[Federal Register Volume 60, Number 170 (Friday, September 1, 1995)]
[Rules and Regulations]
[Pages 45661-45668]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21682]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8617]
RIN 1545-AS58; 1545-AT13
Accuracy-Related Penalty
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations implementing changes
to the accuracy-related penalty under section 6662 of the Internal
Revenue Code of 1986 that were made by section 13251 of the Omnibus
Budget Reconciliation Act of 1993 (OBRA 1993) and Title VII of the
Uruguay Round Agreements Act, implementing the Uruguay Round of the
General Agreement on Tariffs and Trade
[[Page 45662]]
(the GATT Act). The final regulations also provide guidance as to when
a taxpayer may rely upon the advice of others as evidence of reasonable
cause and good faith within the meaning of section 6664(c) for purposes
of avoiding the accuracy-related penalty of section 6662, and as to
what constitutes reasonable cause and good faith within the meaning of
section 6664(c) as applicable to the substantial understatement penalty
of section 6662(b)(2) with respect to tax shelter items of a
corporation. These regulations affect taxpayers subject to the
accuracy-related penalty.
EFFECTIVE DATE: These regulations are effective September 1, 1995.
FOR FURTHER INFORMATION CONTACT: Rochelle L. Hodes, (202) 622- 6232
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
As part of OBRA 1993, Congress made certain changes to the
accuracy-related penalty. These changes eliminated the disclosure
exception for the negligence penalty (section 6662(b)(1) of the
Internal Revenue Code (Code)) and raised the disclosure standard for
purposes of the penalties for disregard of rules or regulations
(section 6662(b)(1) of the Code) and substantial understatement of
income tax (section 6662(b)(2) of the Code) from ``not frivolous'' to
``reasonable basis.''
On March 17, 1994, temporary regulations (TD 8533) reflecting
changes to the accuracy-related penalty made by OBRA 1993 were
published in the Federal Register (59 FR 12547). A notice of proposed
rulemaking (IA-78-93) relating to the temporary regulations was
published in the Federal Register for the same day (59 FR 12563). On
March 30, 1994, a correction to the temporary regulations was published
in the Federal Register (59 FR 14749) clarifying language in
Sec. 1.6662-7T(a)(2) of the temporary regulations. The same day a
correction to the notice of proposed rulemaking was published in the
Federal Register (59 FR 14810) correcting ``RIN 1545-AS58'' to read
``RIN 1545-AS62'' and other administrative matters and clarifying
language in Secs. 1.6662-2(d)(2) and 1.6662-7(a)(2) of the proposed
regulations.
Section 744 of the GATT Act made further changes to the accuracy-
related penalty. For corporate taxpayers, the GATT Act amended section
6662(d) of the Code to eliminate the exception to the substantial
understatement penalty regarding tax shelter items for which the
taxpayer had substantial authority and reasonably believed that its
treatment was more likely than not the proper treatment. The
legislative history of the GATT Act states that ``the standards
applicable to corporate tax shelters are tightened'' and ``in no
instance [will] this modification result in a penalty not being imposed
where a penalty would have been imposed under prior law.'' S. Rep. No.
412, 103d Cong., 2d Sess. 165 (1994); H.R. Rep. No. 826, 103d Cong., 2d
Sess. 198-99 (1994).
On January 4, 1995, a notice of proposed rulemaking (IA-55-94) was
published in the Federal Register (60 FR 406) implementing the changes
made by the GATT Act and providing guidance with regard to reliance
upon the advice of others as evidence of reasonable cause and good
faith within the meaning of section 6664(c) of the Code for purposes of
avoiding the accuracy-related penalty of section 6662, and what
constitutes reasonable cause and good faith within the meaning of
section 6664(c) as it applies to the substantial understatement penalty
of section 6662(b)(2) with respect to tax shelter items of a
corporation.
Written comments responding to these notices were received. A
public hearing on the notices regarding changes made by OBRA 1993 was
held on July 12, 1994. A public hearing on the notice regarding changes
made by the GATT Act was held on April 28, 1995. After consideration of
all the comments, the proposed regulations under sections 6662 and 6664
of the Code are adopted as revised by this Treasury decision.
Explanation of Provisions
Reasonable Basis Standard for Disclosure
With respect to the reasonable basis standard, the final
regulations adopt the proposed regulations without substantive change.
The regulations provide that the reasonable basis standard is
``significantly higher than the not frivolous standard applicable to
preparers under section 6694.'' In the preamble to the proposed
regulations, Treasury requested comments on any additional guidance as
to the reasonable basis standard for purposes of the negligence,
disregard of rules or regulations, and substantial understatement
penalties. Several commentators recommended adopting as the definition
of reasonable basis the description that existed in Sec. 1.6662-4(d)(2)
of the regulations prior to amendment by these final regulations. Other
commentators recommended equating the reasonable basis standard with
the negligence standard and the realistic possibility of success
standard, taking into account the relative knowledge and experience of
the taxpayer. The IRS and Treasury are continuing to consider these
comments in connection with a separate project to publish a notice of
proposed rulemaking providing further guidance as to the reasonable
basis standard. Treasury and the IRS invite additional comments and
suggestions regarding this project.
Reliance on Tax Advisor
Under sections 6662 and 6664, and applicable regulations, a
taxpayer's good faith reliance on the advice (including an opinion) of
a professional tax advisor will generally be taken into account for
purposes of determining whether the taxpayer will be subject to an
accuracy-related penalty. See, e.g., Secs. 1.6662-4(g)(4)(ii) and
1.6664-4(b). The proposed regulations clarify when a taxpayer may be
considered to have reasonably relied in good faith upon advice
(including an opinion provided by a professional tax advisor), for
purposes of sections 6662 and 6664. In general, Sec. 1.6664-4(c) of the
proposed regulations requires advice to be based on all material facts
(including, for example, the taxpayer's purposes for entering into a
transaction) and to relate applicable law to such facts in reaching its
conclusion. The advice must not be based upon unreasonable factual or
legal assumptions (including assumptions as to future events), nor
unreasonably rely on the representations, findings or agreements of the
taxpayer or any other person. The proposed regulations also indicate
that reliance may not be reasonable or in good faith if the taxpayer
knew, or should have known, that the advisor lacked knowledge in the
relevant aspects of Federal tax law.
Several commentators recommended changes to these provisions of the
proposed regulations. For example, one commentator suggested
eliminating language in Sec. 1.6664-4(c)(1) of the proposed regulations
that reliance on advice may not be reasonable and in good faith if the
taxpayer knew, or should have known, that the advisor lacked knowledge
in the relevant aspects of Federal tax law.
The final regulations do not adopt this suggestion. In requiring
that reliance on advice must be reasonable in light of all of the facts
and circumstances, the final regulations do not depart from prior law.
In most situations it will generally be reasonable for a taxpayer to
conclude that an attorney, an accountant, or an enrolled agent is
qualified to give advice on Federal tax law.
[[Page 45663]]
Another commentator suggested eliminating the requirements that
advice must be based on all material facts and reasonable factual and
legal assumptions. The commentator stated that taxpayers are not in a
position to determine what facts are material, particularly in complex
transactions, nor are they in a position to determine whether the
advisor based the opinion on material facts and reasonable factual and
legal assumptions. An additional commentator requested guidance to
distinguish the term pertinent as it is used throughout the regulations
and the term material as it is used in Sec. 1.6664-4(c) of the proposed
regulations.
In response to these comments, and in order to resolve confusion,
the final regulations provide that advice must be based upon all
pertinent facts and circumstances and the law as it relates to those
facts and circumstances. As used in this context, pertinent is intended
to have the same meaning as it has in Sec. 1.6662-4(g)(4)(ii), which
provides that a taxpayer may satisfy the reasonable belief requirement
of section 6662(d)(2)(C)(i) through reliance on an advisor's analysis
of pertinent facts and authorities. To clarify that separate rules
apply to taxpayers and advisors, the final regulations have also been
revised to include a cross-reference to the preparer penalties under
Secs. 1.6694-1 through 1.6694-3 and Circular 230 (contained in 31 CFR
part 10).
Another commentator recommended eliminating, or in the alternative
revising and clarifying, the requirement that advice take into account
the taxpayer's purposes for entering into a transaction or structuring
a transaction in a particular manner. The final regulations do not
adopt this recommendation. It is appropriate to consider a taxpayer's
reasons for structuring a transaction in a particular manner in
determining whether the taxpayer acted in good faith in its tax return
treatment of items from the transaction.
Reasonable Cause for Tax Shelter Items of a Corporation
The proposed regulations provide that a corporation's legal
justification may be taken into account, as appropriate, in
establishing that the corporation acted with reasonable cause and in
good faith in its treatment of a tax shelter item only if there is
substantial authority for the treatment of the item and the corporation
reasonably believes in good faith that such treatment is more likely
than not the proper treatment. Under the proposed regulations,
satisfaction of the substantial authority and reasonable belief
criteria is an important factor to be considered in determining whether
the taxpayer acted with reasonable cause and in good faith, but is not
necessarily dispositive. The proposed regulations also provide that
facts and circumstances other than a corporation's legal justification
may be taken into account, as appropriate, in determining whether it
acted with reasonable cause and in good faith, regardless of whether
the substantial authority and reasonable belief requirements are
satisfied.
One commentator urged removal of the special reasonable cause
standard for corporate tax shelter items under the proposed
regulations. According to the commentator, there is no authority in
section 6664 or its legislative history for a reasonable cause standard
for tax shelter items of corporate taxpayers that differs from the
standard for noncorporate taxpayers.
Other commentators recommended revising the legal justification
test for determining reasonable cause. Particularly, these commentators
recommended removing the objective requirement that substantial
authority be present for the taxpayer's position (the authority
requirement). Alternatively, one commentator suggested making the legal
justification test a ``safe harbor.'' Under this alternative, a
taxpayer that satisfies the authority requirement and the belief
requirement under proposed Sec. 1.6664-4(e)(2) would be treated as
having acted with reasonable cause and in good faith.
The final regulations do not adopt these suggestions. Treasury and
the IRS continue to believe that the regulations, including the
authority requirement, properly implement the statute and Congressional
intent.
Satisfaction of the minimum requirements under the legal
justification test is an important factor to be considered in
determining whether a corporate taxpayer acted with reasonable cause
and in good faith, but is not necessarily dispositive. For example,
depending on the circumstances, satisfaction of the minimum
requirements may not be dispositive if the taxpayer's participation in
the tax shelter lacked significant business purpose, if the taxpayer
claimed tax benefits that are unreasonable in comparison to the
taxpayer's investment in the tax shelter, or if the taxpayer agreed
with the organizer or promoter of the tax shelter that the taxpayer
would protect the confidentiality of the tax aspects of the structure
of the tax shelter. In addition, a taxpayer that does not satisfy the
authority requirement may nonetheless demonstrate that it acted with
reasonable cause and in good faith based on facts and circumstances
unrelated to its legal justification (the other factors test).
Although several commentators requested additional guidance with
regard to the other factors test, they provided no examples of factors
(other than factors related to legal justification) that they would
like to be included in the final regulations. The suggested factors
were not adopted because legal justification is not relevant to the
other factors test. While the final regulations do not provide
additional guidance in this area, Treasury and the IRS continue to
welcome comments on the issue.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notices of proposed rulemaking preceding these regulations were
submitted to the Small Business Administration for comment on their
impact on small business.
Drafting Information
The principal authors of these regulations are Rochelle L. Hodes,
Office of Assistant Chief Counsel (Income Tax and Accounting), and
David Meyer formerly of that office. However, other personnel from the
IRS and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.6662-0 is amended by:
1. Revising the introductory language.
2. Revising the entry for Sec. 1.6662-2(d) and adding entries for
(d) (1), (2), and (3).
[[Page 45664]]
3. Revising the entries for Secs. 1.6662-3(b)(3) and 1.6662-4(g).
4. Adding an entry for Sec. 1.6662-7.
5. Removing the entry for Sec. 1.6662-7T.
The additions and revisions read as follows:
Sec. 1.6662-0 Table of contents.
This section lists the captions that appear in Secs. 1.6662-1
through 1.6662-7.
* * * * *
Sec. 1.6662-2 Accuracy related penalty.
* * * * *
(d) Effective dates.
(1) Returns due before January 1, 1994.
(2) Returns due after December 31, 1993.
(3) Special rules for tax shelter items.
* * * * *
Sec. 1.6662-3 Negligence or disregard of rules or regulations.
* * * * *
(b) * * *
(3) Reasonable basis.
(i) In general [Reserved].
(ii) Relationship to other standards.
* * * * *
Sec. 1.6662-4 Substantial understatement of income tax.
* * * * *
(g) Items relating to tax shelters.
(1) In general.
(i) Noncorporate taxpayers.
(ii) Corporate taxpayers.
(A) In general.
(B) Special rule for transactions occurring prior to December 9,
1994.
(iii) Disclosure irrelevant.
(iv) Cross-reference.
(2) Tax shelter.
(i) In general.
(ii) Principal purpose.
(3) Tax shelter item.
(4) Reasonable belief.
(i) In general.
(ii) Facts and circumstances; reliance on professional tax
advisor.
(5) Pass-through entities.
* * * * *
Sec. 1.6662-7 Omnibus Budget Reconciliation Act of 1993 changes to
the accuracy-related penalty.
(a) Scope.
(b) No disclosure exception for negligence penalty.
(c) Disclosure standard for other penalties is reasonable basis.
(d) Definition of reasonable basis.
(1) In general [Reserved].
(2) Relationship to other standards.
Par. 3. In Sec. 1.6662-1, the second and third sentences of the
concluding text are revised to read as follows:
Sec. 1.6662-1 Overview of the accuracy-related penalty.
* * * * *
* * * The penalties for disregard of rules or regulations and for a
substantial understatement of income tax may be avoided by adequately
disclosing certain information as provided in Sec. 1.6662-3(c) and
Secs. 1.6662-4(e) and (f), respectively. The penalties for negligence
and for a substantial (or gross) valuation misstatement under chapter 1
may not be avoided by disclosure. * * *
Par. 4. Section 1.6662-2 is amended by:
1. Revising the heading of paragraph (d), redesignating the text of
paragraph (d) following the heading as paragraph (d)(1), adding a new
heading for newly designated paragraph (d)(1), and revising the first
and second sentences of newly redesignated paragraph (d)(1).
2. Adding new paragraphs (d)(2) and (3).
The additions and revisions read as follows:
Sec. 1.6662-2 Accuracy-related penalty.
* * * * *
(d) Effective dates--(1) Returns due before January 1, 1994.
Section 1.6662-3(c) and Secs. 1.6662-4 (e) and (f) (relating to methods
of making adequate disclosure) (as contained in 26 CFR part 1 revised
April 1, 1995) apply to returns the due date of which (determined
without regard to extensions of time for filing) is after December 31,
1991, but before January 1, 1994. Except as provided in the preceding
sentence and in paragraphs (d)(2) and (3) of this section,
Secs. 1.6662-1 through 1.6662-5 apply to returns the due date of which
(determined without regard to extensions of time for filing) is after
December 31, 1989, but before January 1, 1994. * * *
(2) Returns due after December 31, 1993. Except as provided in
paragraph (d)(3) and the last sentence of this paragraph (d)(2), the
provisions of Secs. 1.6662-1 through 1.6662-4 and Sec. 1.6662-7 (as
revised to reflect the changes made to the accuracy-related penalty by
the Omnibus Budget Reconciliation Act of 1993) and of Sec. 1.6662-5
apply to returns the due date of which (determined without regard to
extensions of time for filing) is after December 31, 1993. These
changes include raising the disclosure standard for the penalties for
disregarding rules or regulations and for a substantial understatement
of income tax from not frivolous to reasonable basis, eliminating the
disclosure exception for the negligence penalty, and providing guidance
on the meaning of reasonable basis. The Omnibus Budget Reconciliation
Act of 1993 changes relating to the penalties for negligence or
disregard of rules or regulations will not apply to returns (including
qualified amended returns) that are filed on or before March 14, 1994,
but the provisions of Secs. 1.6662-1 through 1.6662-3 (as contained in
26 CFR part 1 revised April 1, 1995) relating to those penalties will
apply to such returns.
(3) Special rules for tax shelter items. Sections 1.6662-4(g)(1)
and 1.6662-4(g)(4) apply to returns the due date of which (determined
without regard to extensions of time for filing) is after September 1,
1995. Except as provided in the last sentence of this paragraph (d)(3),
Secs. 1.6662-4(g)(1) and 1.6662-4(g)(4) (as contained in 26 CFR part 1
revised April 1, 1995) apply to returns the due date of which
(determined without regard to extensions of time for filing) is on or
before September 1, 1995 and after December 31, 1989. For transactions
occurring after December 8, 1994, Secs. 1.6662-4(g)(1) and 1.6662-
4(g)(2) (as contained in 26 CFR part 1 revised April 1, 1995) are
applied taking into account the changes made to section 6662(d)(2)(C)
(relating to the substantial understatement penalty for tax shelter
items of corporations) by section 744 of Title VII of the Uruguay Round
Agreements Act, Pub. L. 103-465 (108 Stat. 4809).
Par. 5. Section 1.6662-3 is amended by:
1. Revising the second sentence of paragraph (a).
2. Revising paragraph (b)(3).
3. Revising paragraphs (c)(1) and (2).
The revisions read as follows:
Sec. 1.6662-3 Negligence or disregard of rules or regulations.
(a) * * * The penalty for disregarding rules or regulations does
not apply, however, if the requirements of Sec. 1.6662-3(c)(1) are
satisfied and the position in question is adequately disclosed as
provided in Sec. 1.6662-3(c)(2), or to the extent that the reasonable
cause and good faith exception to this penalty set forth in
Sec. 1.6664-4 applies. * * *
(b) * * *
(3) Reasonable basis--(i) In general. [Reserved].
(ii) Relationship to other standards. The reasonable basis standard
is significantly higher than the not frivolous standard applicable to
preparers under section 6694 and defined in Sec. 1.6694-2(c)(2).
(c) * * * (1) In general. No penalty under section 6662(b)(1) may
be imposed on any portion of an underpayment that is attributable to a
position contrary to a rule or regulation if the position is disclosed
in accordance with the rules of paragraph (c)(2) of this section and,
in case of a position contrary to a regulation, the
[[Page 45665]]
position represents a good faith challenge to the validity of the
regulation. This disclosure exception does not apply, however, in the
case of a position that does not have a reasonable basis or where the
taxpayer fails to keep adequate books and records or to substantiate
items properly.
(2) Method of disclosure. Disclosure is adequate for purposes of
the penalty for disregarding rules or regulations if made in accordance
with the provisions of Secs. 1.6662-4(f)(1), (3), (4), and (5), which
permit disclosure on a properly completed and filed Form 8275 or 8275-
R, as appropriate. In addition, the statutory or regulatory provision
or ruling in question must be adequately identified on the Form 8275 or
8275-R, as appropriate. The provisions of Sec. 1.6662-4(f)(2), which
permit disclosure in accordance with an annual revenue procedure for
purposes of the substantial understatement penalty, do not apply for
purposes of this section.
* * * * *
Par. 6. Section 1.6662-4 is amended by:
1. Removing the third sentence in paragraph (d)(2).
2. Revising paragraph (e)(2).
3. Revising paragraphs (g)(1), (g)(4), and (g)(5).
The revisions read as follows:
Sec. 1.6662-4 Substantial understatement of income tax.
* * * * *
(e) * * *
(2) Circumstances where disclosure will not have an effect. The
rules of paragraph (e)(1) of this section do not apply where the item
or position on the return--
(i) Does not have a reasonable basis (as defined in Sec. 1.6662-
3(b)(3));
(ii) Is attributable to a tax shelter (as defined in section
6662(d)(2)(C)(iii) and paragraph (g)(2) of this section); or
(iii) Is not properly substantiated, or the taxpayer failed to keep
adequate books and records with respect to the item or position.
* * * * *
(g) Items relating to tax shelters--(1) In general--(i)
Noncorporate taxpayers. Tax shelter items (as defined in paragraph
(g)(3) of this section) of a taxpayer other than a corporation are
treated for purposes of this section as if such items were shown
properly on the return for a taxable year in computing the amount of
tax shown on the return, and thus the tax attributable to such items is
not included in the understatement for the year, if--
(A) There is substantial authority (as provided in paragraph (d) of
this section) for the tax treatment of that item; and
(B) The taxpayer reasonably believed at the time the return was
filed that the tax treatment of that item was more likely than not the
proper treatment.
(ii) Corporate taxpayers--(A) In general. Except as provided in
paragraph (g)(1)(ii)(B) of this section, all tax shelter items (as
defined in paragraph (g)(3) of this section) of a corporation are taken
into account in computing the amount of any understatement.
(B) Special rule for transactions occurring prior to December 9,
1994. The tax shelter items of a corporation arising in connection with
transactions occurring prior to December 9, 1994 are treated for
purposes of this section as if such items were shown properly on the
return if the requirements of paragraph (g)(1)(i) are satisfied with
respect to such items.
(iii) Disclosure irrelevant. Disclosure made with respect to a tax
shelter item of either a corporate or noncorporate taxpayer does not
affect the amount of an understatement.
(iv) Cross-reference. See Sec. 1.6664-4(e) for certain rules
regarding the availability of the reasonable cause and good faith
exception to the substantial understatement penalty with respect to tax
shelter items of corporations.
* * * * *
(4) Reasonable belief--(i) In general. For purposes of section
6662(d) and paragraph (g)(1)(i)(B) of this section (pertaining to tax
shelter items of noncorporate taxpayers), a taxpayer is considered
reasonably to believe that the tax treatment of an item is more likely
than not the proper tax treatment if (without taking into account the
possibility that a return will not be audited, that an issue will not
be raised on audit, or that an issue will be settled)--
(A) The taxpayer analyzes the pertinent facts and authorities in
the manner described in paragraph (d)(3)(ii) of this section, and in
reliance upon that analysis, reasonably concludes in good faith that
there is a greater than 50-percent likelihood that the tax treatment of
the item will be upheld if challenged by the Internal Revenue Service;
or
(B) The taxpayer reasonably relies in good faith on the opinion of
a professional tax advisor, if the opinion is based on the tax
advisor's analysis of the pertinent facts and authorities in the manner
described in paragraph (d)(3)(ii) of this section and unambiguously
states that the tax advisor concludes that there is a greater than 50-
percent likelihood that the tax treatment of the item will be upheld if
challenged by the Internal Revenue Service.
(ii) Facts and circumstances; reliance on professional tax advisor.
All facts and circumstances must be taken into account in determining
whether a taxpayer satisfies the requirements of paragraph (g)(4)(i) of
this section. However, in no event will a taxpayer be considered to
have reasonably relied in good faith on the opinion of a professional
tax advisor for purposes of paragraph (g)(4)(i)(B) of this section
unless the requirements of Sec. 1.6664-4(c)(1) are met. The fact that
the requirements of Sec. 1.6664-4(c)(1) are satisfied will not
necessarily establish that the taxpayer reasonably relied on the
opinion in good faith. For example, reliance may not be reasonable or
in good faith if the taxpayer knew, or should have known, that the
advisor lacked knowledge in the relevant aspects of Federal tax law.
(5) Pass-through entities. In the case of tax shelter items
attributable to a pass-through entity, the actions described in
paragraphs (g)(4)(i)(A) and (B) of this section, if taken by the
entity, are deemed to have been taken by the taxpayer and are
considered in determining whether the taxpayer reasonably believed that
the tax treatment of an item was more likely than not the proper tax
treatment.
Par. 7. Section 1.6662-7 is added to read as follows:
Sec. 1.6662-7 Omnibus Budget Reconciliation Act of 1993 changes to the
accuracy-related penalty.
(a) Scope. The Omnibus Budget Reconciliation Act of 1993 made
certain changes to the accuracy-related penalty in section 6662. This
section provides rules reflecting those changes.
(b) No disclosure exception for negligence penalty. The penalty for
negligence in section 6662(b)(1) may not be avoided by disclosure of a
return position.
(c) Disclosure standard for other penalties is reasonable basis.
The penalties for disregarding rules or regulations in section
6662(b)(1) and for a substantial understatement of income tax in
section 6662(b)(2) may be avoided by adequate disclosure of a return
position only if the position has at least a reasonable basis. See
Sec. 1.6662-3(c) and Secs. 1.6662-4(e) and (f) for other applicable
disclosure rules.
(d) Definition of reasonable basis--(1) In general. [Reserved].
(2) Relationship to other standards. The reasonable basis standard
is significantly higher than the not frivolous standard applicable to
[[Page 45666]]
preparers under section 6694 and defined in Sec. 1.6694-2(c)(2).
Sec. 1.6662-7T [Removed]
Par. 8. Section 1.6662-7T is removed.
Par. 9. Section 1.6664-0 is amended by revising the entries for
Secs. 1.6664-1(b) and 1.6664-4 to read as follows:
Sec. 1.6664-0 Table of contents.
* * * * *
Sec. 1.6664-1 Accuracy-related and fraud penalties; definitions
and special rules.
* * * * *
(b) Effective date.
(1) In general.
(2) Reasonable cause and good faith exception to section 6662
penalties.
* * * * *
Sec. 1.6664-4 Reasonable cause and good faith exception to section
6662 penalties.
(a) In general.
(b) Facts and circumstances taken into account.
(1) In general.
(2) Examples.
(c) Reliance on opinion or advice.
(1) Fact and circumstances; minimum requirements.
(i) All facts and circumstances considered.
(ii) No unreasonable assumptions.
(iii) Law is related to actual facts.
(2) Definitions.
(i) Advice.
(ii) Material.
(3) Cross-reference.
(d) Pass-through items.
(e) Special rules for substantial understatement penalty
attributable to tax shelter items of corporations.
(1) In general; facts and circumstances.
(2) Reasonable cause based on legal justification.
(i) Minimum requirements.
(A) Authority requirement.
(B) Belief requirement.
(ii) Legal justification defined.
(3) Minimum requirements not dispositive.
(4) Other factors.
(f) Transactions between persons described in section 482 and
net section 482 transfer price adjustments. [Reserved]
(g) Valuation misstatements of charitable deduction property.
(1) In general.
(2) Definitions.
(i) Charitable deduction property.
(ii) Qualified appraisal.
(iii) Qualified appraiser.
* * * * *
Par. 10. Section 1.6664-1 is amended by revising paragraph (b) to
read as follows:
Sec. 1.6664-1 Accuracy-related and fraud penalties; definitions
and special rules.
* * * * *
(b) Effective date--(1) In general. Sections 1.6664-1 through
1.6664-3 apply to returns the due date of which (determined without
regard to extensions of time for filing) is after December 31, 1989.
(2) Reasonable cause and good faith exception to section 6662
penalties. Section 1.6664-4 applies to returns the due date of which
(determined without regard to extensions of time for filing) is after
September 1, 1995. Except as provided in the last sentence of this
paragraph (b)(2), Sec. 1.6664-4 (as contained in 26 CFR part 1 revised
April 1, 1995) applies to returns the due date of which (determined
without regard to extensions of time for filing) is on or before
September 1, 1995 and after December 31, 1989. For transactions
occurring after December 8, 1994, Sec. 1.6664-4 (as contained in 26 CFR
part 1 revised April 1, 1995) is applied taking into account the
changes made to section 6662(d)(2)(C) (relating to the substantial
understatement penalty for tax shelter items of corporations) by
section 744 of Title VII of the Uruguay Round Agreements Act, Pub. L.
103-465 (108 Stat. 4809).
Par. 11. Section 1.6664-4 is amended by:
1. Revising the last sentence of paragraph (a).
2. Revising paragraph (b)(1).
3. Revising the introductory language of paragraph (b)(2) and
Example 1.
4. Redesignating paragraphs (c), (d), and (e) as paragraphs (d),
(f), and (g), respectively.
5. Revising newly designated paragraph (d).
6. Adding new paragraphs (c) and (e).
The additions and revisions read as follows:
Sec. 1.6664-4 Reasonable cause and good faith exception to section
6662 penalties.
(a) * * * Rules for determining whether the reasonable cause and
good faith exception applies are set forth in paragraphs (b) through
(g) of this section.
(b) Facts and circumstances taken into account--(1) In general. The
determination of whether a taxpayer acted with reasonable cause and in
good faith is made on a case-by-case basis, taking into account all
pertinent facts and circumstances. (See paragraph (e) of this section
for certain rules relating to a substantial understatement penalty
attributable to tax shelter items of corporations.) Generally, the most
important factor is the extent of the taxpayer's effort to assess the
taxpayer's proper tax liability. Circumstances that may indicate
reasonable cause and good faith include an honest misunderstanding of
fact or law that is reasonable in light of all of the facts and
circumstances, including the experience, knowledge, and education of
the taxpayer. An isolated computational or transcriptional error
generally is not inconsistent with reasonable cause and good faith.
Reliance on an information return or on the advice of a professional
tax advisor or an appraiser does not necessarily demonstrate reasonable
cause and good faith. Similarly, reasonable cause and good faith is not
necessarily indicated by reliance on facts that, unknown to the
taxpayer, are incorrect. Reliance on an information return,
professional advice, or other facts, however, constitutes reasonable
cause and good faith if, under all the circumstances, such reliance was
reasonable and the taxpayer acted in good faith. (See paragraph (c) of
this section for certain rules relating to reliance on the advice of
others.) For example, reliance on erroneous information (such as an
error relating to the cost or adjusted basis of property, the date
property was placed in service, or the amount of opening or closing
inventory) inadvertently included in data compiled by the various
divisions of a multidivisional corporation or in financial books and
records prepared by those divisions generally indicates reasonable
cause and good faith, provided the corporation employed internal
controls and procedures, reasonable under the circumstances, that were
designed to identify such factual errors. Reasonable cause and good
faith ordinarily is not indicated by the mere fact that there is an
appraisal of the value of property. Other factors to consider include
the methodology and assumptions underlying the appraisal, the appraised
value, the relationship between appraised value and purchase price, the
circumstances under which the appraisal was obtained, and the
appraiser's relationship to the taxpayer or to the activity in which
the property is used. (See paragraph (g) of this section for certain
rules relating to appraisals for charitable deduction property.) A
taxpayer's reliance on erroneous information reported on a Form W-2,
Form 1099, or other information return indicates reasonable cause and
good faith, provided the taxpayer did not know or have reason to know
that the information was incorrect. Generally, a taxpayer knows, or has
reason to know, that the information on an information return is
incorrect if such information is inconsistent with other information
reported or otherwise furnished to the taxpayer, or with the taxpayer's
knowledge of the transaction. This knowledge includes, for example, the
taxpayer's knowledge of the terms of his employment relationship or of
the rate of return on a payor's obligation.
[[Page 45667]]
(2) Examples. The following examples illustrate this paragraph (b).
They do not involve tax shelter items. (See paragraph (e) of this
section for certain rules relating to the substantial understatement
penalty attributable to the tax shelter items of corporations.)
Example 1. A, an individual calendar year taxpayer, engages B, a
professional tax advisor, to give A advice concerning the
deductibility of certain state and local taxes. A provides B with
full details concerning the taxes at issue. B advises A that the
taxes are fully deductible. A, in preparing his own tax return,
claims a deduction for the taxes. Absent other facts, and assuming
the facts and circumstances surrounding B's advice and A's reliance
on such advice satisfy the requirements of paragraph (c) of this
section, A is considered to have demonstrated good faith by seeking
the advice of a professional tax advisor, and to have shown
reasonable cause for any underpayment attributable to the deduction
claimed for the taxes. However, if A had sought advice from someone
that A knew, or should have known, lacked knowledge in the relevant
aspects of Federal tax law, or if other facts demonstrate that A
failed to act reasonably or in good faith, A would not be considered
to have shown reasonable cause or to have acted in good faith.
* * * * *
(c) Reliance on opinion or advice--(1) Facts and circumstances;
minimum requirements. All facts and circumstances must be taken into
account in determining whether a taxpayer has reasonably relied in good
faith on advice (including the opinion of a professional tax advisor)
as to the treatment of the taxpayer (or any entity, plan, or
arrangement) under Federal tax law. However, in no event will a
taxpayer be considered to have reasonably relied in good faith on
advice unless the requirements of this paragraph (c)(1) are satisfied.
The fact that these requirements are satisfied will not necessarily
establish that the taxpayer reasonably relied on the advice (including
the opinion of a professional tax advisor) in good faith. For example,
reliance may not be reasonable or in good faith if the taxpayer knew,
or should have known, that the advisor lacked knowledge in the relevant
aspects of Federal tax law.
(i) All facts and circumstances considered. The advice must be
based upon all pertinent facts and circumstances and the law as it
relates to those facts and circumstances. For example, the advice must
take into account the taxpayer's purposes (and the relative weight of
such purposes) for entering into a transaction and for structuring a
transaction in a particular manner. In addition, the requirements of
this paragraph (c)(1) are not satisfied if the taxpayer fails to
disclose a fact that it knows, or should know, to be relevant to the
proper tax treatment of an item.
(ii) No unreasonable assumptions. The advice must not be based on
unreasonable factual or legal assumptions (including assumptions as to
future events) and must not unreasonably rely on the representations,
statements, findings, or agreements of the taxpayer or any other
person. For example, the advice must not be based upon a representation
or assumption which the taxpayer knows, or has reason to know, is
unlikely to be true, such as an inaccurate representation or assumption
as to the taxpayer's purposes for entering into a transaction or for
structuring a transaction in a particular manner.
(2) Advice defined. Advice is any communication, including the
opinion of a professional tax advisor, setting forth the analysis or
conclusion of a person, other than the taxpayer, provided to (or for
the benefit of) the taxpayer and on which the taxpayer relies, directly
or indirectly, with respect to the imposition of the section 6662
accuracy-related penalty. Advice does not have to be in any particular
form.
(3) Cross-reference. For rules applicable to advisors, see e.g.,
Secs. 1.6694-1 through 1.6694-3 (regarding preparer penalties), 31 CFR
10.22 (regarding diligence as to accuracy), 31 CFR 10.33 (regarding tax
shelter opinions), and 31 CFR 10.34 (regarding standards for advising
with respect to tax return positions and for preparing or signing
returns).
(d) Pass-through items. The determination of whether a taxpayer
acted with reasonable cause and in good faith with respect to an
underpayment that is related to an item reflected on the return of a
pass-through entity is made on the basis of all pertinent facts and
circumstances, including the taxpayer's own actions, as well as the
actions of the pass-through entity.
(e) Special rules for substantial understatement penalty
attributable to tax shelter items of corporations--(1) In general;
facts and circumstances. The determination of whether a corporation
acted with reasonable cause and in good faith in its treatment of a tax
shelter item (as defined in Sec. 1.6662-4(g)(3)) is based on all
pertinent facts and circumstances. Paragraphs (e)(2), (3), and (4) of
this section set forth rules that apply, in the case of a penalty
attributable to a substantial understatement of income tax (within the
meaning of section 6662(d)), in determining whether a corporation acted
with reasonable cause and in good faith with respect to a tax shelter
item.
(2) Reasonable cause based on legal justification--(i) Minimum
requirements. A corporation's legal justification (as defined in
paragraph (e)(2)(ii) of this section) may be taken into account, as
appropriate, in establishing that the corporation acted with reasonable
cause and in good faith in its treatment of a tax shelter item only if
the authority requirement of paragraph (e)(2)(i)(A) of this section and
the belief requirement of paragraph (e)(2)(i)(B) of this section are
satisfied (the minimum requirements). Thus, a failure to satisfy the
minimum requirements will preclude a finding of reasonable cause and
good faith based (in whole or in part) on the corporation's legal
justification.
(A) Authority requirement. The authority requirement is satisfied
only if there is substantial authority (within the meaning of
Sec. 1.6662-4(d)) for the tax treatment of the item.
(B) Belief requirement. The belief requirement is satisfied only
if, based on all facts and circumstances, the corporation reasonably
believed, at the time the return was filed, that the tax treatment of
the item was more likely than not the proper treatment. For purposes of
the preceding sentence, a corporation is considered reasonably to
believe that the tax treatment of an item is more likely than not the
proper tax treatment if (without taking into account the possibility
that a return will not be audited, that an issue will not be raised on
audit, or that an issue will be settled)--
(1) The corporation analyzes the pertinent facts and authorities in
the manner described in Sec. 1.6662-4(d)(3)(ii), and in reliance upon
that analysis, reasonably concludes in good faith that there is a
greater than 50-percent likelihood that the tax treatment of the item
will be upheld if challenged by the Internal Revenue Service; or
(2) The corporation reasonably relies in good faith on the opinion
of a professional tax advisor, if the opinion is based on the tax
advisor's analysis of the pertinent facts and authorities in the manner
described in Sec. 1.6662-4(d)(3)(ii) and unambiguously states that the
tax advisor concludes that there is a greater than 50-percent
likelihood that the tax treatment of the item will be upheld if
challenged by the Internal Revenue Service. (For this purpose, the
requirements of paragraph (c) of this section must be met with respect
to the opinion of a professional tax advisor.)
(ii) Legal justification defined. For purposes of this paragraph
(e), legal justification includes any justification relating to the
treatment or characterization under the Federal tax
[[Page 45668]]
law of the tax shelter item or of the entity, plan, or arrangement that
gave rise to the item. Thus, a taxpayer's belief (whether independently
formed or based on the advice of others) as to the merits of the
taxpayer's underlying position is a legal justification.
(3) Minimum requirements not dispositive. Satisfaction of the
minimum requirements of paragraph (e)(2) of this section is an
important factor to be considered in determining whether a corporate
taxpayer acted with reasonable cause and in good faith, but is not
necessarily dispositive. For example, depending on the circumstances,
satisfaction of the minimum requirements may not be dispositive if the
taxpayer's participation in the tax shelter lacked significant business
purpose, if the taxpayer claimed tax benefits that are unreasonable in
comparison to the taxpayer's investment in the tax shelter, or if the
taxpayer agreed with the organizer or promoter of the tax shelter that
the taxpayer would protect the confidentiality of the tax aspects of
the structure of the tax shelter.
(4) Other factors. Facts and circumstances other than a
corporation's legal justification may be taken into account, as
appropriate, in determining whether the corporation acted with
reasonable cause and in good faith with respect to a tax shelter item
regardless of whether the minimum requirements of paragraph (e)(2) of
this section are satisfied.
* * * * *
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Approved: August 18, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-21682 Filed 8-31-95; 8:45 am]
BILLING CODE 4830-01-U
