INTERIM GUIDANCE

The Internal Revenue Service and the Treasury Department intend to issue regulations providing rules under section 6707A. Because section 6707A is effective for returns and statements the due date for which is after October 22, 2004, however, the Service and Treasury are providing the following interim guidance regarding the imposition and rescission of penalties under section 6707A. These

February 14, 2005 493 2005–7 I.R.B.

tion, Washington, DC 20044. Submissions also may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (Notice 2005–11), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit electronic comments directly to the IRS e-mail address: notice.comments@irscounsel.treas.gov .

DRAFTING INFORMATION

The principal author of this notice is Matthew S. Cooper of the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this notice, contact Matthew S. Cooper at 202–622–4940 (not a toll-free call).

Temporary Rules Under Section 6662A and Sections 6662 and 6664, as Amended

Notice 2005–12

The purpose of this notice is to alert taxpayers to the recent enactment of section 6662A and amendments to sections 6662 and 6664 of the Internal Revenue Code, provide interim guidance relating to these provisions and invite comments from the public regarding the rules and standards relating to section 6662A and sections 6662 and 6664, as amended.

BACKGROUND

The American Jobs Creation Act of 2004, Pub. L. No. 108–357, 118 Stat. 1418 (the Act), was enacted on October 22, 2004. Section 812 of the Act added section 6662A, which provides a new penalty for understatements with respect to reportable transactions. Section 812 also added section 6664(d), which provides a defense to the penalty under section 6662A if the taxpayer acted with reasonable cause and in good faith. Sections 812 and 819 of the Act amended section 6662(d) to modify the accuracy-related penalty under section 6662(d) for substantial understatements of income tax.

interim rules will apply until further guidance is issued.

A. Imposition of the Section 6707A Penalty

The Service will impose a penalty under section 6707A with respect to each failure to disclose a reportable transaction within the time and in the form and manner provided by section 6011 and the regulations thereunder. Accordingly, a taxpayer will be subject to a penalty under section 6707A for: (1) the failure to attach a reportable transaction disclosure statement to an original or amended return; or (2) the failure to provide a copy of a disclosure statement to OTSA, if required. A taxpayer that fails to attach a reportable transaction disclosure statement to an original or amended return and fails to provide a copy of a required disclosure statement to OTSA will be subject to a single penalty under section 6707A. The following examples illustrate this provision:

Example 1 : Taxpayer T was required to attach a Form 8886 to its original return for the 2005 taxable year and to send a copy of the Form 8886 to OTSA at the time it filed its original return. T failed to attach the Form 8886 to its return and failed to send a copy of the Form 8886 to OTSA. Taxpayer T is subject to a penalty under section 6707A for a failure to disclose because Taxpayer T failed to comply with both of the disclosure requirements. A penalty under section 6707A also would apply if T had failed to comply with either of the two requirements.

Example 2 : Same as Example 1, except that T subsequently filed an amended return for 2005 that reflects Taxpayer T’s participation in the reportable transaction. Taxpayer T failed to attach a Form 8886 to the amended return as required by section 1.6011–4(e)(1). Accordingly, Taxpayer T is subject to an additional penalty under section 6707A for failing to disclose a reportable transaction.

The penalty under section 6707A applies to each failure to provide a disclosure statement that is required to be attached to an original or amended return filed after October 22, 2004 (with a copy sent to OTSA, if required), regardless of whether the original return was due on or before October 22, 2004. Under section 1.6011–4(e)(1), a reportable transaction disclosure statement is due upon the filing of a return or amended return reflecting a taxpayer’s participation in a reportable transaction. Accordingly, a penalty under section 6707A will not be imposed until a taxpayer fails to provide the required disclosure statement with an original or amended return, or fails to provide a copy

to OTSA, if applicable, even if the return is filed after the due date. In addition, a penalty under section 6707A will not be imposed if the disclosure statement is attached to a return that is filed after the due date for filing the return unless the taxpayer fails to provide a copy of the disclosure statement to OTSA, if applicable.

B. Rescission Authority

If it has been determined that a taxpayer failed to disclose a reportable transaction and a penalty is imposed under section 6707A, section 6707A(d) authorizes the Commissioner to rescind all or any portion of a penalty imposed under section 6707A only if (1) the violation relates to a reportable transaction other than a listed transaction and (2) rescission of the penalty would promote compliance with the requirements of the Code and effective tax administration. In determining whether rescission would promote compliance with the requirements of the Code and effective tax administration, the Commissioner (or his delegate) will take into account all of the relevant facts and circumstances, including: (1) whether the taxpayer has a history of complying with the tax laws; (2) whether the violation results from an unintentional mistake of fact; and (3) whether imposing the penalty would be against equity and good conscience. The Commissioner’s determination whether to rescind a penalty in whole or in part is not reviewable by the IRS Appeals Division or any court.

REQUEST FOR COMMENTS

The Service and Treasury invite interested persons to submit comments regarding rules and standards relating to section 6707A, including the factors that should be considered in exercising the rescission authority under section 6707A(d). Comments are also requested on how voluntary, but untimely disclosures ( e.g., if a taxpayer failed to make a required disclosure upon filing a return, but subsequently submits the required disclosure statement) should be treated in applying the section 6707A penalty. Comments are encouraged to be submitted by February 28, 2005, to: Internal Revenue Service, CC:PA:LPD:PR (Notice 2005–11), room 5203, P.O. Box 7604, Ben Franklin Sta

2005–7 I.R.B. 494 February 14, 2005

other than corporations, will not be reduced even if the taxpayer has substantial authority and a reasonable belief that the tax treatment of an item attributable to a tax shelter item was more likely than not the proper treatment. The taxpayer may, however, demonstrate reasonable cause and good faith under section 6664(c).

(3) Section 6664, Definitions and Special Rules .

The accuracy-related penalty under section 6662A does not apply with respect to any portion of a reportable transaction understatement if, pursuant to section 6664(d), it is shown that there was reasonable cause and the taxpayer acted in good faith with respect to that portion of the understatement. A taxpayer does not have reasonable cause and did not act in good faith unless (1) the relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with regulations prescribed under section 6011; (2) there is or was substantial authority; and (3) the taxpayer reasonably believed that its treatment of the item was more likely than not the proper tax treatment. A taxpayer is treated as having a reasonable belief only if the belief is based on the facts and the law that exist at the time the return is filed and the belief relates solely to the taxpayer’s chances of success on the merits of the tax treatment of the issue.

An opinion of a tax advisor may not be relied upon to establish the reasonable belief of the taxpayer if the advisor or the opinion is disqualified. A tax advisor is disqualified if the tax advisor (1) is a material advisor under section 6111, as amended, and participates in the organization, management, promotion, or sale of the transaction or is related to any person who so participates; (2) is compensated directly or indirectly by a material advisor with respect to the transaction; (3) has a fee arrangement with respect to the transaction that is contingent on all or part of the intended tax benefits from the transaction being sustained; or (4) has any other disqualifying financial interest with respect to the transaction as identified by the Secretary.

An opinion is disqualified if the opinion (1) is based on unreasonable factual or legal assumptions (including assumptions as to future events); (2) unreason

(1) Section 6662A, Imposition of Accuracy-Related Penalty on Understatements with Respect to Reportable Transactions .

Section 812 of the Act added section 6662A to the Code, which provides that a 20-percent accuracy-related penalty may be imposed on any reportable transaction understatement. Under section 6662A, a “reportable transaction understatement” means the sum of (1) the product of (A) the amount of the increase (if any) in taxable income which results from a difference between the proper tax treatment of an item to which section 6662A applies and the taxpayer’s treatment of such item (as shown on the taxpayer’s return of tax), and (B) the highest rate of tax imposed by section 1 (section 11 in the case of a corporation), and (2) the amount of the decrease (if any) in the aggregate amount of credits determined under subtitle A which results from a difference between the taxpayer’s treatment of an item to which section 6662A applies (as shown on the taxpayer’s return of tax) and the proper tax treatment of such item.

The penalty provided by section 6662A applies only (1) to listed transactions and (2) to reportable transactions (other than a listed transaction) if a significant purpose of the transaction is the avoidance or evasion of Federal income tax. In addition, a higher 30-percent penalty applies to a reportable transaction understatement if a taxpayer does not adequately disclose, in accordance with regulations prescribed under section 6011, the relevant facts affecting the tax treatment of the item giving rise to the reportable transaction understatement. The reasonable cause and good faith defense is not available with respect to the 30-percent penalty. See I.R.C. §§ 6662A(c) and 6664(d)(2)(A).

Section 6662A(e)(3) sets forth a special rule for amended returns. The tax treatment on an amendment or supplement to a return is not taken into account in determining the amount of a reportable transaction understatement if the amendment or supplement is filed after the earlier of (1) the date the taxpayer is first contacted by the IRS regarding an examination of the return or (2) any other date specified by the Secretary.

(2) Section 6662, Imposition of Accuracy-Related Penalty on Underpayments .

Section 6662(d) imposes a 20-percent accuracy-related penalty for any substantial understatement of income tax. Under section 6662(d)(1)(B), as amended, in the case of a corporation (other than an S corporation or a personal holding company), there is a substantial understatement of income tax for any taxable year if the amount of the understatement for the taxable year exceeds the lesser of (1) 10 percent of the tax required to be shown on the return for the taxable year (or, if greater, $10,000), or (2) $10,000,000. In the case of all other taxpayers, an understatement is substantial if it exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000.

Under section 6662(d)(2), an understatement is the excess of (i) the amount of tax required to be shown on the return for the taxable year over (ii) the amount of tax imposed which is shown on the return, reduced by any rebate. This excess is determined without regard to items to which section 6662A applies. The reportable transaction understatement, however, is added to the understatement calculated under section 6662(d)(2) for purposes of determining whether an understatement is substantial under section 6662(d)(1). Under section 6662A(e)(1)(B), in the case of an understatement, the addition to tax under section 6662(a) applies only to the excess of the amount of the substantial understatement over the aggregate amount of the reportable transaction understatements. Accordingly, the accuracy-related penalty attributable to substantial understatement of income tax does not apply to an understatement on which the section 6662A penalty is imposed. Section 6662A does not apply to any portion of an understatement on which the section 6663 fraud penalty or the section 6662(h) accuracy-related penalty for a gross valuation misstatement is imposed. Section 6662(e) (substantial valuation misstatement) does not apply to any portion of an understatement on which a penalty under section 6662A is imposed.

Under section 6662(d)(2), as amended, the understatement with respect to any item attributable to a tax shelter item, including tax shelter items of taxpayers

February 14, 2005 495 2005–7 I.R.B.

opinion, prospectus, or other document describing the transaction, or (C) register the transaction with any federal, state or local government body.

A material advisor participates in the “management” of a transaction if the material advisor is involved in the decisionmaking process regarding any business activity with respect to the transaction. Participation in the management of a transaction includes managing assets, directing business activity, or acting as general partner, trustee, director or officer of an entity involved in the transaction.

A material advisor participates in the “promotion or sale” of a transaction if the material advisor is involved in the marketing of the transaction or tax strategy. Marketing activities include: (1) soliciting, directly or through an agent, taxpayers to enter into a transaction or tax strategy using direct contact, mail, telephone or other means; (2) placing an advertisement for the transaction in a newspaper, magazine, or other publication or medium; or (3) instructing or advising others with respect to marketing of the transaction or tax strategy.

Consistent with the legislative history, a tax advisor, including a material advisor, will not be treated as participating in the organization, management, promotion or sale of a transaction if the tax advisor’s only involvement is rendering an opinion regarding the tax consequences of the transaction. In the course of preparing a tax opinion, a tax advisor is permitted to suggest modifications to the transaction, but the tax advisor may not suggest material modifications to the transaction that assist the taxpayer in obtaining the anticipated tax benefits. Merely performing support services or ministerial functions such as typing, photocopying, or printing will not be considered participation in the organization, management, promotion or sale of a transaction.

(b) Disqualified Compensation Arrangements

As stated above, a disqualified tax advisor includes a tax advisor who has a disqualified compensation arrangement. A disqualified compensation arrangement includes (1) an arrangement by which the advisor is compensated directly or indirectly by a material advisor with respect

ably relies on representations, statements, findings or agreements of the taxpayer or any other person; (3) does not identify and consider all relevant facts; or (4) fails to meet any other requirement as the Secretary may prescribe.

INTERIM PROVISIONS

The Treasury Department and the IRS intend to issue regulations implementing the requirements of section 6662A and sections 6662 and 6664, as amended. Section 812 of the Act, which added section 6662A and amended sections 6662 and 6664 is effective for taxable years ending after October 22, 2004. Section 819 of the Act, which separately amended section 6662, is effective for taxable years beginning after October 22, 2004. The Treasury Department and the IRS provide the following interim rules to implement the requirements of sections 6662, 6662A and 6664. These interim rules will apply until further guidance is issued.

(1) Adequate disclosure in accordance with section 6011

As noted above, the 30-percent penalty provided by section 6662A applies to a reportable transaction understatement if the taxpayer does not adequately disclose the relevant facts affecting the tax treatment of the item under section 6011. A taxpayer has adequately disclosed the facts for purposes of section 6662A, and section 6664(d)(2)(A), if the taxpayer has filed a disclosure statement in the form and manner prescribed by Treas. Reg. § 1.6011–4(d) or the taxpayer has been deemed to have satisfied its disclosure obligations under Rev. Proc. 2004–45, 2004–31 I.R.B. 140 (August 2, 2004), as applicable, or any other published guidance prescribing the form and manner of disclosure under section 6011.

(2) Special rule for amended returns

For purposes of determining the amount of any reportable transaction understatement, the IRS will not take into account an amendment or supplement to a return filed after the dates specified in Treas. Reg. § 1.6664–2(c)(3) and Notice 2004–38, 2004–21 I.R.B. 949 (May 24, 2004), or any amendments thereto, which are the

dates after which a taxpayer may not file a “qualified amended return.”

(3) Disqualified tax advisor

As stated above, a taxpayer may not rely on the opinion of a disqualified tax advisor to establish reasonable belief under section 6664(d). A disqualified tax advisor is any advisor who (a) is a material advisor (under section 6111, as amended) and who participates in the organization, management, promotion or sale of the transaction or is related (within the meaning of section 267(b) or 707(b)(1)) to any person who so participates, (b) has a disqualified compensation arrangement, or (c) has a disqualifying financial interest identified by the Secretary.

A material advisor is defined in Treas. Reg. § 301.6112–1. In addition, the existing rules under Treas. Reg. § 301.6112–1(c)(2), (c)(3) and (d) (without regard to the provisions relating to a transaction required to be registered under former section 6111), including the minimum fee amounts for listed transactions under Treas. Reg. § 301.6112–1(c)(3)(ii), shall apply. See Notice 2004–80, 2004–50 I.R.B. 963 (December 13, 2004). The definition of material advisor, and the rules described here, will apply for purposes of section 6662A until the IRS issues further guidance.

(a) Organization, Management, Promotion or Sale

A material advisor participates in the “organization” of a transaction if the advisor:

(1) devises, creates, investigates or initiates the transaction or tax strategy;

(2) devises the business or financial plans for the transaction or tax strategy;

(3) carries out those plans through negotiations or transactions with others; or

(4) performs acts relating to the development or establishment of the transaction.

The performance of an act relating to the development or establishment of a transaction includes preparing documents that (A) establish the structure used in connection with the transaction, e.g., a partnership agreement or articles of incorporation, (B) describe the transaction for use in the promotion or sale of the transaction, e.g., an offering memorandum, tax

2005–7 I.R.B. 496 February 14, 2005

provided in Rev. Proc. 94–69, 1994–2 C.B. 804, should apply.